                      T.C. Memo. 2001-64



                  UNITED STATES TAX COURT



   EPIC ASSOCIATES 84-III, WILLIAM C. GRIFFITH, JR., AND
   DOTTIE M. GRIFFITH, TAX MATTERS PARTNERS, Petitioners
      v. COMMISSIONER OF INTERNAL REVENUE, Respondent

   EPIC ASSOCIATES 83-XII, WILLIAM C. GRIFFITH, JR., AND
   DOTTIE M. GRIFFITH, TAX MATTERS PARTNERS, Petitioners
      v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 3877-92, 3963-92.     Filed March 19, 2001.


     William C. Griffith, Jr., pro se.

     Carolyn Lee Harber, for respondent.



          MEMORANDUM FINDINGS OF FACT AND OPINION


     WHALEN, Judge:   Respondent issued notices of final

partnership administrative adjustment (notices of FPAA)

in which respondent determined the following adjustments
                                  - 2 -


with respect to the partnership items reported by Epic

Associates 83-XII (referred to herein as EA 83-XII):

                                      1983        1984       1985

Disallow interest and point          $483,029    $556,564   $576,848
  amortization deductions
Disallow depreciation                173,119     173,119    173,119
  deductions
Disallow claimed net investment      (341,010)     -0-        -0-
  loss
Disallow qualified investment             -0–    303,571    330,529
  income
Disallow qualified investment             -0-    908,960    909,831
  expenses
Disallow excess expenses from         10,859       -0-        -0-
  net lease property
Disallow investment interest          66,366       -0-        -0-
  income
Disallow net investment income        29,306       -0-        -0-
Disallow investment income             -0-            90      1,262


     Respondent issued notices of FPAA in which respondent

determined the following adjustments with respect to the

partnership items reported by Epic Associates 84-III

(referred to herein as EA 84-III):

                                      1983        1984       1985

Disallow interest and point          $121,535    $536,280   $559,662
  amortization deductions
Disallow depreciation                 56,910     170,742    170,742
  deductions
Disallow deductions in                    -0-      -0-       44,219
  excess of income
Disallow claimed net                 (141,142)     -0-        -0-
  investment loss
Disallow qualified investment             -0–    217,619    229,131
  income
Disallow qualified investment             -0-    872,376    997,436
  expenses
Disallow net investment income       6,097         -0-        -0-
Disallow investment income             -0-         -0-          494
                            - 3 -


     Among the adjustments summarized above, respondent

disallowed all of the interest and depreciation claimed as

deductions by each partnership.     The principal issues in

these cases are whether certain nonrecourse promissory

notes issued by each partnership to purchase real estate

constitute bona fide indebtedness and whether the activity

of each partnership is an "activity not engaged in for

profit", as that phrase is defined by section 183(c).

Unless stated otherwise, all section references in this

opinion are to the Internal Revenue Code as in effect

during the years in issue, and all Rule references are to

the Tax Court Rules of Practice and Procedure.


                      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.

EA 83-XII and EA 84-III are limited partnerships.     At the

time the instant petitions were filed on their behalf, each

partnership was doing business in the State of Virginia,

and the tax matters partners of each partnership, William

C. Griffith, Jr., and Dottie M. Griffith, resided in

Atlanta, Georgia.   Both limited partnerships reported
                           - 4 -


income and expenses on a calendar year basis and used the

accrual method of accounting.


EA 83-XII

     EA 83-XII was formed on December 3, 1982, pursuant to

the Uniform Limited Partnership Act of the Commonwealth of

Virginia for a 10-year term ending on December 3, 1992.

The Amended and Restated Certificate and Agreement of

Limited Partnership dated June 1, 1983 (referred to herein

as the 83 partnership agreement) describes the business of

EA 83-XII in the following terms:


     Business of the Partnership

     The business of the Partnership shall be to
     acquire, directly or indirectly, and finance,
     fee interests in certain improved residential
     real properties and to operate, manage, lease
     or otherwise deal with such properties with
     the objective of distributing income generated
     thereby among the Partners as provided for
     herein; and to hold such properties for invest-
     ment with the objective of capital appreciation
     therein and to engage in and perform all acts
     and activities required in connection with or
     incident to the foregoing.


     The partnership's sole general partner was Equity

Programs Investment Corp. (EPIC), a corporation that was

originally incorporated in Virginia in 1974 and was

reincorporated in Maryland in 1983.   EPIC's business

involved the purchase, lease, and sale of residential
                             - 5 -


houses and condominiums.    We discuss EPIC at greater length

below.

      The 83 partnership agreement provides that EPIC's

"interest shall be deemed to be a one-percent (1%) share in

the Partnership's capital contributions for which it shall

contribute" $10,580.81.    In addition, the 83 partnership

agreement authorizes two classes of limited partnership

interests:    1 class A unit and 25 class B units.   The class

A unit was sold to four investors for an aggregate sum of

$90,000.    The purchasers of the class A unit made cash

payments totaling $50,000 and executed recourse promissory

notes totaling $40,000 that were payable to the partnership

on July 1, 1983.    These investors were admitted to the

partnership on April 16, 1983.

     EA 83-XII also sold 25 class B units of limited

partnership interest for $38,300 per unit or a total of

$957,500.    Approximately $3,300 of the amount paid for each

class B unit was paid in cash and the balance of $35,000

was paid in the form of a recourse promissory note payable

to EX 83-XII in 14 quarterly installments of $2,500 each

with the last payment due on April 1, 1987.

     Before selling the class B units in EA 83-XII, EPIC

circulated a confidential private placement offering

memorandum dated June 1, 1983 (referred to herein as the
                                - 6 -


83 offering memorandum).       The 83 offering memorandum states

that persons who purchased class B units would be admitted

to EA 83-XII as limited partners commencing September 1,

1983.

        The 83 offering memorandum states that the limited

partners' contributions would be used primarily to fund

operating deficits of the partnership.             The 83 offering

memorandum includes the following summary of EA 83-XII's

anticipated sources and uses of the proceeds of the

offering:
               Sources                               Amount    Percent

Proceeds from sale of class A unit                   $90,000    1.66
Proceeds from sale of class B units                  957,500   17.68
Capital contribution of general partner               10,581    0.19
First mortgage loans                               3,706,150   68.38
Builder rebate [referred to herein                   655,319   12.09
  as rental deficit contribution]
                                                   5,419,550   100.00
               Uses
                                               1
Purchase price of homes                            3,901,550   71.98
Sales commissions to broker/dealers                   83,800    1.55
  [8% of the price paid for each unit]
Escrows and prepaid insurance                         20,370    0.38
First mortgage loan origination fees                 148,246    2.73
Organization fee to general partner                   41,900    0.77
  [4% of the price paid for each unit]
Estimated cash-flow deficits through
  April 15, 1983                                      58,350    1.08
Available for cash-flow deficits                   1,165,334   21.51

                                                   5,419,550   100.00
Note:   Footnotes omitted.
1
 This amount is $255 more than the actual purchase price, $3,901,295.


As set forth above, it was anticipated that $58,350 of the

proceeds of the offering would be offset by cash-flow
                                  - 7 -


deficits through April 15, 1983, and $1,165,334 of the

offering proceeds would be available for cash-flow

deficits after that date.         The projected annual income

and operating costs of EA 83-XII as set forth in the 83

offering memorandum show an annual operating deficit of

$345,344 calculated as follows:

                                                     Percentage of
      Projected Annual Income             Amount     Total Income

Builder lease                             $65,784       20.30
Rental income (less 20%
  vacancy & expense factor)               258,240       79.70

Total projected income                    324,024       100.00


  Annual Operating Expenditures

Aggregate first mortgage
  principal & interest                    $546,102      168.54
Real estate taxes                           49,213       15.19
Insurance & homeowner's dues                21,500        6.64
Audit expenses                               4,877        1.51
Property administration fee                 30,600        9.44
Allowance for maintenance & repairs         17,076        5.27

 Total projected cash expenditures        669,368       206.59

Projected operating deficit               345,344       106.59


The 83 offering memorandum also includes a cash-flow

analysis for EA 83-XII from inception to June 30, 1987,

as set forth in appendix A to this opinion.

    In the 83 offering memorandum, it was contemplated that

EPIC would finance the partnership's operating deficits by

advancing funds to the partnership.           The 83 partnership

agreement provides that EA 83-XII would pay interest on all
                            - 8 -


unsecured advances of funds by the general partner at the

rate of 15 percent per annum.   The 83 partnership agreement

also permits the partnership to advance to the general

partner any funds that were not distributed to the limited

partners, and the agreement provides that the general

partner would pay interest to EA 83-XII on such advances at

the rate of 12 percent per annum.

     The 83 partnership agreement provides that cash from

operations is to be distributed in the following order of

priority:   (i) To EPIC to repay any unsecured advances made

by EPIC to the partnership together with interest; (ii) to

the partners in the ratio that the cumulative cash capital

contributions of each partner bear to the cumulative cash

capital contributions of the partners until such amounts

equal the partners' cumulative cash capital contributions;

(iii) 25 percent to EPIC and 75 percent to the limited

partners holding the class A and class B units.

     The 83 partnership agreement further provides that

cash from sales and from financings is to be distributed

in the following order of priority:   (i) To repay partner-

ship debt secured by the property sold or refinanced and

to pay the expenses of selling each property; (ii) to repay

any unsecured advances made by EPIC to the partnership

together with interest; (iii) to pay EPIC a disposition
                             - 9 -


fee equal to 2.5 percent of the price for    which any

partnership properties are sold; (iv) to the partners

in the ratio that each partner's total cash capital

contributions bear to the cumulative cash capital

contributions of all partners until such amounts equal

the partners' cumulative cash capital contributions; and

(v) 25 percent of any remaining amount to EPIC and 75

percent to the limited partners holding class A and class

B units.

     The partnership agreement specifies that EA 83-XII

shall pay the following compensation to EPIC:


     Compensations of the General Partner

               *    *    *     *     *   *      *

     (a) At the time of subscription, a Partnership
     Organization Fee, as detailed in the Confidential
     Private Offering Memorandum for the Partnership,
     being 4% of Limited Partners capital contribution
     upon admission to the Partnership or a maximum
     total payment of $41,900 for non-recurring
     services which may be incurred before or after
     formation of the Partnership, to include
     furnishing legal, financial, accounting and
     operational assistance review of rental schedules
     and expense forecasts and other services which do
     not give rise to the acquisition of specific
     properties or the obtaining of financing
     therefor;

     (b) During each full or partial month of the
     Partnership, the General Partner shall be paid
     an administration fee equal to Fifty and 00/100
     ($50.00) for each Partnership property;
                          - 10 -


     (c) Such loan origination fees or service fees
     at commercially prevailing market rates that may
     derive from originating or servicing of any
     security interests, including mortgages and deeds
     of trust, placed upon Partnership property;

     (d) Reimbursement of all carrying costs of the
     Partnership properties including, but not by way
     of limitation, interest on mortgage indebtedness
     encumbering the properties, incurred prior to the
     admission of the Limited Partners to the
     Partnership;

     (e) Two-and-one-half percent (2 1/2%) disposi-
     tion fee on all resale of Partnership properties
     except in connection with an exchange with a
     builder for like kind property;

     (f) For all unsecured advances of funds to the
     Partnership, the General Partner shall be
     entitled to interest on all such funds advanced
     at the rate of 15% per annum; and

     (g) Any difference between costs incurred by the
     General Partner on pooled insurance policies for
     all partnerships sponsored by the General Partner
     and premiums charged to the Partnership for all
     risk insurance coverage (including fire and
     hazard) for each Partnership property plus the
     premium attributable to decreasing the deductible
     amount to $100 shall be the property of the
     General Partner.


Purchase of Model Houses in Carrollton, Texas, From Raldon
Corp.

     EPIC executed a contract entitled Epic Model Home

Purchase and Leaseback Agreement (purchase and leaseback

agreement), dated December 9, 1982, under which it agreed

to purchase five houses located in Carrollton, Texas, from

Raldon Corp. (Raldon) for $485,995 and to lease the houses
                           - 11 -


back to Raldon for use as model houses for an initial term

of 18 months.   For each of the five houses, there is a

schedule attached to the agreement that lists the address;

the base price; the "optional extras" included with the

house, such as carpeting, wallpaper, and mirrored walls;

the "marketing extras", such as drapes, sprinkler systems,

built-ins, and landscaping; the price for each of the

extras; and the "purchase price" of the house.   The

purchase price for each of the five houses was $8,000 to

$10,000 more than the base price because of the "extras".

     As one of the conditions of closing under the

purchase and leaseback agreement, Raldon agreed to pay

EPIC 6 percent of the purchase price of the properties.

The agreement provides as follows:


          On the Closing Date, Seller [Raldon] shall
     pay to Equity Programs Investment Corporation a
     sum equal to six percent (6%) of the Purchase
     Price of the Properties, and the execution of
     this Agreement by Seller shall constitute an
     irrevocable assignment to Equity Programs
     Investment Corporation from the sale proceeds
     of a sum sufficient to make the payment due
     under this Subparagraph 5.7.


We refer to the amount payable under the above provision as

the builder fee.
                           - 12 -


     Another condition under the purchase and leaseback

agreement required Raldon to pay at closing the first full

month's rent for each of the properties plus the pro rata

portion of the monthly rent for the month of closing.    The

agreement provides as follows:


          Seller, as tenant, shall have * * * (ii)
     paid to Purchaser, as Landlord, the first full
     month's Adjusted Monthly Rental for each of the
     Properties plus the pro rata portion of the
     Adjusted Monthly Rental for the month during
     which the Closing Date occurs.


We refer to this amount as the rent advance.

     Finally, as a condition to closing, the purchase

and leaseback agreement required Raldon to supply to

the purchaser an appraisal that showed the value of the

property and improvements equal to or greater than the

purchase price.   The agreement provides as follows:


     An appraisal of the Properties and improvements
     prepared by a FNMA/FHLMC qualified appraiser
     acceptable to Purchaser on a standard FNMA/FHLMC
     form which shall reflect a value of the Property
     and improvements equal to or greater than the
     Purchase Price.


     EPIC made the following internal cash-flow analysis

of the transaction with Raldon:
                                             - 13 -

      Raldon Corp.             Year 1        Year 2     Year 3       Year 4          Total

Builder lease payments      $61,819          $30,909      -0-          -0-          $92,728
Tax, ins., HOA reimburse      4,476            2,238      -0-          -0-            6,714
Tenant rental                  -0-            17,489   $37,776       $40,798         96,063
Rental deficit contribution    -0-              -0-       -0-          -0-            -0-
Interest income                -0-              -0-       -0-          -0-            -0-

  Total revenue                 66,295        50,636    37,776        40,798        195,505

First trust interest           -68,031       -68,031   -68,031       -68,031    -272,124
Tax, ins., HOA expense          -4,476        -4,476    -4,476        -4,476     -17,904
Repairs & maintenance             -0-         -1,215    -2,430        -2,430      -6,075
Property management fee         -2,100        -2,100    -2,100        -2,100      -8,400
Audit fee                         -607          -607      -607          -607      -2,428
Interest on EPIC advances       -6,288        -6,288    -6,288        -6,288     -25,152

  Total expenses               -81,502       -82,717   -83,932       -83,932    -332,083

Anticipated cash deficit       -15,207       -32,081   -46,156       -43,134    -136,578
As a percent of purchase        -3.13%        -6.60%    -9.50%        -8.88%     -28.10%
  price


According to the above analysis, EPIC projected a cash

deficit from the transaction at the end of the fourth year

of $136,578 or 28.10 percent of the original purchase

price (viz $485,995).                   EPIC further projected that the

following appreciation rates would be required to recoup

the investment in the properties after sales expenses of

7 percent and a disposition fee of 2.5 percent to be

paid to EPIC:
                                         Investment     Appreciation Rate
                                         1
                  End of 2d year          $615,744               12.56
                                          1                      1
                  End of 3d year            678,408              11.76
                                          1                      1
                  End of 4th year           723,785              10.47

     1
       EPIC's projection, as contained in the record is difficult to read and this
amount may differ from the projection.



       By instrument dated December 22, 1982, EPIC assigned

to EA 83-XII EPIC's "right, title and interest" in the

purchase and leaseback agreement with Raldon.                                  On
                           - 14 -


December 27, 1982, EA 83-XII closed the purchase of each

of the five model houses from Raldon.

     To finance its purchase of the subject houses, EA 83-

XII borrowed approximately 95 percent of the purchase

price of each of the properties from EPIC Mortgage, Inc.

(EMI), a corporation affiliated with EPIC.   EMI's business

was to originate mortgages for EPIC partnerships.   At

closing, EA 83-XII executed five nonrecourse promissory

notes, in the aggregate principal amount of $461,675,

payable to EMI in monthly installments of interest only on

the unpaid principal balance for 5 years at the rate of

14.375 percent.   The entire indebtedness under each note

was due 5 years after the date of the first payment of

interest required under the note.

     Each nonrecourse promissory note was secured by a

deed of trust bearing the date of closing and recorded

on January 3, 1983, in the land records of Denton County,

Texas.   A mortgage insurance company, Ticor Mortgage

Insurance (TMI), issued a commitment and certificate of

insurance dated December 28, 1982, providing mortgage

insurance for 25 percent of the first loss amount with

respect to the mortgage on each of the five properties.

     Set out below is a list of each of the properties

that EX 83-XII purchased from Raldon, the purchase price
                                       - 15 -


of each property, the builder fee, the rent advance, and

the amount borrowed with respect to each property:

                                 Purchase        Builder      Rent
     Raldon Corp.                 Price           Fee       Advance    Loan

    2109   Avignon   Dr.         $88,995        $5,339.70   $1,004    $84,525
    2111   Avignon   Dr.          89,500         5,370.00    1,009     85,025
    2113   Avignon   Dr.         100,500         6,030.00    1,134     95,475
    2115   Avignon   Dr.         100,500         6,030.00    1,134     95,475
    2117   Avignon   Dr.         106,500         6,390.00    1,201    101,175

                                 485,995        29,159.70    5,482    461,675



     A settlement statement was prepared for the sale of

each house.          Each statement shows the above purchase price

as the contract sales price of the house and shows the

builder fee and rent advance for each house as charges to

the seller, Raldon, and, thus, as reductions of the amount

due to Raldon.             Each statement also shows the total of the

"amounts paid by/for" EA 83-XII, as consisting principally

of the loan proceeds and the sum of the builder fees and

rent advances.             The total of these amounts exceeded the

amount due from EA 83-XII.                  Set out below is a summary of

the settlement statements showing that a total of $8,801.60

was due to the buyer, EA 83-XII, at closing:
                                         - 16 -


             Raldon Corp.                           Buyer                   Seller

     Contract sales price                        $485,995.00           $485,995.00
     Settlement charges to buyer                    2,132.60                -0-
     Price adjustment                                  12.50                 12.50

     Gross amount due                             488,140.10               486,007.50

     Principal amount of loans                    461,675.00                    -0-
     Builder fee                                   29,159.70                29,159.70
     Rent advance                                   5,482.00                 5,482.00
     Rental deficit contribution                       -0-                      -0-
     Other credits                                    625.00                   625.00
     Settlement charges to seller                      -0-                   5,835.04

       Total credits                              496,941.70                41,101.74

     Amount due buyer                               8,801.60                    -0-
     Amount due seller                                 -0-                 444,905.76


       According to the settlement sheets, the aggregate

principal amount of the loans, $461,675, was credited as

follows:
                                      Buyer          Seller       Others             Total

Settlement charges to buyer            -0-            -0-       $2,132.60       $2,132.60
Amount due less loan               $-26,465.10        -0-          -0-         -26,465.10
Builder fee                          29,159.70        -0-          -0-          29,159.70
Rent advance                          5,482.00        -0-          -0-           5,482.00
Other credit                            625.00        -0-          -0-             625.00
Settlement charges to seller           -0-            -0-        5,835.04        5,835.04
Amount due seller                                 $444,905.76      -0-         444,905.76

                                      8,801.60     444,905.76    7,967.64      461,675.00



       EMI assigned to Community Savings & Loan, Inc. (CSL),

a savings and loan association affiliated with EPIC, its

interest in each of the promissory notes and related deeds

of trust that had been issued by EA 83-XII in connection

with its purchase of the five properties from Raldon.                                 EMI

made the assignment in an Assignment of Deed of Trust dated

March 30, 1983.             In the same instrument, CSL further

assigned its interest as holder of each promissory note

under the related deed of trust to the North Jersey Savings
                           - 17 -


& Loan Association.   Thus, shortly after EA 83-XII

purchased the subject properties from Raldon, North Jersey

Savings & Loan Association purchased the promissory notes

that EA 83-XII had issued to EMI.


Purchase of Production Houses in Odessa, Texas

     EPIC executed a Residential Rental Purchase Agreement

(rental purchase agreement) dated December 18, 1982, under

which it agreed to purchase seven houses located in the

Hollywood View subdivision in Odessa, Texas, from Fox and

Jacobs, Inc. (Fox & Jacobs), for $394,600.    The rental

purchase agreement had originally called for the purchase

of eight properties for a total of $449,500 but was amended

by deleting one house sometime before closing.

     The rental purchase agreement includes an exhibit B

for each of the seven properties that sets forth the base

price of the property and the appliances and interior

decorations included in the purchase price.    This exhibit

also lists an "estimated rental amount" for the property.

Exhibit C to the rental purchase agreement gives EPIC the

right to rent each of the properties and states that, for

each property not leased as of the closing date, Fox &

Jacobs agrees to pay to the purchaser on the closing date

an amount equal to three times the monthly rent for that
                           - 18 -


property as set forth on exhibit B.   We refer to this

amount as the rent advance.

     Under the rental purchase agreement, Fox & Jacobs

agreed to pay to EPIC 6.8 percent of the purchase price

of the properties.   The rental purchase agreement provides

for this payment as a condition to "the obligation of

the Purchaser to purchase each of the Properties" in the

following terms:


          On the Closing Date, Seller shall pay to
     Equity Programs Investment Corporation a sum
     equal to six and eight-tenths percent (6.8%)
     of the Purchase Price of the Properties, and
     the execution of this Agreement by Seller shall
     constitute an irrevocable assignment to Equity
     Programs Investment Corporation from the sale
     proceeds of a sum sufficient to make the payment
     due under Subparagraph 4.6.


We refer to this sum as the builder fee.

     As a further condition to the purchaser's obligation

under the rental purchase agreement, Fox & Jacobs agreed

to pay to "the Purchaser a sum equal to the percentage as

set forth on Exhibit 'A' hereof of the purchase price of

each Property as a contribution towards rental deficits"

(referred to herein as the rental deficit contribution).

The percentages set forth on exhibit A attached to the

rental purchase agreement range from 16.38 to 17.90
                                   - 19 -


percent.          We refer to this payment as the rental deficit

contribution.

       The rental purchase agreement also provided, as a

condition to the purchaser's obligation to purchase the

properties, that the "purchaser shall have obtained an

appraisal of each of the Properties by a FNMA/FHLMC

qualified appraiser * * * which shall reflect the value

of each Property equal to or greater than the purchase

price applicable to that Property".

       EPIC made the following internal cash-flow analysis

of the transaction with Fox & Jacobs:

    Fox & Jacobs, Inc.          Year 1      Year 2    Year 3    Year 4     Total

Builder lease payments           -0-          -0-       -0-       -0-        -0-
Tax, ins., HOA reimburse         -0-          -0-       -0-       -0-        -0-
Tenant rental                  $48,740      $49,659   $53,632   $57,922   $209,953
Rental deficit contribution     69,190         -0-      -0-        -0-      69,190
Interest income                  6,556        3,935     1,312      -0-      11,803

  Total revenue                124,486       53,594    54,944    57,922    290,946

First trust interest           -62,922      -62,922   -62,922   -62,922   -251,688
Tax, ins., HOA expense          -7,920       -7,920    -7,920    -7,920    -31,680
Repairs & maintenance           -2,247       -2,247    -2,247    -2,247     -8,988
Property management fee           -562         -562      -562      -562     -2,248
Audit fee                       -3,360       -3,360    -3,360    -3,360    -13,440
Interest on EPIC advances       -5,815       -5,815    -5,815    -5,815    -23,260

  Total expenses               -82,826      -82,826   -82,826   -82,826   -331,304

Anticipated cash deficit        41,660      -29,232   -27,882   -24,904    -40,358
As a percent of purchase          9.27         -6.5      -6.2     -5.54      -8.98
  price--check Nos.



       The above analysis is based upon the original plan to

purchase eight houses for $449,500.              As shown above, EPIC

projected a cash deficit from that transaction at the end

of the fourth year of $40,358 or 8.98 percent of the
                            - 20 -


purchase price.    EPIC further projected that the following

appreciation rates would be required to recoup the invest-

ment in the properties after sales expenses of 7 percent

and the disposition fee of 2.5 percent to be paid to EPIC:


                                        Appreciation
                           Investment      Rates

     End of 2d year        $507,668        6.27
     End of 3d year         541,663        6.41
     End of 4th year        572,185        6.22


     EPIC's analysis of the transaction included a

computation of the rental deficit contribution.        First,

EPIC personnel estimated that the project would generate a

monthly deficit of $2,101, taking into account estimated

monthly operating expenses of $7,961, tenant rentals of

$4,600 (with a vacancy rate of 11.7 percent), and monthly

contributions of investor capital of $1,798.      According to

the analysis, the present value of the monthly deficit

over 36 months discounted at 13 percent is $62,364.        The

analysis, which is reproduced below, designates this amount

as the rental deficit contribution:
                                 - 21 -

Operating expenses per month                                     $7,961
Tenant rental revenue                                            -4,600
Rent-up factor                                                    0.883
Net tenant rental                                                -4,062

Operating deficit                                                3,899

Investor contribution
  purchase price                  $449,500    x     0.004        –1,798
Net monthly deficit                                               2,101
Present value of deficit
  over 36 mos. at 13%
  monthly deficit of                  2,101    x    29.68      62,364 [sic]
Rental deficit contribution                                    62,364
As a percent of purchase price                              0.1387408


The rental deficit contribution shown above was calculated using a net
borrowing cost, exclusive of servicing and private mortgage insurance
of 16.75 percent.


The rental deficit contribution computed in the above

analysis, $62,364, differs from the amount used in EPIC's

cash-flow analysis for the project, $69,190, and differs

from the rental deficit contribution finally negotiated

with Fox & Jacobs, $67,643.

     By instrument dated December 21, 1982, EPIC assigned

to EA 83-XII "its entire right, title and interest, as

purchaser and landlord" in the rental purchase agree-

ment dated December 18, 1982, with Fox & Jacobs.            On

December 30, 1982, EA 83-XII closed the purchase of each

of the properties.

     To finance its purchase of the subject properties,

EA 83-XII borrowed approximately 95 percent of the purchase

price of each of the properties from EMI.          On the closing

date, EA 83-XII executed seven nonrecourse promissory
                           - 22 -

notes, in the aggregate principal amount of $374,850,

payable to EMI with monthly installments of interest only

on the unpaid principal balance for 5 years at the rate of

14.375 percent.   Thereafter, the notes required EA 83-XII

to pay monthly installments of principal and interest for

5 years.   The principal amount of each note was due at the

end of 10 years, or January 1, 1993.   On March 1, 1983, the

parties executed an Allonge to Note for each of the seven

notes.   The Allonge to Note states as follows:


          The Note shall bear interest at the rate
     computed as follows: (a) the rate of interest
     for the first sixty (60) full calendar months
     of the loan term shall be Fourteen and 375/1000
     (14.375%) per annum; (b) thereafter, the rate of
     interest shall be adjusted annually, commencing
     with the sixty-first (61st) full calendar month
     of the loan term, to a rate per annum equal to
     the sum of the FNMA auction price in effect on
     the first day of the calendar month immediately
     preceding the month of such adjustment plus 237.5
     basis points, payable as follows:

          Interest only on the unpaid principal
     balance, computed as set forth in (a) above,
     shall be payable on the first day of each month
     commencing April 1, 1983 and on the first day
     of each succeeding month through and including
     March 1, 1988. Thereafter, payments of monthly
     installments of principal and interest at the
     rate per annum as set forth in (b) above, shall
     be fully amortized over the remaining sixty (60)
     months of the loan term, except that any remain-
     ing indebtedness, if not sooner paid, shall be
     due and payable in full on March 1, 1993.
                                    - 23 -

        Each nonrecourse promissory note was secured by a deed

of trust bearing the closing date.            The deeds of trust were

recorded in the land records of Ector County, Texas, on

January 14, 1983.         Each deed of trust was amended on

March 1, 1983, to reflect the changes made by the Allonge

to Note.       A mortgage insurance company, TMI, issued a

Commitment and Certificate of Insurance dated January 7,

1983, providing mortgage insurance for 25 percent of the

first loss amount with respect to the mortgage on each of

the properties.

        Set out below is a list of the seven houses that

EA-XII purchased from Fox & Jacobs, Inc., together with

the purchase price, the builder fee, the rental deficit

contribution, the rent advance, and the amount borrowed

with respect to each property:

                       Purchase     Builder   Rental Deficit    Rent
Fox & Jacobs, Inc.      Price        Fee      Contribution   Advance     Loan

1612 Hemphill Ave.     $57,400    $3,903.20     $10,039      $1,725    $54,525
1921 W. 17th St.        54,000     3,672.00       8,847       1,725     51,300
1716 Coronado Ave.      56,900     3,869.20       9,864       1,725     54,050

1720   Coronado Ave.    59,400     4,039.20      10,635       1,725     56,425
1728   Coronado Ave.    54,000     3,672.00       8,847       1,725     51,300
1700   Linda Ave.       56,900     3,869.20       9,864       1,725     54,050
1916   Hollywood Dr.    56,000     3,808.00       9,547       1,725     53,200

  Subtotal             394,600    26,832.80      67,643     12,075     374,850


        A settlement statement was prepared for the sale of

each property.         In each case, the statement shows the above

purchase price as the "contract sales price" of the
                                 - 24 -

property.     Each statement also shows the builder fee, the

rent advance, and the rental deficit contribution as

charges to the seller, Fox & Jacobs, and, thus, as

reductions of the amount due to Fox & Jacobs.           Each

statement also shows the total of the "amounts paid by/for"

EA 83-XII, as consisting principally of the loan proceeds

and the sum of the builder fees, rent advances, and rental

deficit contributions.          The total of these amounts

exceeded the amount due from         EA 83-XII.    Set out below is

a summary of the settlement statements showing that a total

of $92,331.55 had been overpaid by or on behalf of the

buyer, EA 83-XII:


           Fox & Jacobs, Inc.             Buyer        Seller

     Contract sales price            $394,600.00      $394,600.00
     Settlement charges to buyer        1,794.25      ___________

     Gross amount due                396,394.25       394,600.00

     Principal amount of loans       374,850.00
     Builder fee                      26,832.80        26,832.80
     Rent advance                     12,075.00        12,075.00
     Rental deficit contribution      67,643.00        67,643.00
     Other credits                     7,325.00         7,325.00
     Settlement charges to seller    __________         6,026.94

      Total credits                  488,725.80       119,902.74

     Amount due buyer                 92,331.55
     Amount due seller                                274,697.26


According to the settlement statements, the aggregate

principal amount of the loans, $374,850, was credited as

follows:
                                          - 25 -
                                  Buyer        Seller        Others       Total

Settlement charges to buyer        -0-          -0-        $1,794.25    $1,794.25
Amount due less loans          $-21,544.25      -0-           -0-      -21,544.25
Builder fee                      26,832.80      -0-           -0-       26,832.80
Rent advance                     12,075         -0-           -0-       12,075.00
Rental deficit contribution      67,643.00      -0-           -0-       67,643.00
Other credits                     7,325.00      -0-           -0-        7,325.00
Settlement charges to seller        -0-         -0-         6,026.94     6,026.94
Amount due seller               __________   $274,697.26    ________   274,697.26

                                 92,331.55    274,697.26    7,821.19   374,850.00



       EMI assigned to CSL its interest in each of the

promissory notes and related deeds of trust that had been

issued by EA 83-XII in connection with its purchase of

the seven houses from Fox & Jacobs, Inc.                      EMI made the

assignment in an Assignment of Deed of Trust dated

March 31, 1983.          In the same instrument, CSL further

assigned its interest as holder of each promissory note

under the related deed of trust to National Bank of

Washington.        Thus, shortly after EA 83-XII purchased the

subject properties from Fox & Jacobs, National Bank of

Washington purchased the promissory notes that EA 83-XII

had issued to EMI.             Ultimately, Westinghouse Credit Corp.

acquired the deeds of trust related to the seven houses.


Purchase of 39 Condominium Units in Paseos Castellanos

       EPIC executed a Residential Rental Purchase Agreement

(rental purchase agreement) dated December 22, 1982, under

which it agreed to purchase 39 condominium units located

in the Paseos Castellanos condominium complex in Miami,
                           - 26 -

Florida, from Babcock Co. (Babcock), a subsidiary of

Weyerhaeuser, for $3,020,700.   For each condominium unit

covered by the rental purchase agreement, there is attached

to the agreement an exhibit B which identifies the unit,

its purchase price, and the monthly rent, and lists the

appliances and interior decorations that are included in

the purchase.

     Paseos Castellanos was constructed in 1982.   It con-

sists of eight two-story buildings, with 8 units in each

building for a total of 64 units.   There is a garage for

each unit.   In each building, there are two one-story units

on the second floor, over the garages; four two-story units

in the center of the building; and two one-story units on

the ground floor at the rear of the building.

     The 39 units purchased by EA 83-XII are scattered

among seven of the buildings.   Seven are one-story units on

the second floor, each with two bedrooms, 2-1/2 bathrooms,

and 968 square feet of living space; 13 are two-story units

in the center of the building, each with two bedrooms, 2-

1/2 bathrooms, and 1,240 square feet; 12 are two-story

units in the center of the building, each with three

bedrooms, 1-1/2 bathrooms, and 1,240 square feet; and the

remaining 7 are one-story units on the ground level, each

with three bedrooms, two bathrooms, and 1,090 square feet.
                           - 27 -

     The purchaser's obligation under the rental purchase

agreement to purchase the subject properties was subject

to the following condition:


     Rental of the Properties to individual tenants
     shall have been arranged, or shall be arranged,
     upon execution by Purchaser of this Agreement
     in accordance with the procedures set forth in
     Exhibit "C," attached hereto and by this
     reference made a part hereof.


According to exhibit C, in the event that EPIC had not

leased all of the properties as of the closing date, then

Babcock agreed to pay to the purchaser an amount equal to

three times the monthly fair market rent of each property

not leased as of the closing date as a nonrefundable

contribution toward the expense of listing, showing, and

leasing such property after the closing date.   We refer

to this amount as the rent advance.

     Under the rental purchase agreement, Babcock agreed

to pay to EPIC 6.8 percent of the purchase price of each

property on the closing date.   We refer to this amount as

the builder fee.   The agreement further requires as a

condition to the purchaser's obligation under the agreement

that Babcock pay to the purchaser 19.455 percent of the

purchase price of each property "as a contribution towards

rental deficits (referred to as the Rental Deficit
                                        - 28 -

Contribution)."             In this opinion, we refer to this payment

as the rental deficit contribution.                  Finally, the rental

purchase agreement provides, as a condition to the

purchaser's obligation to purchase the properties, that the

"purchaser shall have obtained an appraisal of each of the

Properties by a FNMA/FHLMC qualified appraiser * * * which

shall reflect the value of each Property equal to or

greater than the purchase price applicable to that

property".

       EPIC made the following internal cash-flow analysis

of the transaction with Babcock:

   Paseos Castellanos         Year 1     Year 2     Year 3     Year 4       Total

Builder lease payments        -0-          -0-        -0-        -0-         -0-
Tax, ins., HOA reimburse      -0-          -0-        -0-        -0-         -0-
Tenant rental               $243,873    $246,792   $266,536   $287,858   $1,045,059
Rental deficit contribution 659,929        -0-        -0-        -0-        659,929
Interest income               62,531      37,533     12,514      -0-        112,578

  Total revenue               966,333    284,325    279,050    287,858    1,817,566


First trust interest         -424,784   -424,784   -424,784   -424,784   -1,699,136
Tax, ins., HOA expense        -71,196    -71,196    -71,196    -71,196     -284,784
Repairs & maintenance         -15,173    -15,173    -15,173    -15,173      -60,692
Property management fee       -16,380    -16,380    -16,380    -16,380      -65,520
Audit fee                      -3,793     -3,793     -3,793     -3,793      -15,172
Interest on EPIC advances     -39,259    -39,259    -39,259    -39,259     -157,036

  Total expenses             -570,585   -570,585   -570,585   -570,585   -2,282,340

Anticipated cash deficit      395,748   -286,260   -291,535   -282,727     -464,774
As a percent of purchase        13.04      -9.43      -9.61      -9.32       -15.32
  price



As shown above, EPIC projected a cash deficit from the

transaction at the end of the fourth year of $464,774,

or 15.32 percent of the purchase price (viz $3,034,550).

EPIC further projected that the following appreciation
                            - 29 -

rates would be required to recoup the investment in the

properties after sales expenses of 7 percent and a

disposition fee of 2.5 percent to be paid to EPIC:

                     Investment      Appreciation Rate

   End of 2d year    3405798              5.94
   End of 3d year    3755078              7.36
   End of 4th year   4094090              7.77


     EPIC's analysis of the transaction included a

computation of the rental deficit contribution.          First,

EPIC personnel estimated the monthly deficit from the

project, $22,235, taking into account estimated monthly

operating expenses of $54,696, tenant rentals of $22,860

(with a vacancy rate of 11.1 percent), and a monthly

contribution of investor capital of $12,138.         According

to the analysis, the present value of the monthly deficit,

$22,235, discounted over 36 months at 13 percent, is

$659,929.   The analysis, which is reproduced below,

designates this amount as the rental deficit contribution:
                               - 30 -

Operating expenses per month                                 $54,696

Tenant rental revenue                                        -22,860
Rent-up factor                                                 0.889
Net tenant rental                                            -20,323

Operating deficit                                             34,373
Investor contribution
  purchase price              $3,034,550   x    0.004        –12,138
Net monthly deficit                                           22,235
Present value of deficit
  over 36 mos. at 13%
  monthly deficit of              22,235   x    29.68        659,929 [sic]
Rental deficit contribution                                  659,929
As a percent of purchase price                             0.2174716


The rental deficit contribution shown above was calculated using a net
borrowing cost, exclusive of servicing and private mortgage insurance
of 16.75.


The rental deficit contribution computed in the above

analysis differs from the amount finally negotiated with

Babcock, $587,676.

     By instrument dated December 29, 1982, EPIC assigned

to EA 83-XII "all its right, title and interest" in the

rental purchase agreement dated December 22, 1982, with

Babcock.   Thereafter, EA 83-XII closed the sale of each

of the 39 condominium units as of December 30, 1982.

     To finance its purchase of the condominium units in

the Paseos Castellanos complex, EA 83-XII borrowed from

EMI approximately 95 percent of the purchase price of each

unit.   On or about the closing date, EA 83-XII executed 39

nonrecourse promissory notes in the aggregate principal

amount of $2,869,625 payable to EMI in monthly installments

of interest only for 5 years at the rate of 14.375 percent.
                           - 31 -

Thereafter, the notes required EA 83-XII to pay monthly

installments of interest and principal for 5 years.

The notes required payment in full on January 1, 1993.

     EA 83-XII executed an Allonge to Note dated March 1,

1983, for each of the 39 notes providing for a variable

interest rate for the second 5-year term.   The Allonge to

Note extended the date for full payment of the indebtedness

to March 1, 1993.   EA 83-XII also executed a mortgage on

the date of closing for each of the condominium units with

EA 83-XII as the mortgagor and EMI as the mortgagee.   The

mortgages were modified on March 1, 1983, to reflect that

the maturity date of the notes had changed from January 1,

1993, to March 1, 1993.

     Set out below is a list of the 39 condominium units

in the Paseos Castellanos complex that EA 83-XII purchased

from Babcock, together with the purchase price, the builder

fee, the rental deficit contribution, the rent advance, and

the amount borrowed with respect to each condominium unit:
                                   - 32 -
  The Babcock Co.     Contract      Builder     Rental Deficit    Rent
Paseos Castellanos     Price          Fee        Contribution    Advance      Loan

     H   101          $82,000       $5,576.00     $15,953        $1,800      $77,900
     H   102           80,000        5,440.00      15,564         1,800       76,000
     H   103           74,500        5,066.00      14,494         1,800       70,775
     H   105           80,000        5,440.00      15,564         1,800       76,000
     H   106           74,500        5,066.00      14,494         1,800       70,775
     H   107           82,000        5,576.00      15,953         1,800       77,900
     H   108           68,450        4,654.60      13,317         1,575       65,025
     B   105           79,450        5,402.60      15,457         1,800       75,475
     B   107           81,450        5,538.60      15,846         1,800       77,375
     D   101           81,450        5,538.60      15,846         1,800       77,375
     D   105           79,450        5,402.60      15,457         1,800       75,475
     D   107           81,450        5,538.60      15,846         1,800       77,375
     C   101           81,450        5,538.60      15,846         1,800       77,375
     C   102           79,450        5,402.60      15,457         1,800       75,475
     C   105           79,450        5,402.60      15,457         1,800       75,475
     C   107           81,450        5,538.60      15,846         1,800       77,375
     C   108           67,450        4,586.60      13,122         1,575       64,075
     E   101           82,000        5,576.00      15,953         1,800       77,900
     E   102           80,000        5,440.00      15,564         1,800       76,000
     E   103           74,500        5,066.00      14,494         1,800       70,775
     E   104           68,450        4,654.60      13,317         1,575       65,025
     E   105           80,000        5,440.00      15,564         1,800       76,000
     E   106           74,500        5,066.00      14,494         1,800       70,775
     E   107           82,000        5,576.00      15,953         1,800       77,900
     G   101           82,000        5,576.00      15,953         1,800       77,900
     G   102           80,000        5,440.00      15,564         1,800       76,000
     G   103           74,500        5,066.00      14,494         1,800       70,775
     G   104           68,450        4,654.60      13,317         1,575       65,025
     G   105           80,000        5,440.00      15,564         1,800       76,000
     G   106           74,500        5,066.00      14,494         1,800       70,775
     G   107           82,000        5,576.00      15,953         1,800       77,900
     G   108           68,450        4,654.60      13,317         1,575       65,025
     F   101           82,000        5,576.00      15,953         1,800       77,900
     F   102           80,000        5,440.00      15,564         1,800       76,000
     F   104           68,450        4,654.60      13,317         1,575       65,025
     F   105           80,000        5,440.00      15,564         1,800       76,000
     F   106           74,500        5,066.00      14,494         1,800       70,775
     F   107           82,000        5,576.00      15,953         1,800       77,900
     F   108           68,450        4,654.60      13,317         1,575       65,025

         Subtotal    3,020,700     205,407.60     587,676        68,625    2,869,625



         A settlement statement was prepared for the sale of

each condominium unit.           Each statement shows the above

purchase price as the contract sales price.                  The statements

treat the builder fees, the rent advances, and the rental

deficit contributions as charges to Babcock and, thus, as

reductions of the amount due to Babcock as seller.                    In

the case of each of the subject condominium units, the

"amounts paid by/for" EA 83-XII as shown on each settlement
                                           - 33 -

statement is the amount of the loan proceeds.                             Set out

below is a summary of the settlement sheets for the

purchase of the 39 condominium units in Paseos Castellanos:


          Paseos Castellanos                       Buyer              Seller

    Contract sales price                       $3,020,700.00       $3,020,700.00
    Price adjustment                                  476.97              476.97
    Other charges                                  30,934.87             -0-

    Gross amount due                            3,052,111.84        3,021,176.97

    Principal amount of loans                   2,869,625.00             -0-
    Builder fee                                                       205,407.60
    Rent advance                                    -0-                68,625.00
    Rental deficit contribution                     -0-               587,676.00
    Other credits                                   -0-               141,575.39

    Amount due from buyer                         182,486.84
    Amount due to seller                                            2,017,892.98



According to the settlement sheets, the aggregate principal

amount of the loans, $2,869,625, was credited as follows:

                                   Buyer            Seller       Others            Total

Settlement charges                 -0-               -0-        $30,934.87       $30,934.87
Builder fee                    $205,407.60           -0-            -0-          205,407.60
Rent advance                     68,625.00           -0-            -0-           68,625.00
Rental deficit contribution     587,676.00           -0-            -0-          587,676.00
Other credits                      -0-               -0-        141,575.39       141,575.39
Amount due from buyer          -182,486.84           -0-            -0-         -182,486.84
Amount due to seller               -0-          $2,017,892.98       -0-        2,017,892.98

                                  679,221.76     2,017,892.98   172,510.26     2,869,625.00


       TMI issued a Commitment and Certificate of Insurance

dated January 11, 1983, under which it committed to issue

mortgage insurance for 25 percent of the first loss amount

with respect to the mortgage on each condominium unit.

Subsequently, EMI and CSL executed an Assignment of

Mortgage dated March 31, 1983, for each condominium unit

transferring their interest in each note to the National
                                   - 34 -

Bank of Washington.      Thus, shortly after EA 83-XII

purchased the subject properties from Babcock, National

Bank of Washington purchased the promissory notes that

EA 83-XII had issued to EMI.          Ultimately, Westinghouse

Credit acquired the notes.

     In summary, the aggregate contract prices of the

properties purchased by EA 83-XII, the aggregate rental

deficit contributions attributable to those properties,

and the aggregate amounts borrowed are as follows:

                       Contract        Rent Deficit     Loan
                         Price         Contribution    Amount

        Raldon          $485,995           -0-         $461,675
        Fox & Jacobs     394,600         $67,643        374,850
        Babcock        3,020,700         587,676      2,869,625

          Total        3,901,295         655,319      3,706,150



The 83 offering memorandum states that investors would

break even if the real properties acquired by EA 83-XII

appreciated at the annual rate of 7.99 percent over the

4-year period that the partnership planned to hold the

properties.


Financial Statements for EA 83-XII

     The general partner prepared and circulated to the

limited partners quarterly statements for EA 83-XII

entitled "Results of Operations and Taxable Income (Loss)."

The record contains the statements for the nine quarters
                                       - 35 -

beginning April 16, 1983, and ending June 30, 1985.                        If

the entries designated "current period" on the quarterly

statements for a particular year are added, the totals for

each year or part of a year during the period beginning

April 16, 1983, and ending June 30, 1985, are as follows:

                                             4/16/83 to   1/1/84 to   1/1/85 to
                                              12/31/83    12/31/84     6/30/85
Revenue:
  Rental income                             $265,635.60   $306,577    $158,108
  Interest income--general partner             2,219.83          90      -0-
  Other income                                   274.10      -0-         -0-

  Total revenue                              268,129.53    306,667     158,108

Expenses:
  Interest on first mortgage                 386,821.70    546,197     273,062
  Additional mortgage interest                   -0-         -0-         -0-
  Other interest expense                         -0-         -0-         2,106
  Real estate taxes, insurance, HOA           54,204.89     72,927      39,391
  Audit fee                                    3,545.83      4,900       2,450
  Repairs and maintenance                      1,940.72     32,412       7,260
  Property administration fee                 21,675.00     30,778      15,300
  Interest expense--general partner              -0-         7,147      10,459
  Rental commission                           24,110.00     21,950       7,461
  Legal fees                                     725.75      7,915         730
  Other expenses                                  77.40      -0-             24

    Total expenses                           493,101.29    724,226     358,243

Net results of operations                   -224,971.76   -417,559    -200,135

Taxable income (loss):
  Net results of operations                 -224,971.76   -417,559    -200,135
  Plus: mortgage amortization                   -0-          -0-         -0-
  Less: depreciation                         122,625.76    173,120      86,560
        Amortization of loan fees             11,808.84     16,672       8,336
        Amortization of refinancing costs       -0-          -0-         -0-
        Accrued mortgage interest               -0-          -0-         -0-

Taxable income (loss)                       -359,406.36   -607,351    -295,031



The above amounts can be compared with the cash-flow

projection that was set out in the 83 offering memorandum

and is reproduced as appendix A.

       As shown above, one of the expenses recorded as having

been paid on behalf of EA 83-XII during the quarters begin-

ning April 16, 1983, and ending June 30, 1985, is "interest
                             - 36 -

expense--general partner" in the amount of zero during

1983, $7,147 during 1984, and $10,459 during 1985.   Three

of the quarterly statements contain the following note or

words of similar import:


     Interest Expense--GP:

     Cash advances by the General Partner necessary to
     sustain operations of the partnership continued
     to be greater than budget resulting in additional
     interest expense.


The quarterly statements also record "interest income--

general partner" during this period of $2,219.83, $90, and

zero, respectively.

     The record also contains audited financial statements

of EX 83-XII for the years ended December 31, 1983 and

1984, that were prepared by a firm of certified public

accountants.   Included in those financial statements is the

following statement of operations and changes in partners'

capital:
                                 - 37 -

                                      Year Ended December 31,
                                      1984              1983
Revenues:
  Rental income                     $306,577         $287,640
  Interest income                         90            9,344
  Other income                         –0-                548
                                     306,667          297,532

Expenses:
  Interest                           539,893          532,724
  Depreciation                        86,559           86,559
  Real estate taxes                   49,213           49,224
  Amortization                        48,096           31,096
  Repairs and maintenance             30,866           20,620
  Property management fee             30,600           30,600
  Rental commissions                  21,950           25,460
  Homeowner's association dues        20,620            5,624
  Insurance                           16,438           27,744
  Professional fees                   12,993            1,347
  Other expenses                       2,722            1,952

                                     859,950          812,950

Net loss                            (553,283)        (515,418)

Partners' capital (deficit)          516,606          (10,974)
  at beginning of year
Partners' contributions                   -0-       1,042,998
Partners' distributions                    (263)        –0-

Partners' capital (deficit)          (36,940)         516,606
  at end of year


One of the notes accompanying the financial statements

deals with related-party transactions and states as

follows:


     4.    Related party transactions

           Equity Programs Investment Corporation
           (EPIC) is the sole general partner for
           EPIC Associates 83-XII. The general part-
           ner manages, controls and administers the
           business of the Partnership. The general
           partner is compensated for these services
           in accordance with the fee structure set
           forth in the Private Placement Offering
           Memorandum of the Partnership. The
           Partnership incurred $30,600 of cost per
                          - 38 -

          year to EPIC for these services during
          1984 and 1983.

          Interest is charged or paid to the
          Partnership on the due to/from general
          partner balance in accordance with the rates
          prescribed in the Private Placement Offering
          Memorandum. The Partnership incurred $7,057
          and earned $9,344 of interest to/from EPIC
          and affiliates during 1984 and 1983,
          respectively. While not obligated to do so
          under the Partnership agreement, the general
          partner is anticipated to advance funds to
          cover cash flow deficits.


Federal Income Tax Returns Filed on Behalf of EA 83-XII

For Federal income tax purposes, EA 83-XII reported the

following income and expenses for the years in issue:
                             - 39 -

      EA 83-XII                1983      1984         1985

Rent income                  $287,640   $306,577     $331,743
Late charges                      548      -0-          -0-
Interest income                 9,344         90        1,262
Miscellaneous                   -0-        -0-            883

 Total gross income           297,532   306,667      333,888

Interest (noninvestment)      466,358   539,893      560,177
Commissions                    25,460    21,950       24,846
Insurance                      27,744    16,438       18,992
Legal and professional fee        726     8,093          574
Repairs                         1,348    30,866       15,075
Taxes                          49,224    49,213       45,962
Utilities                         464     1,547          951
Homeowners dues                20,620    20,620       25,350
Audit fee                       4,900     4,900        3,267
Points amortization            16,671    16,671       16,671
Property management            30,600    30,600       29,837
Real estate tax service         1,278     -0-          -0-
Miscellaneous                     107     -0-            856
Depreciation                  173,119   173,119      173,119
Bad debts                       -0-       1,174        -0-
Amortization org. expense       -0-       3,150        -0-
Recording fees                  -0-       -0-             24
Service fee-EMI                 -0-       -0-          3,413

 Total expenses               818,619   918,234      -919,114

Net rental income            -521,087   -611,567     -585,226



On its Schedule K, Partner's Share of Income Credits,

Deductions, etc., for 1983, EA 83-XII reported an ordinary

loss of $521,087, investment interest expense of $66,366,

net investment income of $29,306, and excess expenses from

"net lease property" of $10,859; and for purposes of

allocating tax preference items to its partners, EA 83-XII

reported a net investment loss of $341,010.

     On its Schedules K for 1984 and 1985, EA 83-XII

reported ordinary losses of $611,567 and $585,226,

respectively, and investment income of $90 and $1,262,
                           - 40 -

respectively; and for purposes of allocating tax preference

items to its partners, EA 83-XII reported qualified

investment income of $303,571 and $330,529, respectively,

and qualified investment expenses of $908,960 and $909,831,

respectively.

     For depreciation purposes, EA 83-XII treated the

aggregate contract price of its 51 properties, $3,901,295,

less the aggregate rental deficit contribution, $655,319,

as its aggregate basis in the real estate; viz $3,245,976.

EA 83-XII allocated 20 percent of that amount to land;

viz $649,195, and 80 percent to buildings; viz $2,596,781.

EA 83-XII depreciated the latter amount on a straight-line

basis over 15 years and claimed depreciation of $173,119

in each of the years in issue.

     For each of the years in issue, EA 83-XII was

obligated under the promissory notes that it had issued

to EMI to pay interest on the aggregate principal amount

of the notes, $3,706,150, at the annual rate of 14.375

percent.   Thus, EA 83-XII was obligated to pay interest to

EMI in the aggregate amount of $532,759 during each of the

years in issue (i.e., $3,706,150 x 14.375 percent).

     EA 83-XII was also obligated under the 83 partnership

agreement to pay interest at the annual rate of 15 percent

to compensate the general partner for unsecured advances of
                                 - 41 -

funds to the partnership.          The returns filed on behalf of

EA 83-XII for the years in issue report the following

liabilities to the general partner on Schedule L, Balance

Sheets:


          Year Ended   Amount of Advances        Accrued Interest

          12/31/83           $2,991                    -0-
          12/31/84          104,754                  $7,147
          12/31/85           57,567                  12,929


     EA 83-XII reported the following interest expense on

its returns for the years in issue:

                                       1983         1984            1985

    Interest (noninvestment)         $466,358     $539,893     $560,177
    Investment interest income         66,366         -0-          -0-

       Total                          532,724      539,893      560,177


The difference between the above amounts and the interest

paid or incurred with respect to the partnership's first

mortgage notes is as follows:

                                       1983         1984            1985

Total interest expense reported      $532,724     $539,893     $560,177
Interest on first mortgage notes      532,759      532,759      532,759

 Difference                               (35)       7,134          27,418


The record of this case does not explain the above

differences.
                             - 42 -

    EA 83-XII paid loan origination fees to EMI in the

aggregate amount of $148,246 equal to 4 percent of the

principal amount of the first mortgage loans (i.e.,

$3,706,150 x 4 percent).    This amount was amortized over

the life of the loans.    For each of the years in issue,

EA 83-XII reported "points amortization" expense of $16,671

on each of the subject returns.


EA 84-III

    EPIC formed EA 84-III on September 14, 1983, pursuant

to the Uniform Limited Partnership Act of the Commonwealth

of Virginia for a 10-year term ending on September 14,

1993.   EPIC was the sole general partner.    The Certificate

and Agreement of Limited Partnership was amended by the

execution and filing of an Amended and Restated Certificate

and Agreement of Limited Partnership dated October 1, 1983,

which was recorded on December 20, 1983, among the limited

partnership records maintained by the clerk of the court of

Fairfax County, Virginia.     The Certificate and Agreement of

Limited Partnership of EA 84-III was amended for a second

time on April 1, 1985.     The Second Amended and Restated

Certificate and Agreement of Limited Partnership (84

partnership agreement) describes the business of EA 84-III

in the following terms:
                             - 43 -

    Business of the Partnership

    The business of the Partnership has been and
    shall be to acquire, directly or indirectly, own
    and finance fee interests in certain improved
    residential real properties and to hold such
    properties for investment with the objective of
    attaining maximum capital appreciation therein
    and to engage in and perform all necessary and
    proper acts and activities in connection there-
    with including, but not limited to, operating,
    managing, maintaining, leasing, mortgaging,
    selling, exchanging or otherwise dealing with
    such properties with the objective of distribut-
    ing income generated thereby among the Partners
    as provided for herein.


    The 84 partnership agreement provides that EPIC's

"interest shall be deemed to be a one-percent (1%) share

in the partnership's capital contributions for which it

shall contribute" $12,267.    In addition, the 84 partnership

agreement authorizes five enumerated classes of limited

partnership interest, classes A through E, and such

additional classes as are authorized by the general

partner.

    The 84 partnership agreement states that one class A

unit, representing an aggregate capital contribution of

$132,918.89, was sold to four investors, one class B unit,

representing a capital contribution of $56,900, was sold

to one investor, and one class C unit, representing an

aggregate capital contribution of $208,750, was sold to

three investors.   It also appears that thereafter two
                           - 44 -

investors made an aggregate capital contribution of

$51,381.

    According to the partnership agreement, if the need

for additional equity arose, the general partner could

authorize any number of additional classes of limited

partnership interest.   Purchasers of the additional classes

would be admitted to the limited partnership starting on

July 1, 1986.   The agreement also states that the general

partner, in its sole discretion, may authorize future class

units from January 1, 1988, through and until the

termination of the partnership.

    Before offering class D and class E units of limited

partnership interest in EA 84-III for sale, EPIC circulated

a confidential private placement offering memorandum (84

offering memorandum) dated April 1, 1985.    The 84 offering

memorandum states that the class A, B, C, D, and E limited

partners' contributions would be used primarily to fund

operating deficits of EA 84-III.    The 84 offering memo-

randum contains a chart summarizing EA 84-III's anticipated

sources and uses of the proceeds of the offering as

follows:
                               - 45 -

            Sources                             Amount   Percent

Proceeds from sale of class A unit            $132,918    2.32
Proceeds from sale of class B unit              56,900    1.00
Proceeds from sale of class C unit             208,750    3.64
Proceeds from sale of class D unit              75,000    1.31
Proceeds from sale of class E unit             290,850    5.07
Proceeds from sale of additional class(es)     450,000    7.85
Capital contributions of general partner        12,266    0.21
First mortgage loans                         3,453,450   60.24
Builder rebates                                755,287   13.17
General partner advances                       297,400    5.19

 Total                                       5,732,821   100.00

               Uses

Purchase price of homes                      3,956,700   69.02
Sales commissions to broker/dealers             97,153    1.70
Escrows and prepaid insurance                   18,070     .32
First mortgage loan origination fees           138,138    2.40
Organizational fee to general partner           85,009    1.48
Estimated cash-flow deficits
  through September 30, 1984                   473,417    8.26
Available for cash-flow deficits               964,334   16.82

    Total                                    5,732,821   100.00



As set forth above, it was anticipated that $473,417 of

the proceeds of the offering would be offset by cash-flow

deficits through September 30, 1984, and $964,334 of the

offering proceeds would be available for cash-flow deficits

after that date.

     The projected annual income and operating costs of

EA 84-III as set forth in the 84 offering memorandum shows

an annual operating deficit of $431,115 calculated as

follows:
                                 - 46 -

                                                    Percentage of
   Projected Annual Income                Amount    Total Income

   Rental income (less 20%
     vacancy & expense factor)        $231,293         100.00

     Total projected income               231,293      100.00

   Annual Operating Expenditures

   Aggregate first mortgage
     principal & interest                 502,217      217.14
   Real estate taxes                       72,617       31.40
   Insurance & homeowner's
     association dues                     12,511         5.41
   Audit expenses                          4,945         2.14
   Property administration fee            33,000        14.27
   Allowance for maintenance
     & repairs                            19,783         8.55

   Additional interest                    17,335         7.49

   Total projected cash
     expenditures                         662,408      286.40

   Projected operating deficits           431,115      186.40


The 84 offering memorandum also includes a cash-flow

analysis for EA 84-III from October 1, 1983, through

December 31, 1987, as set forth in appendix B to this

opinion.

     In the 84 offering memorandum, it was contemplated

that EPIC would finance the partnership's operating

deficits by advancing funds to the partnership.             The 84

partnership agreement provides that EA 84-III would pay

interest on all unsecured advances of funds by the

general partner at the rate of 15 percent per annum.                The

84 partnership agreement permits the partnership to advance

to the general partner any funds that were not distributed
                           - 47 -

to the limited partners, and the agreement provides that

the general partner would pay interest to EA 84-III on such

advances at the rate of 12 percent per annum.

     The 84 partnership agreement provides that cash from

operations is to be distributed generally in the following

order of priority:   (i) To EPIC to repay any unsecured

advances made by EPIC to the partnership together with

interest; (ii) to the partners in the ratio that the

cumulative cash capital contributions of each partner bear

to the cumulative cash capital contributions of the

partners until such amounts equal the partners' cumulative

cash capital contributions; (iii) 25 percent to EPIC and 75

percent to the limited partners holding the class A, B, C,

D, E, and additional class units.

     The partnership agreement further provides that

cash from sales not associated with a liquidation and/or

financings is to be distributed generally in the following

order of priority:   (i) To repay the partnership debt

secured by the property sold or refinanced; (ii) to repay

general creditors of the partnership, including EPIC, any

advances with interest; (iii) to establish such reserves as

the general partner deems necessary; (iv) to the partners

in the ratio that the cumulative cash capital contributions

of each partner bear to the cumulative cash capital
                             - 48 -

contributions of the partners up to the amounts which equal

the partners' cumulative cash capital contributions; and

(v) 25 percent to EPIC and 75 percent to the limited

partners.

     The 84 partnership agreement states that EA 84-III

shall compensate EPIC as follows:


     Compensation of the General Partner and Affiliates

               *    *    *      *     *   *   *

     (a) At the time of subscription, the General
     Partner shall receive seven percent (7%) of each
     Class A, Class B, Class C, Class D, Class E and
     any Additional Class or Classes Limited Partner's
     full contribution to the Partnership as a
     Partnership organization fee, as defined in the
     Confidential Private Offering Memorandum for the
     Partnership, or a maximum total payment of
     eighty-five thousand nine and 32/100 dollars
     ($85,009.32) for nonrecurring services which may
     be incurred before or after formation of the
     Partnership, including the furnishing of legal,
     financial, accounting and operational assistance,
     reviewing rental schedules and expense forecasts
     and providing other services which do not give
     rise to the acquisition or leasing of specific
     properties or the obtaining of financing
     therefor.

     (b) At the time of subscription to Future Class
     Units authorized pursuant to section 8(k), the
     General Partner, in its sole discretion, shall
     receive up to seven percent (7%) of the proceeds
     of the full contribution of each holder of a
     Future Class Unit for nonrecurring services which
     may be performed before or after authorization
     and sale of such Future Class Units, which may
     include furnishing legal, financial, accounting
     and operational assistance, reviewing and analyz-
     ing the Partnership's condition and determining
                        - 49 -

the need for an amount of such additional capital
to be raised by the sale of such Future Class
Units.

(c) During each full or partial month of the
Partnership, the General Partner shall be paid
a Property Administration Fee equal to fifty
dollars ($50) per month for each Partnership
property.

          *    *    *      *     *   *   *

(d) Such loan origination fees or service fees
as may derive from originating or servicing any
security interests, including mortgages and deeds
of trust, placed upon Partnership property.

(e) Reimbursement of all carrying costs of the
Partnership properties, including, but not
limited to, interest on mortgage indebtedness
encumbering the properties incurred prior to the
admission to the Partnership of the Limited
Partners.

(f) On all Advances of funds to the Partnership
made by the General Partner pursuant to section
8(a)(xiv), the General Partner shall be entitled
to interest at the rate of fifteen percent (15%)
per annum.

          *    *    *      *     *   *   *

(i) Any item of Partnership expense or cost
may be paid to an entity or person affiliated
directly or indirectly with the General Partner,
subject only to the requirement that such
affiliated or related person or entity perform
such service as is contracted for or requested
in consideration for such cost or expense.
                            - 50 -

Purchase of Production Houses in Texas and Arizona

     EPIC entered into a Residential Rental Purchase

Agreement (rental purchase agreement), dated September 16,

1983, under which it agreed to purchase 142 residential

properties from U.S. Home Corp. (U.S. Home) for an

aggregate purchase price of $8,767,850.   The location and

purchase price of each property is set forth in exhibit A

to the rental purchase agreement.

     As a condition to the purchaser's obligation under

the rental purchase agreement, U.S. Home agreed to pay to

EPIC 6.8 percent of the purchase price of each property on

the closing date.   The rental purchase agreement provides

for this payment in the following language:


          On the Closing Date, Seller shall pay to
     Equity Programs Investment Corporation a sum
     equal to six and eight-tenths (6.8%) of the
     Purchase Price of the Properties, and the
     execution of this Agreement by Seller shall
     constitute an irrevocable assignment to Equity
     Programs Investment Corporation from the sale
     proceeds of a sum sufficient to make the payment
     due under this Subparagraph 4.6.


We refer to this amount as the builder fee.

     The rental purchase agreement also requires U.S. Home

to pay to the purchaser 3 months' rent for each property

under certain conditions.   That provision states as

follows:
                           - 51 -

     On the Closing Date, Seller shall pay to
     Purchaser a sum equal to the total estimated
     rent for three (3) months, as shown on Exhibit
     A for each of the Properties (the "Reserve").
     At such time as all of the Properties have been
     rented at least once, or upon the expiration of
     seven (7) months from the Closing Date,
     whichever shall first occur, Purchaser shall
     refund the Reserve to Seller, less the product
     of the rent, as shown in Exhibit A, times the
     period of vacancy for each Property since the
     Closing Date. For seven (7) full months after
     the Closing Date, Purchaser shall furnish Seller
     written monthly reports detailing occupancy and
     rents.


In this opinion, we refer to the payment required under the

above provision as the rent advance.

     The agreement further obligated U.S. Home to pay to

the purchaser "a sum equal to the amount as set forth on

Exhibit 'A' hereof of the purchase price of each Property

as a contribution towards rental deficits (rental deficit

contribution)."   We refer to this amount as the rental

deficit contribution.   Finally, the rental purchase

agreement conditioned the purchaser's obligation under the

agreement on the acquisition of "an appraisal of each of

the Properties by a FNMA/FHLMC qualified appraiser on a

standard FNMA/FHLMC form which shall reflect the value of

each Property equal to or greater than the purchase price

applicable to that Property".
                            - 52 -

     EPIC assigned its right, title, and interest as

purchaser under the rental purchase agreement with U.S.

Home to various limited partnerships of which it was

general partner.   EPIC assigned its right to purchase 15

of the 142 properties to EA 84-III.   On September 19, 1982,

EA 84-III purchased the 15 properties it had been assigned

for an aggregate purchase price of $908,700.

     To finance its purchase of the 15 properties, EA 84-

III borrowed $863,250, approximately 95 percent of the

purchase price, from EMI.   On the closing date, EA 84-III

executed 15 nonrecourse promissory notes in the aggregate

principal amount of $863,250, payable to EMI with monthly

installments of interest only for 5 years at the annual

rate of 14.625 percent.   Thereafter, the notes required

EA 84-III to pay monthly installments of principal and

interest for 5 years.   The full indebtedness was due and

payable on October 1, 1993.

     Each nonrecourse promissory note was secured by a

deed of trust dated on the closing date.   Most of the deeds

of trust were recorded either in the land records of Harris

County or Bexar County, Texas, or Pima County, Arizona.     A

mortgage insurance company, Republic Mortgage Insurance Co.

(RMIC), issued a commitment and certificate of insurance

providing mortgage insurance for 25 percent of the first
                                 - 53 -

loss amount with respect to the mortgage on each of the

properties.

          Set out below is a list of the 15 properties,

together with the purchase price, the builder fee, the

rental deficit contribution, the rent advance, and the

amount borrowed with respect to each property:

                                                    Rental
                             Purchase     Builder   Deficit     Rent
  Houses and Condominiums     Price         Fee     Contrib.   Advance    Loan

5419 Heronwood Dr.           $54,000    $3,672.00    $6,189    $1,395    $51,300
5411 Heronwood Dr.            65,000     4,420.00     9,610     1,395     61,750
3518 Tower Hill Lane          63,750     4,335.00     8,959     1,425     60,550
12347 Northcliff Manor Dr.    58,500     3,978.00     7,326     1,425     55,575
13066 Clarewood Dr.           57,000     3,876.00     8,169     1,275     54,150
6351 S. Briar Bayou Dr.       61,500     4,182.00     8,914     1,350     58,425
12103 Kingslake Forest Dr.    60,500     4,012.00     8,341     1,380     57,475
12107 Kingslake Forest Dr.    50,500     3,434.00     5,231     1,380     47,975
12111 Kingslake Forest Dr.    56,000     3,808.00     6,549     1,425     53,200
12115 Kingslake Forest Dr.    64,000     4,352.00     9,037     1,425     60,800
12231 Carola Forest Dr.       59,000     4,114.00     7,482     1,425     56,050
4850 West Ferret Dr.          71,000     4,828.00     9,905     1,575     67,450
4107 Medical Dr. (Condo.)     59,950     4,076.60     7,777     1,425     56,950
13739 Earlywood Dr.           64,000     4,352.00     9,692     1,350     60,800
6402 Ridgecreek Dr.           64,000     4,352.00     9,692     1,350     60,800

  Total                      908,700    61,791.60   122,873    21,000    863,250



          The sale of each property to EA 84-III is reflected on

a settlement statement executed on the date of closing that

shows the purchase price listed above as the contract sales

price.       For each of the properties, the total of the

"amounts paid by/for" EA 84-III, consisting principally of

the loan proceeds and the sum of the builder fee, rent

advance, and rental deficit contribution, exceeded the

gross amount due from EA 84-III.            Set out below is a

summary of the settlement statements showing that a total
                                       - 54 -

of approximately $142,658.49 had been overpaid by or behalf

of the buyer, EA 84-III:

     U.S. Home Corp.                                  Buyer                     Seller

Contract sales price                            $908,700.00                   $908,700.00
Settlement charges to buyer                       18,600.95                       -0-
Price adjustment                                     830.16                        830.16

                                                    928,131.11                 909,530.16

Principal amount of loans                           863,250.00                    -0-
Builder fee                                          61,791.60                  61,791.60
Rent advance                                         21,000.00                  21,000.00
Rental deficit contribution                         122,873.00                 122,873.00
Other credits                                         1,875.00                   1,875.00
Settlement charges to seller                            -0-                     11,320.94

                                               1,070,789.60                    218,860.54
                                                1
Amount due to buyer                                 142,658.49
Amount due to seller                                                           690,669.62

     1
       The record does not contain 4 of the 15 settlement statements and some amounts
composing this total were estimated.



       According to the settlement statements, the aggregate

principal amount of the loans, $863,250, was credited as

follows:

       U.S. Home Corp.              Buyer              Seller        Others              Total

Settlement charges to buyer          -0-                -0-        $18,600.95        $18,600.95
Amount due less loan             $-64,881.11            -0-            -0-           -64,881.11
Builder fee                        61,791.60            -0-            -0-            61,791.60
Rent advance                       21,000.00            -0-            -0-            21,000.00
Rental deficit contribution       122,873.00            -0-            -0-           122,873.00
Other credits                       1,875.00            -0-            -0-             1,875.00
Settlement charges to seller         -0-                -0-         11,320.94         11,320.94
Amount due seller                    -0-            $690,669.62        -0-           690,669.62

                                  142,658.49         690,669.62     29,921.89        863,250.00



       In passing, we note that the parties stipulated that

U.S. Home sold to EA 84-III the two houses at 5411 and 5419

Heronwood Drive, and the four houses at 12103, 12107,

12111, and 12115 Kingslake Forest Drive.                          These six

properties are listed among the properties covered by the
                            - 55 -

Residential Rental Purchase Agreement dated September 16,

1983, between EPIC and U.S. Home.    Furthermore, the

settlement statement for the sale of five of those

properties lists the seller as U.S. Homes.    The record does

not contain the settlement statement for the sale of 12103

Kingslake Forest Drive.

     At trial, respondent introduced warranty deeds that

show that on or about June 1, 1982, the two properties on

Heronwood Drive were transferred by U.S. Home to Tanmis

Models, Inc., and on or about August 26, 1983, were

transferred by Tanmis Models, Inc., to EA 84-III.

Respondent also introduced warranty deeds that show that

on or about September 1, 1981, the four properties on

Kingslake Forest Drive were transferred by U.S. Home

to Dyblof Models, Inc., and on or about August 26, 1983,

were transferred by Dyblof Models, Inc., to EA 84-III.

     Apparently, these six properties were models that EPIC

acquired from U.S. Home through companies affiliated with

EPIC, Tanmis Models, Inc., and Dyblof Models, Inc., and

leased back to U.S. Home.   Under its agreement with EPIC,

U.S. Home had the right to buy each property back at the

original purchase price at the end of the lease term.

     EMI assigned to CSL its interest in each of the

promissory notes and related deeds of trust that had been
                            - 56 -

issued by EA 84-III in connection with its purchase of the

15 properties from U.S. Home.    EMI made the assignment in

documents entitled Assignment of Deed of Trust that are

dated November 29, 1983.    In the same instruments, CSL

further assigned to the National Bank of Washington its

interest as holder of each promissory note under the

related deed of trust.   This documents the fact that

shortly after EA 84-III purchased the subject properties

from U.S. Home, National Bank of Washington purchased the

promissory notes that EA 84-III had issued to EMI.    Salomon

Brothers, Inc., ultimately acquired the deeds of trust for

all of the 15 properties.

     As general partner of EA 84-III, EPIC executed 16

promissory notes dated February 1, 1985.    Each of the

notes was payable to CSL in the principal amount of $5,000,

a total of $80,000.   Under each of the promissory notes,

EA 84-III promised to pay monthly installments of interest

only on the unpaid principal balance at the annual rate

of 15 percent with the principal due and payable on

February 1, 1987.   Fifteen of the promissory notes were

secured by deeds of trust on the 15 properties described

above.   Each of the deeds of trust states that it is

"subordinate to the lien of the institutional first deed

of trust which was recorded prior to this Deed of Trust".
                             - 57 -

The 16th promissory note and the related deed of trust are

similar to the others, except they refer to unit 101 of

The Reflections condominium complex, described below.


Purchase of 40 Condominiums Units in the Reflections

     EPIC executed a Residential Rental Purchase Agreement

(rental purchase agreement), dated August 3, 1983, under

which it agreed to purchase a condominium complex located

in San Antonio, Texas, known as the Reflections from Pitman

Properties, Inc., and Japhet Properties, Inc. (herein

Pitman & Japhet), for $3,048,000.     For each condominium

unit, there is attached to the agreement an exhibit B that

identifies the unit, lists the appliances and furnishings

included in the purchase price, and states the estimated

monthly rent for the unit.

     The Reflections is a 40-unit condominium complex

which was new at the time of this transaction in 1983.

The complex is composed of seven buildings with a total of

40,356.85 square feet of net rentable living area located

on 2.233 acres.   The units have fireplaces, parking spaces,

1,135 square feet of storage space, and patios, porches and

balconies.   There is a pool and exterior landscaping, and

one side of the complex faces a man-made lake.
                             - 58 -

     Under the rental purchase agreement, Pitman & Japhet

agreed as a condition to closing to pay to EPIC 6.8 percent

of the purchase price of each unit.    We refer to this

amount as the builder fee.    As a further condition to

closing, Pitman & Japhet agreed to pay to the purchaser a

sum equal to the percentage of the purchase price of each

unit that is set forth on exhibit A to the agreement as a

contribution towards rental deficits (rental deficit

contribution).   The percentages set forth on exhibit A

range from 20.30 percent to 21.39 percent.     We refer to

this amount as the rental deficit contribution.

     As a further condition to EPIC's obligation, the

agreement provides:


     Rental of the Properties to individual tenants
     shall have been arranged, or shall be arranged,
     upon execution by Purchaser of the Agreement
     in accordance with the procedures set forth in
     Exhibit "C", attached hereto and by this
     reference made a part hereof.


Pursuant to exhibit C, in the event that any of the

properties were not leased as of 7 days before closing,

Pitman & Japhet agreed to pay to the purchaser, in addition

to the rental deficit contribution, an amount equal to

three times the monthly rent set forth for each unit that
                            - 59 -

was not rented as of the closing date.    We refer to this

payment as the rent advance.

     The purchaser's obligations under the rental purchase

agreement were also subject to the condition that the

purchaser shall have obtained "an appraisal of each of the

Properties prepared by a FNMA/FHLMC qualified appraiser on

a standard FHMA/FHLMC form which shall reflect the value of

each Property equal to or greater than the purchase price".

     It appears that EPIC assigned to EA 84-III its rights

as purchaser under the rental purchase agreement dated

August 3, 1983, with Pitman & Japhet.    The record does not

contain an instrument of assignment.    In any event, on

September 30, 1983, EA 84-III purchased the 40 condominium

units at the Reflections.

     To finance its purchase of the condominiums, EA 84-III

borrowed $2,590,200, approximately 85 percent of the

aggregate purchase price, from EMI.    EA 84-III executed 40

nonrecourse promissory notes in the aggregate principal

amount of $2,590,200, that were each payable to EMI with

monthly installments of interest at the annual rate of

14.125 percent.   The record does not contain any of the

40 promissory notes, but their terms are summarized in the

84 offering memorandum as follows:
                          - 60 -

     Thirty-five month interest only, thirteen months
     amortizing on the leases [sic] of a thirty year
     amortization schedule, six year level pay fully
     amortizing, with no adjustments in the interest
     rate during the life of the loan.


Each promissory note was secured by a deed of trust and was

covered by a private mortgage insurance policy.   The record

does not contain the deeds of trust or documents relating

to the private mortgage insurance.   At some time,

Philadelphia Savings Fund of Philadelphia acquired the

promissory notes that EA 84-III had issued to EMI and EMI

assigned each of the 40 deeds of trust to Philadelphia

Savings Fund of Philadelphia.

     Set out below is a list of the 40 condominiums that

EA 84-III purchased together with the purchase price,

rental deficit contribution, rent advance, and loan amount:
                                           - 61 -
                                           Rental
                Purchase      Builder      Deficit     Rent
Unit             Price          Fee        Contrib.   Advance      Loan

A   101         $91,900      $6,249.20     $19,661    $1,800      $78,100
A   102          97,900       6,657.20      20,596     1,950       83,200
A   103          97,900       6,657.20      20,596     1,950       83,200
A   104          91,900       6,249.20      19,661     1,800       78,100
B   201          91,900       6,249.20      19,661     1,800       78,100
B   202          97,900       6,657.20      20,597     1,950       83,200
B   203          97,900       6,657.20      20,597     1,950       83,200
B   204          91,900       6,249.20      19,661     1,800       78,100
C   301          91,900       6,249.20      19,661     1,800       78,100
C   302          97,900       6,657.20      20,597     1,950       83,200
C   303          97,900       6,657.20      20,597     1,950       83,200
C   304          91,900       6,249.20      19,661     1,800       78,100
D   401          75,900       5,161.20      15,616     1,575       64,500
D   402          75,900       5,161.20      15,616     1,575       64,500
D   403          75,900       5,161.20      15,616     1,575       64,500
D   404          75,900       5,161.20      15,616     1,575       64,500
E   501          75,900       5,161.20      15,616     1,575       64,500
E   502          57,900       3,937.20      11,751     1,245       49,200
E   503          75,900       5,161.20      15,616     1,575       64,500
E   504          57,900       3,937.20      11,751     1,245       49,200
E   505          57,900       3,937.20      11,751     1,245       49,200
E   506          75,900       5,161.20      15,616     1,575       64,500
E   507          57,900       3,937.20      11,751     1,245       49,200
E   508          75,900       5,161.20      15,616     1,575       64,500
F   601          75,900       5,161.20      15,616     1,575       64,500
F   602          57,900       3,937.20      11,751     1,245       49,200
F   603          75,900       5,161.20      15,616     1,575       64,500
F   604          57,900       3,937.20      11,751     1,245       49,200
F   605          57,900       3,937.20      11,751     1,245       49,200
F   606          57,900       3,937.20      11,751     1,245       49,200
F   607          57,900       3,937.20      11,751     1,245       49,200
F   608          57,900       3,937.20      11,751     1,245       49,200
F   609          57,900       3,937.20      11,751     1,245       49,200
F   610          75,900       5,161.20      15,616     1,575       64,500
F   611          57,900       3,937.20      11,751     1,245       49,200
F   612          75,900       5,161.20      15,616     1,575       64,500
G   701          75,900       5,161.20      15,616     1,575       64,500
G   702          75,900       5,161.20      15,616     1,575       64,500
G   703          75,900       5,161.20      15,616     1,575       64,500
G   704          75,900       5,161.20      15,616     1,575       64,500

    Total     3,048,000     207,264.00     632,414    62,640    2,590,200



            The sale of each condominium to EA 84-III is reflected

on a settlement statement executed on the date of closing

that shows the purchase price listed above as the "contract

sales price".              On each settlement statement, the builder

fee, rent advance, and rental deficit contribution are

treated as charges to Pitman & Japhet, reducing the amount

due Pitman & Japhet.               These amounts are also treated as

credits to EA 84-III.                   Set out below is a summary of the
                                     - 62 -

settlement statements showing that the aggregate amounts

paid by or on behalf of the buyer, EA 84-III, exceeded the

aggregate amount due from the buyer by $441,356.12:

Pitman & Japhet Properties                       Buyer                Seller

Contract sales price                      $3,048,000.00           $3,048,000.00
Settlement charges to buyer                   16,018.38                 -0-

                                              3,064,018.38         3,048,000.00

Principal amount of loans                     2,590,200.00              -0-
Builder fee                                     207,264.00           207,264.00
Rent advance                                     62,640.00            62,640.00
Rental deficit contribution                     632,414.00           632,414.00
Adjustments                                       1,756.50             1,756.00
Other credits                                    11,100.00            11,100.00
Payoff loans                                       -0-             1,548,548.53
Settlement charges to seller                       -0-               132,833.00

                                              3,505,374.50         2,596,556.03

Amount due buyer                                441,356.12
Amount due seller                                                    451,443.97



According to the settlement statements, the aggregate

principal amount of the loans, $2,590,200, was credited as

follows:

Pitman & Japhet Properties        Buyer            Seller         Others              Total

Settlement charges to buyer         -0-              -0-        $16,018.38          $16,018.38
Amount due less loans          $-473,818.38          -0-            -0-            -473,818.38
Builder fee                      207,264.00          -0-            -0-             207,264.00
Rent advance                      62,640.00          -0-            -0-              62,640.00
Rental deficit contribution      632,414.00          -0-            -0-             632,414.00
Adjustments                        1,756.50          -0-            -0-               1,756.50
Other credits                     11,100.00          -0-            -0-              11,100.00
Payoff loans                         -0-             -0-       1,548,548.53       1,548,548.53
Settlement charges to seller         -0-             -0-         132,833.00         132,833.00
Amount due seller                    -0-         $451,443.97        -0-             451,443.97

                                 441,356.12       451,443.97   1,697,399.91       2,590,200.00
                                     - 63 -

     In summary, the aggregate contract prices of the

properties purchased by EA 84-III, the aggregate rental

deficit contributions attributable to those properties,

and the aggregate amounts borrowed are as follows:

                          Contract       Rental Deficit     Loan
                            Price         Contribution     Amount

        U.S. Home          $908,700           $122,873     $863,250
        Pitman & Japhet   3,048,000            632,414    2,590,200

            Total         3,956,700            755,287    3,453,450



The 84 offering memorandum states that investors would

break even if the real properties acquired by EA 84-III

appreciated at the annual rate of 9.15 percent over the

4-year period that the partnership planned to hold the

properties.


Financial Statements for EA 84-III

     The general partner prepared and circulated to the

limited partners quarterly statements for EA 84-III

entitled "Results of Operations and Tax Income (Loss)".

The record contains the statements for the eight quarters

beginning September 19, 1983, and ending June 30, 1985.

If the entries designated "current period" on the quarterly

statements for a particular year are added, the totals for

each entry for each year or part of a year during the
                                       - 64 -

period beginning September 16, 1983, and ending June 30,

1985, are as follows:

             EA 84-III                       9/19/83 to   1/1/84 to     1/1/85 to
                                              12/31/83    12/31/84       6/30/85
Revenue:
  Rental income                              $76,790.36   $228,516      $107,858
  Interest income--general partner             6,097.26      -0-           -0-
  Other income                                    -0-        -0-           2,866

  Total revenue                               82,887.62    228,516       110,724

Expenses:
  Interest on first mortgage                 118,081.87    504,391       250,902
  Additional mortgage interest                   -0-         -0-           -0-
  Other interest expense                         -0-         -0-           5,000
  Real estate taxes, insurance, HOA           26,480.69     83,110        45,240
  Audit fee                                    5,000.00      5,000         2,500
  Repairs and maintenance                     10,225.44    120,032        30,811
  Property administration fee                  8,250.00     33,000        16,500
  Interest expense--general partner              -0-        28,175        18,680
  Rental commission                            5,305.42     23,198        10,118
  Legal fees                                      15.00        687           167
  Other expenses                                 140.81      -0-               90

    Total expenses                           173,499.23    797,593       380,008

Net results of operations                    -90,611.61   -569,077      -269,284

Taxable income (loss):
  Net results of operations                  -90,611.61   -569,077      -269,284
  Plus: mortgage amortization                    -0-         -0-           -0-
  Less: depreciation                          42,685.50    170,742        85,372
        Amortization of loan fees              3,454.45     13,812         6,906
        Amortization of refinancing costs        -0-         -0-           -0-
        Accrued mortgage interest                -0-         -0-           -0-
        Misc. expenses                           -0-             28            -5

Taxable income (loss)                       -136,750.56   -753,659      -361,557



The above amounts can be compared with the cash-flow

projection that was set out in the 84 offering memorandum

and is reproduced as appendix B.

       As shown above, one of the expenses recorded as having

been paid on behalf of EA 84-III during the period begin-

ning September 19, 1983, and ending June 30, 1985,

is interest expense--general partner of zero during 1983,

$28,175 during 1984, and $18,680 during 1985.                         Three of
                             - 65 -

the statements contain the following note or words of

similar import:


     Interest Expense--GP:

     Cash advances by the General Partner necessary
     to sustain operations of the partnership
     continued to be greater than budget resulting
     in additional interest expense.


The quarterly statements also record that EA 84-III

received interest income--general partner of $6,097.26

during 1983.

     The record contains audited financial statements of

EA 84-III for the period beginning September 14 (inception)

to December 31, 1983, that were prepared by a firm of

certified public accountants.    Included therein   is the

following statement of operations and changes in partners'

capital:
                             - 66 -

     Revenues:
       Rental income                        $76,790
       Interest income                        2,756

                                            79,546
     Expenses:
       Interest                             118,082
       Depreciation                          21,343
       Real estate taxes                     18,123
       Amortization                           3,804
       Property management fee                8,250
       Rental commission                      5,305
       Insurance                              5,480
       Repairs and maintenance                8,500
       Other                                  9,759

                                            198,646

     Loss from operations                  (119,100)
     Partners' capital contributions        134,334

     Partners' capital at end of year       15,234



     One of the accompanying notes deals with related-party

transactions and states as follows:


     4.   Related party transactions

          Equity Programs Investment Corporation
          (EPIC) is the sole general partner for EPIC
          Associates 84-III. The general partner
          manages, controls and administers the
          business of the Partnership. The general
          partner is compensated for these services in
          accordance with the fee structure set forth
          in the Private Placement Offering Memorandum
          of the Partnership. The Partnership
          incurred $8,250 of cost to EPIC for these
          services during 1983. In addition the
          partnership paid organization fees to EPIC
          of $83,755.

          Interest is charged or paid to the
          Partnership on the due to/from general
          partners balance in accordance with the
          rates prescribed in the Private Placement
          Offering Memorandum. The Partnership earned
                               - 67 -

           $2,756 of interest net from EPIC during
           1983. While not obligated to do so under
           the Partnership agreement, the general
           partner is anticipated to advance funds for
           any cash flow deficits.

           The Partnership paid loan origination fees
           of $138,138 to EPIC Mortgage, Inc., an
           affiliate of the general partner.


On the basis of the above, it appears that EA 84-III

realized interest income from EPIC in 1983 and paid or

incurred interest expense on unsecured advances from EPIC

in 1984 and 1985 in the following amounts:


                                        1983    1984       1985

Interest income–-general partner    $6,097.26     -0-        -0-
Interest expense--general partner      -0-      $28,175    $18,680

                                    6,097.26    (28,175)   (18,680)


Federal Income Tax Returns Filed on Behalf of EA 84-III

     For Federal income tax purposes, EA 84-III reported the

following income and expenses for the years in issue:
                             - 68 -

   EA 84-III                          1983    1984        1985

Rent income                       $80,124    $228,516   $230,130
Interest                            -0-         -0-          494

 Total gross income               80,124     228,516     230,624

Interest (noninvestment)          118,082    522,466     545,848

Commissions                        5,305      23,198      19,403
Insurance                          5,480      16,663      19,894
Legal and professional fee         6,895         687       1,008
Repairs                            8,500      19,782     108,459
Taxes                             18,123      72,554      72,617
Utilities                          1,726      33,555       1,830
Homeowners dues                      998       3,993      12,353
Property management fee            8,250      33,000      32,175
Points amortization                3,453      13,814      13,814
Miscellaneous                        141         606         574
Audit fee                           -0-        5,000       3,333
Service fee                         -0-         -0-        3,197
Depreciation                      56,910      170,742    170,742

 Total expenses                   233,863     916,060   1,005,247

Net rental income                -153,739    -687,544   -774,623


     On its Schedule K, Partner's Share of Income,

Credits, Deductions, etc., for 1983, EA 84-III reported

an ordinary loss of $153,739, a net investment loss of

$141,142 for purposes of allocating tax preference items

to its partners, and net investment income of $6,097 for

purposes of computing investment interest.    On its

Schedules K for 1984 and 1985, EA 84-III reported ordinary

losses of $687,544 and $774,623, respectively, and

investment income of zero and $494, respectively; and for

purposes of allocating tax preference items to its

partners, EA 84-III reported qualified investment income
                           - 69 -

of $217,619 and $229,131, respectively, and qualified

investment expenses of $872,376 and $997,436, respectively.

     For depreciation purposes, EA 84-III treated the

aggregate contract price of its 55 properties, $3,956,700,

less the aggregate rental deficit contributions, $755,287,

as its aggregate basis in the real estate; viz $3,201,413.

EA 84-III allocated 20 percent of that amount to land;

viz $640,283, and 80 percent to buildings; viz $2,561,130.

EA 84-III depreciated the later amount on a straight-line

basis over 15 years and claimed deprecation at the annual

rate of $170,742 in each of the years in issue.   EA 84-III

claimed a depreciation allowance for 4 months on its 1983

return, $56,910, and a depreciation allowance for 12 months

on its 1984 and 1985 returns.

     For each of the years in issue, EA 84-III was

obligated under the promissory notes that it had issued to

EMI to pay interest on the aggregate principal amount of

the notes, $3,453,450.   EA 84-III was obligated to pay

interest at the annual rate of 14.625 percent on the notes

issued to purchase the 15 properties from U.S. Home and was

obligated to pay interest at the annual rate of 14.125

percent on the notes issued to purchase the 40 condominium

units from Pitman & Japhet.   Thus, EA 84-III was obligated
                               - 70 -

to pay interest to EMI in the total amount of $492,116.06

during each of the years 1984 and 1985 computed as follows:

                                    Loan        Rate      Annual Interest

U.S. Home properties              $863,250     14.625       $126,250.31
Pitman & Japhet properties       2,590,200     14.125        365,865.75

 Total                           3,453,450                   492,116.06


     EA 84-III was also obligated under the 84 partnership

agreement to pay interest at the annual rate of 15 percent

to compensate the general partner for unsecured advances of

funds to the partnership.       The returns filed on behalf of

EA 84-III for the years in issue report the following

liabilities to the general partner on Schedule L:


                                 Due to
    Taxable Year Ended       General Partner    Accrued Interest–-G/P

         12/31/83                 -0-                     -0-
         12/31/84              $165,481                 $28,174
         12/31/85               373,705                  42,750


     EA 84-III reported noninvestment interest expense on

its returns for the years in issue of $118,082, $552,466,

and $545,848, respectively.       The difference between these

amounts and the interest paid or incurred with respect to

the partnership's first mortgage notes is as follows:
                                      - 71 -

                                            1983       1984       1985

Total interest expense reported           $118,082    $522,466   $545,848
                                          1
Interest on first mortgage notes            123,029    492,116    492,116

Difference                                  (4,947)    30,350     53,732

       1
           Four months of interest.


The record of this case does not fully explain the above

differences.

           EA 84-III paid loan origination fees to EMI in the

aggregate amount of $138,138 equal to 4 percent of the

principal amount of the first mortgage loans (i.e.,

$3,453,450 x 4 percent).              On the subject returns,

EA 84-III claimed a deduction for "amount of points"

of $3,453, $13,814, and $13,814, respectively.


EPIC

           As mentioned above, EPIC, the general partner of

EA 83-XII and EA 84-III, was incorporated in 1974 for

the purpose of acquiring residential real properties

and providing various services in connection with the

acquisition, syndication, management, and disposition

of the properties.          Between 1975 and 1985, EPIC formed

approximately 357 limited partnerships with more than 6,000

limited partners.          EPIC was the general partner of each

limited partnership.           These partnerships owned

approximately 17,600 residential dwelling units located
                           - 72 -

throughout the United States and issued approximately

20,500 mortgages totaling approximately $1,435,000,000.

     When EPIC began its real estate syndication business,

it contracted to purchase properties from developers of

residential real estate and to lease the properties back

to the developers for use as models.   Typically, the

developers were willing to pay to EPIC a commission,

referred to as the builder's fee, of approximately 6

percent of the purchase price of each property and were

willing to pay rent on each property for some period in

advance.

     EPIC would form a limited partnership for the purpose

of buying the models.   EPIC would assign its rights to

purchase the properties to the limited partnership, and the

limited partnership would purchase the properties with

equity capital contributed by the limited partners.     The

early limited partnerships financed 75 or 80 percent of the

purchase of the properties.   These loans were recourse.

The limited partnership would lease the models back to the

developer on a triple net lease basis during completion of

the project, a period ranging from 18 to 24 months.

     Typically, the rental income from the properties

exceeded the amount needed to service the debt, and the

partnership realized a positive cash-flow during the lease
                           - 73 -

term.   The plan called for the limited partnership to sell

the properties for a profit at the end of the developers'

lease term.   These early limited partnerships were referred

to by EPIC's management as income partnerships.

     EPIC's success and the success of its partnerships

depended upon the appreciation of the real properties that

were purchased by the partnerships.   The sales of real

estate by EPIC partnerships before 1980, as shown in

exhibits to the 83 and 84 offering memoranda, reveal high

annual appreciation.

     During 1980, mortgage interest rates increased to

historic levels, and the real estate market began to

deteriorate as a result.   The higher interest rates

significantly increased the costs of selling properties and

reduced profits realized by the partnerships on the sale of

properties.   Accordingly, in 1980, EPIC's management made

the decision to stop selling properties until interest

rates fell.   EPIC's management believed that, as an interim

measure, the company could carry the limited partnerships

until interest rates decreased and profit margins returned

to normal.

     Notwithstanding the cessation of sales, EPIC continued

to syndicate real estate partnerships.   This was EPIC's

core business.   EPIC's management did not consider shutting
                           - 74 -

down that business when interest rates increased in 1980

because EPIC's management believed that the company could

purchase properties that would appreciate and could be sold

for a profit when interest rates declined.

     At this time, EPIC's management undertook to revise

certain characteristics of the limited partnerships that

were syndicated.   EPIC's management had realized that if an

income partnership held properties after the developer's

lease expired, the partnership would realize cash deficits,

and it had no mechanism to fund such deficits.    EPIC's

management wanted greater flexibility in the period of time

that a partnership could hold its properties.    In order to

permit a longer holding period, the partnerships would have

to lease properties to individual tenants, and, as a

result, the rental stream would decrease substantially

because lease rates paid by individual tenants are much

lower than the commercial rates paid by developers.

However, EPIC found that developers would discount the

price of the properties by an amount roughly equivalent

to the present value of the difference in rental rates.

EPIC referred to this discount as the rental deficit

contribution.

     Because of the longer holding period, EPIC's

management also wanted to increase the loan-to-value ratio
                           - 75 -

of its mortgages to 95 percent in order to help carry the

properties.   For the same reason, EPIC's management wanted

the loans to be nonrecourse.

     EPIC found that lenders in the secondary mortgage

market would purchase such loans if the lender's risk,

taking private mortgage insurance into account, was no

greater than 72 percent of the loan.   Thus, in the case of

a 95-percent loan, for example, a secondary lender would

require mortgage insurance of at least 25 percent.   In the

case of a 90-percent loan, a secondary lender would require

mortgage insurance of at least 20 percent, and so on.

Through negotiation, EPIC found that private mortgage

insurance companies were willing to insure nonrecourse

mortgages on residential properties.   As a result of

negotiations with secondary lenders and private mortgage

insurers, EPIC's management found that it could obtain

95-percent nonrecourse financing on single-family houses

and condominiums owned by its investment partnerships.

Finally, EPIC's management found that investors were

willing to purchase interests in the new partnerships

for roughly one-half of the anticipated tax losses; i.e.,

a 2-to-1 ratio.   The new partnerships were known internally

to EPIC's management as "tax partnerships" to distinguish

them from the earlier "income partnerships".
                           - 76 -

     During the period after 1980, EPIC's management

also experimented with resyndicating properties from older

partnerships and with expandable partnerships.    EPIC's

management also formed EPIC Residential Network, Inc.

(ERNI), to act as a real estate broker to be in position

to sell properties when interest rates declined and the

real estate market recovered.

     Thus, beginning in 1981 or 1982, EPIC expanded its

business by entering into agreements to purchase properties

that it intended to rent to the public, rather than to the

developer.   After this change, EPIC did not limit itself

to models in a particular project but contracted to buy

production houses.   This meant that, in some cases, EPIC

acquired a substantial inventory of unsold houses in a

single project and facilitated the developer's completion

of the project.

     Under this business plan, EPIC intended to syndicate

the properties to limited partnerships which would rent

the properties for 4 years before selling them.    EPIC

calculated the capital contributions of the limited

partners to equal one-half of the anticipated tax losses,

resulting in a "two-to-one tax write-off."

     For cash management purposes, EPIC "swept" all funds

from all of the partnerships' accounts daily and deposited
                           - 77 -

the funds into a master account maintained by EPIC.     EPIC

then advanced funds to pay the debts of any of its

partnerships that needed funds.     The amounts borrowed

from each partnership and the amounts advanced to each

partnership were accounted for in the books and records

of the appropriate partnerships.     Interest was credited to

partnerships to which EPIC owed money and was charged to

partnerships which owed money to EPIC (net borrowers and

net lenders).   Among the funds swept from the accounts

of individual partnerships were the funds received by

partnerships upon the acquisition of real properties.

EPIC management believed that a default by any of its

partnerships would have an adverse impact on the entire

EPIC enterprise, and EPIC never permitted any limited

partnership to default on a payment until August 1985 when

all of the limited partnerships sought protection under the

bankruptcy laws.
                            - 78 -

     During the time it was in existence, EPIC formed or

acquired a number of subsidiaries and affiliated companies

to engage in different aspects of the real estate business.

For example, as mentioned above, EMI originated mortgage

loans on behalf of EPIC limited partnerships and received

fees for doing so.    EMI obtained the funds to originate

loans through "warehouse" or interim lines of credit from

CSL, an affiliated savings and loan association, and other

financial institutions.    EPIC sold interests in pass-

through certificates or whole loans in the secondary market

to other financial institutions.     All of the purchase money

promissory notes at issue in these cases were sold in the

secondary market in one form or another.

     Another affiliate, ERSI, managed the properties that

were owned by EPIC limited partnerships, other than

properties leased back to the developers on net leases.

ERSI leased the properties, reviewed tenant applications,

collected and accounted for rental income, secured

insurance and arranged maintenance and repairs.    EPIC

paid ERSI a monthly fee of $35 of the $50 it received

for managing each property.

     Another affiliate, ERNI, acted as a real estate broker

to sell properties.    Generally, ERNI received a real estate
                             - 79 -

commission of 6 percent of the sale price of each unit

sold.

     Another affiliate, Continental Appraisal Group, Inc.

(CAG), appraised the residential properties purchased by

EPIC partnerships.    The appraisals were made either by a

member of the CAG staff or by an outside appraiser and

reviewed by a staff appraiser.    CAG also appraised

properties for unrelated lenders.     Another company, EPIC

Securities, Inc., wholesaled the limited partnership

interests in EPIC partnerships and received a percentage

of the capital contributions as a commission.     Finally,

in October 1983, EPIC or one of its affiliates acquired

Community Savings & Loan, a Maryland-chartered savings

and loan association.


Private Mortgage Insurance

        While EMI originated the loans at issue, each of the

loans was insured by a private mortgage insurance company

for 25 percent of the first loss amount.     Tricor Mortgage

Insurance Co. and Republic Mortgage Insurance Co. (RMIC)

issued mortgage insurance covering the first mortgage loans

at issue in the instant cases.     In addition, EPIC dealt

with other mortgage insurance companies, including Mortgage
                              - 80 -

Guarantee Insurance Corp. (MGIC) and Commonwealth Mortgage

Assurance Corp. (CMAC).

     The private mortgage insurance companies thoroughly

investigated the risks presented by EPIC's business.     For

example, in June 1982, after EPIC had changed the nature

of its limited partnerships, representatives of MGIC's

appraisal department and underwriting evaluation department

made a risk management study of EPIC.      The study sets forth

a detailed description of EPIC's business and the under-

writing risks presented to MGIC from that business.     As

part of the study, MGIC had conducted spot checks of EPIC's

appraisals and had found "inflated property values".     The

report states as follows:


     Based on our spot checks Epic's appraisals had
     inflated property values. The value estimates
     made 2 or 3 years ago by Epic's appraisers are
     higher than the value estimates as of the date of
     contract and the current value estimates of the
     properties. It is not known if Epic Mortgage is
     aware of this over-valuing in as much [sic] as
     they do not have an appraisal department to
     review the appraisals.

             *    *       *    *       *   *   *

     Based on MGIC's   25 spot checks there is over-
     valuing by Epic   that has resulted in inflated
     property values   and 14 properties with loan to
     value ratios in   excess of 95%, up to 112%.

     a.   We can only speculate at the reason for the
          overvaluing because Epic Mortgage utilizes
          independent fee appraisers. The appraisers
                             - 81 -

             might be influenced by the builder's
             indicated cost and are finding higher priced
             comparable sales to justify this cost rather
             than carefully studying the marketplace.

     b.      The higher value estimates by Epic's
             appraisers are a result of using higher
             priced comparable sales, higher land value
             estimates which do not accurately indicate
             the subject property's true market value and
             model upgrade. The model "upgrades"
             increase the sales price of the home and
             typically make it the highest priced home in
             the subdivision with the cost not typically
             recognized by the end purchaser.

     c.      Epic should have the same concerns with
             overvaluing as MGIC because of losses to the
             partnership. Epic's expertise may be in
             syndication and marketing not property
             valuation. This would explain why they are
             only now setting up an appraisal review
             department.


     Representatives of MGIC met with EPIC's management

on two occasions to discuss possible overvaluation of

properties.    Circa 1983, MGIC ceased insuring EPIC

mortgages.    The principal reason given for this action was

the concentration of risk represented by EPIC's business

and the fact that EPIC had switched from syndicating model

properties to production properties.    Nevertheless, MGIC

wished to retain the renewal business for existing EPIC

insurance policies.

     Similarly, beginning in December 1983, before agreeing

to insure any mortgage loans to an EPIC partnership,
                            - 82 -

Mr. James C. Miller, president of Commonwealth Mortgage

Assurance Co. (CMAC), and his staff met on several

occasions with representatives of EPIC's management to

discuss EPIC's business and the risks that CMAC would face

in writing mortgage insurance on mortgage loans issued by

EPIC partnerships.    A memorandum dated February 24, 1984,

written by Mr. Miller before any mortgage insurance was

written describes EPIC's business and the risks presented

by that business.    The memorandum describes the risks as

follows:


     Risks

     They described their program as unique, and it
     is certainly entirely different from the normal
     owner-occupied situation. To hear them tell it,
     there is virtually no chance of borrower default.
     Their track record of selling to high-income
     investors and obtaining the note payments from
     them has been very good to date.

     The next major risk is that the real estate
     projects themselves do not work out. Deprived
     of rental income, the pool's cash flow would be
     negatively impacted. EPIC minimizes this risk
     by wide diversification of the properties--
     geographically, price and style. They showed
     us one sample pool in which the diversification
     seemed to be excellent.

     There's always the possibility that the general
     partner, EPIC, will fail; the most likely form
     of failure would be a series of projects that
     did not rent out adequately. We can review their
     project plans to verify that they have adequate
     margins built in to minimize this risk. We can
                          - 83 -

     also constantly monitor the financial position of
     the general partner.

     Another risk is that the EPIC property management
     company will fail. If the manager is collecting
     the rents and does not promptly forward all of
     the rent to the general partner, the entire
     enterprise is in jeopardy. Of course, this is
     virtually the entire business of EPIC.
     Therefore, it is highly improbable that the
     property management company would fail alone.

     Ultimately, we have the property to look to.
     Of course, the critical question is whether or
     not the property investors are acquiring the
     property at a bargain price, or whether EPIC is
     overcharging the investors. Presumably, this
     is what our underwriting is intended to guard
     against. We'll have to look at it carefully to
     satisfy ourselves that the value is probably
     there if we need it. However, I believe that
     we should be concerned only with the entire
     pool because there is no way that an individual
     property will go into default–-unless the general
     partner can decide to stop making payments on one
     individual mortgage.

     The rates may be standard, owner-occupied rates
     on the primary insurance. Frank Bossle agreed to
     send me copies of the current rates of the other
     PMI companies. He says he is not looking for a
     bargain rate, because the cost of the mortgage
     insurance is passed on to the customer anyway.

     He also says that they do not believe in requir-
     ing an insurer to take property that the insurer
     doesn't want. They like all their business
     relationships to be based upon cooperation and
     mutual trust and profitability.


As noted above, one of the risks that Mr. Miller identified

related to the value of the property; i.e., "whether or not

the property investors are acquiring the property at a
                           - 84 -

bargain price, or whether EPIC is overcharging the

investors."

     In a later memorandum dated August 24, 1984, after

CMAC had written mortgage insurance on a small amount of

EPIC's business, Mr. Miller focused on the risk "that the

overall market for investment property could become

saturated, and/or the EPIC Management might overextend

themselves by paying too much for their properties."

Mr. Miller instructed his staff to order spot-check

appraisals of the EPIC property.    The spot-check appraisals

did not support the values suggested by EPIC's appraisals,

and CMAC was not able to reconcile the differences.

Shortly thereafter, in a letter dated August 5, 1985, CMAC

ended its business relationship with EPIC.


EPIC's Financial Statements

     The record contains EPIC's financial statements for

1981, 1982, and 1983.   These statements show the following

revenue and expenses:
                                - 85 -

                                             Year Ended
                                12/31/81      12/31/82      12/31/83

Revenues:
  Builder Fees                  $8,960,780   $15,895,234   $18,905,034
  Interest income and
    loan service fees           3,910,907     8,871,358     8,233,739

Rental income                   1,613,598     1,219,852         -0-
Property management fees          972,077     1,357,220       941,616
Partnership organization fees     474,220     4,882,669     9,403,021
Loan origination fees             177,031     2,790,098     7,580,544
Other income                      298,442       698,480       443,087

 Total revenue                  16,407,055   35,714,911    45,507,041

Costs and Expenses:
  Interest expense              4,149,063     7,629,826     3,270,713
  Payroll & fringe benefits     3,969,457     8,696,684     8,430,324
  Commissions                     339,277     3,319,496     8,483,881
  Partnership rental expenses   2,799,960     1,916,887        -0-
  Other operating expenses      2,411,917     3,991,804    10,000,887


 Total expenses                 13,669,674   25,554,697    30,185,805

Income from operations          2,737,381    10,160,214    15,321,236


EA 83-XII and EA 84-III's Bankruptcy

     In 1985, the Governor of Maryland shut down the

State's savings and loan system, and the State required

all savings and loan associations subject to Maryland

regulation to liquidate their assets or to obtain Federal

deposit insurance from the Federal Home Loan Bank Board

(FHLBB).   CSL, a nonfederally insured Maryland savings and

loan, applied for deposit insurance issued by the Federal

Savings & Loan Insurance Corp. (FSLIC).

     In July 1985, the FHLBB informed CSL that it would

not approve CSL's application for FSLIC insurance.            As a

result, EPIC and its real estate partnerships, including
                                        - 86 -

EA 84-III and EA 83-XII, could no longer use CSL as a

source of funds necessary for their operations.                                     By

August 15, 1985, EA 83-XII and EA 84-III defaulted on their

respective obligations under the mortgages and deeds of

trust on the properties.              Shortly thereafter, EA 83-XII and

EA 84-III filed petitions in the U.S. Bankruptcy Court for

the Eastern District of Virginia.


Notices of FPAA Issued to EA 83-XII

       In the notices of FPAA issued to EA 83-XII for 1983,

1984, and 1985, respondent adjusted the ordinary income

reported by the partnership as shown below in the second

column for each year:

        EA 83-XII                       1983                         1984                           1985

Rent income                  $287,640      $287,640      $306,577           $306,577     $331,743          $331,743
Late charges                      548           548         -0-                -0-          -0-               -0-
Interest income                 9,344         9,344             90                 90       1,262             1,162
Miscellaneous                   -0-           -0-           -0-                -0-            883               883

  Total gross income          297,532          297,532    306,667            306,667      333,888           333,888

Interest (noninvestment)      466,358            -0-      539,893              -0-        560,177             -0-
Commissions                    25,460          25,460      21,950             21,950       24,846            24,846
Insurance                      27,744          27,744      16,438             16,438       18,992            18,992
Legal and professional fee        726             726       8,093              8,093          574               574
Repairs                         1,348           1,348      30,866             30,866       15,075            15,075
Taxes                          49,224          49,224      49,213             49,213       45,962            45,962
Utilities                         464             464       1,547              1,547          951               951
Homeowner dues                 20,620          20,620      20,620             20,620       25,350            25,350
Audit fee                       4,900           4,900       4,900              4,900        3,267             3,267
Points amortization            16,671           -0-        16,671              -0-         16,671              -0-
Property management            30,600          30,600     30,600              30,600       29,837            29,837
Real estate tax service         1,278           1,278       -0-                -0-          -0-                -0-
Miscellaneous                     107             107       -0-                -0-            856               856
Depreciation                  173,119           -0-       173,119              -0-        173,119              -0-
Bad debts                       -0-             -0-         1,l74              1,174        -0-                -0-
Amortization organization
  expense                       -0-             -0-         3,150              3,150        -0-                -0-
Recording fees                  -0-             -0-         -0-                -0-            24                 24
Service fee-EMI                 -0-             -0-         -0-                -0-         3,413              3,413

  Total expenses              818,619      162,471        918,234            188,551      919,114           169,147

  Total rent income          -521,087      135,061       -611,567            118,116     -585,226           164,741
                             - 87 -

Respondent also disallowed the investment interest expense

of $66,366 claimed on the 1983 return.

     The "explanation of items" attached to the notice of

FPAA for 1983 gives the following explanation of these

adjustments:


     INTEREST EXPENSE AND POINT AMORTIZATION

          *    *    *    *      *     *   *

     The deductions shown on your return as interest
     are not deductible because it has not been
     established that the amounts were for interest on
     a bona fide debt. Consequently, the partnership's
     taxable income is increased.

          *    *    *    *      *     *   *

     In the event that it is determined that there
     was an actual investment associated with the
     acquisition of the property or that there was
     genuine indebtedness on the property, then with
     respect to EPIC Associates 83-XII partnership
     for the taxable year 1983, this activity was not
     engaged in for profit and the allowability of
     interest expenses incurred is limited to the
     investment income of the taxpayer for the tax-
     able year. Consequently, all interest expenses
     relative to this activity are not allowable as
     deductions against ordinary income, but are
     separately stated items subject to the invest-
     ment interest limitations.

     DEPRECIATION

     The deductions shown on your return as
     depreciation are not deductible because it has
     not been established that a bona fide investment
     in depreciable property was made. Consequently,
     the partnership's taxable income is increased.
                             - 88 -

     In the event that it is determined that there was
     an actual investment associated with the
     acquisition of the property or that there was
     genuine indebtedness on the property, then with
     respect to the EPIC Associates 83-XII partner-
     ship for the taxable year 1983 [1984 and 1985],
     this activity was not engaged in for profit and
     only the following deductions are allowable:

             (1) The deductions which would be
             allowable for the taxable year without
             regard to whether or not such activity
             is engaged in for profit, and

             (2) a deduction equal to the amount
             of the deductions which would be
             allowable for the taxable year year
             [sic] only if such activity were
             engaged in for profit, but only to the
             extent that the gross income derived
             from such activity of the taxable year
             exceeds the deductions allowable by
             reason of paragraph (1) above.


The notices of FPAA for 1984 and 1985 are virtually

identical.

     Respondent made other adjustments to EA 83-XII's

returns for 1983, 1984, and 1985.     For taxable year 1983,

respondent disallowed the net investment loss of $341,010

reported for purposes of allocating tax preference items to

its partners, and respondent disallowed the excess expenses

from net lease property of $10,859 and the investment

interest income of $29,306.    For taxable years 1984 and

1985, respondent disallowed the qualified investment income

of $303,571 and $330,529, respectively, the qualified
                           - 89 -

investment expenses of $908,960 and $909,831, respectively,

and the investment interest income of $90 and $1,262,

respectively.   In support of these other adjustments, the

notices of FPAA issued to EA 83-XII state that "it has not

been established that there was an actual investment

associated with the acquisition of the property or that

there was genuine indebtedness on the property."   In

further support of these other adjustments, the notices

state that the activity of EA 83-XII for 1983, 1984, 1985,

and 1986 "was not engaged in for profit."


Notices of FPAA Issued to EA 84-III

     In the notices of FPAA issued to EA 84-III for 1983,

1984, and 1985, respondent adjusted the ordinary income

reported by the partnership as shown below in the second

column for each year:
                                         - 90 -
        EA 84-III                       1983                        1984                          1985

Rent income                   $80,124          $80,124   $228,516          $228,516    $230,130          $230,130
Interest                        -0-              -0-        -0-               -0-           494               494

  Total gross income           80,124           80,124    228,516           228,516     230,624           230,624

Interest (noninvestment)      118,082            -0-      522,466             -0-       545,848             -0-
Commissions                     5,305            5,305     23,198            23,198      19,403            19,403
Insurance                       5,480            5,480     16,663            16,663      19,894            19,894
Legal & professional fee        6,895            6,895        687               687       1,008             1,008
Repairs                         8,500            8,500     19,782            19,782     108,459           108,459
Taxes                          18,123           18,123     72,554            72,554      72,617            72,617
Utilities                       1,726            1,726     33,555            33,555       1,830             1,830
Homeowner dues                    998              998      3,993             3,993      12,353            12,353
Property management fee         8,250            8,250     33,000            33,000      32,175            32,175
Points amortization             3,453            -0-       13,814             -0-        13,814             -0-
Miscellaneous                     141              141        606               606         574               574
Audit fee                       -0-              -0-        5,000             5,000       3,333             3,333
Service fee                     -0-              -0-         -0-              -0-         3,197             3,197
Depreciation                   56,910            -0-      170,742             -0-       170,742             -0-

  Total expenses              233,863           55,418    916,060           209,038   1,005,247           274,843

Net rental income            -153,739           24,706   -687,544            19,478    -774,623           -44,219



The explanation of the above adjustments is virtually

identical to the explanation in the notices of FPAA issued

to EA 83-III, quoted above.

       Respondent made a number of other adjustments to

EA 84-III's returns for 1983, 1984, and 1985.                                  Respondent

disallowed the net investment loss of $141,142 and

investment interest income of $6,097 claimed in 1983.

Respondent disallowed qualified investment income of

$217,619 and qualified investment expenses of $872,376

claimed in 1984.           Respondent disallowed qualified

investment income of $229,131, qualified investment

expenses of $997,436, and investment interest income of

$494 claimed in 1985.            In support of these other

adjustments, the notices of FPAA state that "it has not
                           - 91 -

been established that there was an actual investment

associated with the acquisition of the property or that

there was genuine indebtedness in the property."    In

further support of the other adjustments, the notices state

that the activity of EA 84-III for 1983, 1984, 1985, and

1986 "was not engaged in for profit."


                           OPINION

     In the subject notices of FPAA, respondent disallowed

the interest and depreciation deductions that each part-

nership claimed on its tax returns for 1983, 1984, and

1985.   According to the notices of FPAA, the interest

deductions are disallowed because "it has not been

established that the amounts were for interest on a

bonafide [sic] debt."   Similarly, according to the notices

of FPAA, the depreciation deductions are disallowed because

"it has   not been established that a bona fide investment

in depreciable property was made."

     The interest deductions at issue consist principally,

but not entirely, of amounts paid or accrued with respect

to the nonrecourse promissory notes issued by each

partnership for the purchase of the residential properties

described above.   We sometimes refer to the subject

promissory notices as first mortgage notes.   The
                            - 92 -

depreciation deductions are based entirely on the portion

of the subject promissory notes that each partnership

claims as a basis in the residential properties purchased

with the notes.

     If none of the promissory notes constitutes a bona

fide debt, as determined by the notices of FPAA, it

follows, as discussed below, that no amount paid or accrued

with respect to any of the notes is deductible as interest

under section 163(a).    Furthermore, if none of the

promissory notes constitutes a bona fide debt, it also

follows that neither partnership incurred a cost in issuing

the notes and neither partnership obtained a basis in any

of the properties for depreciation purposes.    Thus, the

first issue for decision in these cases is whether any

of the nonrecourse promissory notes issued by either

partnership constitutes a bona fide debt.

     A portion of the interest deducted by both partner-

ships was for "points amortization".    These deductions

are based upon the loan origination fees paid by both

partnerships to EMI.    The partnerships treated these fees

as additional interest on the first mortgage notes and

amortized them over the life of the loans.    The second

issue for decision in these cases is whether the
                           - 93 -

partnerships are entitled to these deductions for points

amortization.

     The notices of FPAA also take the position that the

activity of each partnership for each of the tax years in

issue, 1983, 1984, and 1985, is an "activity not engaged

in for profit" within the meaning of section 183(c).     The

notices of FPAA state:   "the allowability of interest

expenses incurred is limited to the investment income of

the taxpayer for the taxable year."    Thus, according to the

notices of FPAA, if section 183 applies, then the interest

expenses of each partnership must be treated as investment

interest subject to limitation under section 163(d).     On

that basis, the adjustments to the subject returns would be

similar in amount to the adjustments determined under the

theory, described above, that neither partnership had

entered into a bona fide indebtedness during any of the

years in issue.

     The application of section 183 is not just an

alternative theory.   The notice of FPAA issued to

EA 84-III for 1985 relies on section 183 to disallow

net operating expenses of $44,219.    This is the amount

by which the deductions claimed by EA 84-III exceed the

partnership's gross income, after the deductions for

interest and depreciation are disallowed under the non-bona
                           - 94 -

fide indebtedness theory, described above.     Thus, we must

consider the application of section 183 no matter how we

decide the other issues.   This is the third issue for

decision in these cases.

     It appears that each partnership also deducted, as

interest, amounts paid or accrued during the years in issue

with respect to certain funds advanced to it by EPIC, as

general partner.   By implication, the notices of FPAA take

the position that any such unsecured advance made by EPIC

to either partnership did not create a bona fide

indebtedness of the partnership to EPIC and any amount

paid or accrued with respect to any such advance is not

deductible under section 163(a).     This is the fourth issue

for decision in these cases.

     It also appears that EA 84-III deducted, as interest,

amounts paid or accrued during 1985 with respect to 16

promissory notes issued to CSL.     Each of those promissory

notes was secured by a deed of trust on one of the

properties that had been purchased by EA 84-III in 1983.

As mentioned above, the notices of FPAA disallow all of the

interest deductions claimed by the partnerships on the

ground that the amounts deducted were not shown to have

been paid as interest on a bona fide debt.     Thus, the fifth

issue for decision in these cases is whether any of the 16
                             - 95 -

promissory notes issued by EA 84-III to CSL constitutes a

bona fide debt.


Nonrecourse Promissory Notes

     Generally, a taxpayer is allowed to deduct an amount

as interest under section 163(a) if the amount was paid or

incurred during the taxable year with respect to genuine

indebtedness.     See, e.g., Knetsch v. United States, 364

U.S. 361 (1960); Lukens v. Commissioner, 945 F.2d 92, 97

(5th Cir. 1991), affg. T.C. Memo. 1990-87; Fox v.

Commissioner, 80 T.C. 972, 1019 (1983), affd. sub nom.

Barnard v. Commissioner, 731 F.2d 230 (4th Cir. 1984);

Hager v. Commissioner, 76 T.C. 759, 773 (1981).    Similarly,

a taxpayer is allowed to include purchase money indebted-

ness in the basis of an asset for purposes of computing

the allowance for depreciation under section 167 if the

indebtedness is genuine indebtedness and represents an

actual investment in property.    See, e.g., Brannen v.

Commissioner, 722 F.2d 695, 701 (11th Cir. 1984), affg. 78

T.C. 471 (1982); Siegel v. Commissioner, 78 T.C. 659, 684

(1982).

     Indebtedness is not considered genuine, that is, a

true loan, if the facts show that the parties to the loan

did not intend the principal amount of the indebtedness to
                             - 96 -

be repaid in full.    See, e.g., Siegel v. Commissioner,

supra at 688.    In the case of nonrecourse indebtedness,

such as that involved in the instant cases, the

indebtedness is a lien that the debtor must satisfy

according to its terms in order to retain possession and

use of the encumbered property, but there is no fixed,

unconditional obligation of the debtor to pay.     See, e.g.,

Waddell v. Commissioner, 86 T.C. 848, 898 (1986), affd. 841

F.2d 264 (9th Cir. 1988).     However, the lack of personal

liability of the debtor, by itself, does not mean that

nonrecourse indebtedness will not be repaid, nor does it

disqualify the nonrecourse indebtedness from being

considered genuine.    See, e.g., Hager v. Commissioner,

supra at 773; Mayerson v. Commissioner, 47 T.C. 340, 351-

352 (1966).     A nonrecourse mortgage can be found to be

genuine indebtedness for tax purposes "on the assumption

that the mortgage will be repaid in full."     Commissioner v.

Tufts, 461 U.S. 300, 308 (1983).

     We have previously summarized the approaches taken by

the courts in determining whether a purported nonrecourse

liability is to be treated as true debt for Federal tax

purposes.   See, e.g., Waddell v. Commissioner, supra at

900-902; Fox v. Commissioner, supra at 1019-1021.     In Fox
                          - 97 -

v. Commissioner, supra at 1019-1021, we described these

approaches as follows:


          There are various approaches which may be
     taken in establishing whether a purchaser may
     treat a nonrecourse liability as a bona fide
     debt. One, originating in Estate of Franklin
     v. Commissioner, 544 F.2d 1045 (9th Cir. 1976),
     affg. 64 T.C. 752 (1975), indicates that when
     the amount of the aggregate purchase price
     unreasonably exceeds the value of the property
     securing the note (or when the principal amount
     of the note unreasonably exceeds the value of
     the property securing the note), the debt will
     not be recognized. In such instance, the
     purchaser acquires no equity in the property
     by making payments and, therefore, would have
     no economic incentive to pay off the note.
     Estate of Franklin v. Commissioner, supra at
     1048-1049. The Estate of Franklin analysis,
     comparing the purchase price and size of the
     note to the fair market value of the property
     at the time of purchase, originated in real
     estate transactions (see Estate of Franklin v.
     Commissioner, supra; Narver v. Commissioner,
     75 T.C. 53 (1980), affd. per curiam 670 F.2d
     855 (9th Cir. 1982); Beck v. Commissioner, 74
     T.C. 1534 (1980), affd. 678 F.2d 818 (9th Cir.
     1982)), but has also been applied to the
     purchase of cattle (see Hager v. Commissioner,
     supra), and, more recently, to movies (see
     Wildman v. Commissioner, supra; Siegel v.
     Commissioner, supra; Brannen v. Commissioner,
     supra).

          Another line of cases, in many ways compli-
     mentary to the above, more closely addresses
     the problem of bona fide loans where the sole
     security for such loans is a speculative asset
     with an undeterminable value at the time of
     purchase. This line of decisions holds that
     highly contingent or speculative obligations
     are not recognized for tax purposes until the
     uncertainty surrounding them is resolved. CRC
     Corp. v. Commissioner, 693 F.2d 281 (3d Cir.
                          - 98 -

    1982), revg. and remanding on other grounds
    Brountas v. Commissioner, 73 T.C. 491 (1979);
    Brountas v. Commissioner, 692 F.2d 152, 157 (1st
    Cir. 1982), vacating and remanding on other
    grounds 73 T.C. 491 (1979); Gibson Products Co.
    v. United States, 637 F.2d 1041 (5th Cir. 1981);
    Denver & Rio Grande Western R.R. Co. v. United
    States, 205 Ct. Cl. 597, 505 F.2d 1266 (1974);
    Lemery v. Commissioner, 52 T.C. 367, 377-378
    (1969), affd. on another issue 451 F.2d 173 (9th
    Cir. 1971); Inter-City Television Film Corp. v.
    Commissioner, 43 T.C. 270, 287 (1964); Albany Car
    Wheel Co. v. Commissioner, 40 T.C. 831 (1963),
    affd. per curiam 333 F.2d 653 (2d Cir. 1964).
    For example, in Lemery v. Commissioner, supra, we
    held that an obligation to pay $444,335.17 of the
    $1,131,000 stated purchase price of a business
    only out of future "net profits" was too
    contingent to be included in the purchaser’s
    amortizable basis. [Fn. refs. omitted.]


     Respondent takes the position in the instant cases

that none of the first mortgage notes issued by EA 83-XII

or EA 84-III is a bona fide debt because the aggregate

principal amount of the notes issued by each partnership

exceeds the aggregate fair market value of the property

securing the notes and, for that reason, neither

partnership had an incentive to repay the notes.   See,

e.g., Estate of Franklin v. Commissioner, 544 F.2d 1045

(9th Cir. 1976), affg. 64 T.C. 752 (1975).   Respondent does

not rely on a disparity between the purchase price of the

properties and their value, and neither respondent nor

petitioners address the question whether the value

comparison required under the Estate of Franklin line
                            - 99 -

of cases should be based upon the purchase prices of the

properties as opposed to the principal amounts of the

notes.   See Brannen v. Commissioner, 722 F.2d at 513

(Chabot, J., concurring).   Therefore, as framed by the

parties, the first issue in these cases is whether the

principal amount of the first mortgage notes issued by

each partnership unreasonably exceeds the value of the

properties securing the notes.

     Petitioners argue that "the fair market value of the

properties [purchased by each partnership] was at least

equal to the amount of the debt at the time it was

incurred."   They argue that the fair market value of

each of the subject properties is its contract price, as

established by a contemporaneous appraisal that was made

by an independent, unrelated appraiser.   The appraisals

reflect the sale of each property to an individual buyer,

rather than the bulk sale of all of the properties to a

single buyer.   Petitioners argue that the promissory note

issued to purchase each of the properties, based upon 85

to 95 percent of the contract price, is bona fide

indebtedness.

     Petitioners emphasize that "each of the nonrecourse

mortgages in the partnerships was insured by an unrelated
                            - 100 -

mortgage insurance company" and "was purchased by an

unrelated lender shortly after the loan was funded".

According to petitioners, the unrelated mortgage insurers

and the lenders who acquired the loans in the secondary

market each "had the incentive to ascertain that the value

of the properties was at least equal to the debt" and the

fact that they undertook to participate in the transactions

is "evidence that the fair market value of the properties

was at least equal to the amount of the debt at the time

it was incurred."    Petitioners argue that "the unrelated

lenders and insurers did due diligence" and, in fact "would

have exercised special caution with respect to such loans"

because of the unusual nature of the loans.      They further

argue that the facts show "that there was no attempt by

EPIC to conceal the facts."

     Petitioners acknowledge that the partnerships

purchased the properties with substantial discounts and

that the partnerships did not pay the contract price for

any of the properties purchased.      As stated in their

posttrial brief:    "common sense suggests that a large

and astute investor [such as EPIC] would demand price

concessions."   Thus, petitioners acknowledge that the

prices paid by each partnership reflected the discounts
                            - 101 -

or price concessions that a large buyer would expect

when buying "in bulk".   In fact, as discussed above,

EPIC negotiated with the sellers of the properties various

"discounts" in the aggregate amount of approximately 20

percent of the contract price of the properties.

Furthermore, the tax returns filed on behalf of each

partnership compute the partnership's cost basis for

each property under section 1012 as the contract price

of the property less the rental deficit contribution for

that property and claim depreciation on the portion of the

cost that was allocated to the improvements.   Petitioners

argue that the value of each of the subject properties is

equal to the contract price notwithstanding the fact that

each partnership paid a price that reflected discounts from

the contract price.   Petitioners argue that such discounts

"do not reduce the underlying value of any one item

purchased".

     Finally, petitioners argue that respondent's evidence

relating to the fair market value of the properties is

"rife with errors in assumptions and/or judgement and/or

application of concepts".   Petitioners ask the Court to

conclude that respondent's evidence is biased and not

worthy of consideration.
                           - 102 -

     Respondent argues that the 106 promissory notes issued

by EA 83-XII and EA 84-III should be disregarded for tax

purposes "because the debt substantially exceeded the fair

market value of the underlying property and lacked economic

substance."   According to respondent's posttrial brief:


          Respondent's appraisals reflect that the
     nonrecourse debt by EMI exceeds the actual values
     of EA83-XII's properties by 39.40% and the actual
     values of EA84-III's properties by 19.53% and
     that EA83-XII and EA84-III "overmortgaged" the
     106 properties to support nominal purchase prices
     that permitted Epic to receive substantial
     builder fees, rental deficit contributions, and
     rental advances.


Respondent explains the computation of the above

percentages as follows:


     Respondent's appraisals reflecting values
     totalling $2,658,600.00 for the properties
     acquired by EA83-XII demonstrate that the
     nonrecourse debt totalling $3,706,150.00
     originated by EMI exceeds the actual values
     by $1,047,550.00, or 39.40%. Respondent's
     appraisals reflecting values totalling
     $2,889,150.00 for the properties acquired by
     EA84-III demonstrate that the nonrecourse debt
     totalling $3,453,450.00 originated by EMI exceeds
     the actual values by $564,300.00, or 19.53%.


     According to respondent, EA 83-XII and EA 84-III

"overmortgaged" the 106 properties in order "to generate

substantial builder fees, rental deficit contributions, and

rental advances necessary to feed EPIC's ravenous appetite
                           - 103 -

for fees to enlarge and maintain EPIC's real estate

empire."   As an essential element of the "scheme",

respondent alleges that "EPIC secured inflated, faulty

appraisals to support the nonrecourse debt originated by

EMI to acquire the 106 properties."   In this connection,

respondent asserts that EPIC, through CAG "encouraged

outside appraisers to inflate values on properties acquired

by the partnerships", such as "by requesting appraisers to

value multiple properties purchased in bulk sales as if

purchased separately by different individuals."   As a

result, respondent argues, the nonrecourse debt issued by

EA 83-XII and EA 84-III to acquire the properties exceeded

the value of the properties.   Thus, respondent asserts:

"there was no incentive to repay the debt and the debt

lacked economic substance."

     Respondent also argues that the instant transactions

did not "involve unrelated parties and independent

appraisers establishing purchase prices."   Respondent

argues that the transactions "involved related parties"

and notes that EPIC, acting through its subsidiary, EMI,

"originated, serviced each nonrecourse loan, and was

primarily responsible for any due diligence related to

the loans."   Respondent claims that for at least six

properties acquired by EA 84-XII, EPIC, through two
                           - 104 -

subsidiaries "was both the seller and purchaser".

Respondent argues that the outside appraisers were not

independent because EPIC "influenced their appraisals with

guidelines and requests that precluded the use of bulk sale

methods in purchases of multiple units."    According to

respondent, "EPIC, through CAG, influenced the inflated

appraisals related to the properties and determined the

stated purchase price."

     Respondent also argues that the participation of

secondary lenders and mortgage insurers does not establish

that the value of the properties approximated the debt

because there is no evidence that they engaged in due

diligence.   According to respondent:   "the lack of due

diligence by secondary lenders and mortgage insurers

demonstrates that [the] lenders ignored or did not

understand the realities of the EPIC transactions."    At

the same time, respondent notes the fact that some mortgage

insurers refused to insure "newly-created debt on EPIC

properties."

     The following is a list of the 51 properties purchased

by EA 83-XII (viz 12 single-family residences and 39

condominium units) together with the amount of each loan,

the value of each property as determined by respondent's
                                         - 105 -

appraisers, and the loan to value ratio for each property,

computed using respondent's value:

EA 83-XII
                                                 Respondent's
     Address               Loan Amount              Value             Loan ÷ Value

1612 Hemphill Ave.             $54,525              $57,400               94.99
1921 West 17th St.              51,300                54,000              95.00
1728 Coronado Ave.              51,300                54,000              95.00
1700 Linda Ave.                 54,050                56,900              94.99
                                                    1
1716 Coronado Ave.              54,050                53,900             100.28
1916 Hollywood Dr.              53,200                56,000              95.00
1720 Coronado Ave.              56,425                59,400              94.99
2109 Avignon Dr.                84,525                84,000             100.63
2111 Avignon Dr.                85,025                85,000             100.03
2113 Avignon Dr.                95,475                91,000             104.92
2115 Avignon Dr.                95,475              100,500               95.00
2117 Avignon Dr.               101,175              106,500               95.00
                           2                    2
Paseos Castellanos           2,869,625            1,800,000              159.42
 (39 units)
        Total              3,706,150             2,658,600               139.40

     1
       At trial, respondent's appraiser conceded that this value should equal the
contract price of the property, $56,900.
     2
         This is the aggregate amount for all 39 condominium units.



Respondent's position is that the promissory notes issued

by EA 83-XII, comprising 51 of the 106 notes mentioned

above, should be disregarded for tax purposes because the

aggregate nonrecourse debt represented by those notes

exceeds the value of the properties by 39.40 percent.

         Similarly, the following is a list of the 55

properties purchased by EA 84-III (viz 14 single-family

residences and 41 condominium units) together with the

amount of each loan, the value of each property as

determined by respondent's appraisers, and the loan to

value ratio for each property, computed using respondent's

value:
                                               - 106 -
EA 84-III
                                                   Respondent's
    Address                        Loan Amount        Value       Loan ÷ Value

5419 Heronwood Dr.                   $51,300          $58,000        88.45
5411 Heronwood Dr.                    61,750           65,000        95.00
3518 Tower Hill La.                   60,550           55,000       110.09
12347 Northcliffe Manor Dr.           55,575           45,000       123.50
13066 Clarewood Dr.                   54,150           48,000       112.81
6351 S. Briar Bayou Dr.               58,425           47,000       124.31
12103 Kingslake Forest Dr.            57,475           46,000       124.95
12107 Kingslake Forest Dr.            47,975           38,000       126.25
12111 Kingslake Forest Dr.            53,200           40,000       133.00
12115 Kingslake Forest Dr.            60,800           52,000       116.92
12231 Carola Forest Dr.               56,050           54,000       103.80
4850 W. Ferret                        67,450           71,200        94.73
4107 Medical Dr. (Condo.)             56,950           56,400       100.98
13739 Earlywood Dr.                   60,800           57,600       105.56
6402 Ridgecreek Dr.                   60,800           55,950       108.67
                               1                  1
Reflections Condos                 2,590,200        2,100,000       123.34
 (40 Units)

   Total                           3,453,450       2,889,150        119.530

       1
            This is the aggregate amount for all 40 condominium units in the Reflections.



Respondent's position is that the promissory notes issued

by EA 84-III, comprising 55 of the 106 notes mentioned

above, should be disregarded for tax purposes because the

aggregate nonrecourse debt represented by those notes

exceeds the value of the properties by 19.53 percent.

       The above schedules show that respondent tests

whether the principal amount of the indebtedness exceeds

the value of the property securing it in the aggregate,

rather than loan by loan.                      If the value comparison were

made loan by loan, most of the loans issued with respect

to the single-family residences would approximate the

value of the property securing the loan, even using

respondent's values.                  For example, in the case of the 12

single-family residences acquired by EA 83-XII, as shown
                             - 107 -

in the schedule above, none of the loans issued by the

partnership materially exceeds the value of the related

property, as determined by respondent's appraisers.

Similarly, in the case of the properties acquired by EA

84-III, other than the Reflections condominium units, 7 of

the 15 loans issued by the partnership are 110 percent or

less of the value of the related property, as determined

by respondent's appraisers.    Nevertheless, respondent

determined that all of the loans issued by both partner-

ships are not bona fide because the aggregate principal

amount of the loans issued by each partnership exceeds the

aggregate value of the properties by 39.4 percent in the

case of EA 83-XII and 19.53 percent in the case of EA 84-

III.   Petitioners do not take issue with this aspect of

respondent's approach and the parties do not address the

issue whether the value comparison should be made in the

aggregate or loan by loan.

       In these cases, we must determine whether the fair

market value of the properties acquired by each partner-

ship is more or less than the principal amount of the debt

that was incurred by the partnership in purchasing the

properties.   For purposes of making this comparison, we

must determine the fair market value of the properties as

of the time they were acquired by each partnership.    See,
                           - 108 -

e.g., Bailey v. Commissioner, 993 F.2d 288, 293 (2d Cir.

1993), affg. T.C. Memo. 1992-72; Lebowitz v. Commissioner,

917 F.2d 1314, 1318 (2d Cir. 1990), revg. and remanding

T.C. Memo. 1989-178.   In the case of EA 83-XII, we must

determine the fair market values of the properties as of

December 1982; and, in the case of EA 84-III, we must

determined the fair market values of the properties as of

September 1983.

     The fair market value of an item of property is "the

price at which the property would change hands between a

willing buyer and a willing seller, neither being under

any compulsion to buy or to sell and both having reason-

able knowledge of relevant facts."   E.g., United States

v. Cartwright, 411 U.S. 546, 551 (1973); Narver

v. Commissioner, 75 T.C. 53, 96 (1980), affd. per curiam

670 F.2d 855 (9th Cir. 1982); McShain v. Commissioner, 71

T.C. 998, 1004 (1979); see sec. 1.170A-1(c)(2), Income Tax

Regs.; sec. 20.2031-1(b), Estate Tax Regs.; sec. 25.2512-

1, Gift Tax Regs.   This is a question of fact to be

determined from an examination of the entire record.    See,

e.g., Lio v. Commissioner, 85 T.C. 56, 66 (1985), affd.

sub nom. Orth v. Commissioner, 813 F.2d 837 (7th Cir.

1987); McShain v. Commissioner, supra at 1004.
                             - 109 -

     The fair market value of real property is based on

the highest and best use to which the property could be

put on the date of valuation.    See, e.g., Frazee v.

Commissioner, 98 T.C. 554, 563 (1992); Symington v.

Commissioner, 87 T.C. 892, 896 (1986); Stanley Works v.

Commissioner, 87 T.C. 389, 400 (1986).   Generally, the

highest and best use of a parcel of property is the

reasonable and probable use of the property that supports

the highest present value.    See Frazee v. Commissioner,

supra at 563; Symington v. Commissioner, supra at 896-897.

In determining the highest and best use of the property,

it is necessary to consider the realistic, objective

potential uses for which the property is adaptable and

needed or likely to be needed in the foreseeable future.

See Stanley Works v. Commissioner, supra at 400.    See

generally Olson v. United States, 292 U.S. 246, 255-256

(1934).

     In the process of establishing the fair market value

of an item of property on the basis of its highest and

best use, it is sometimes necessary to consider the most

appropriate market through which the property would change

hands from a willing seller to a willing buyer.    See,

e.g., Akers v. Commissioner, 799 F.2d 243 (6th Cir. 1986),

affg. T.C. Memo. 1984-490; Anselmo v. Commissioner, 757
                          - 110 -

F.2d 1208 (11th Cir. 1985), affg. 80 T.C. 872 (1983); cf.

United States v. Cartwright, supra at 551-552.   In

identifying what market to use in estimating the value of

an item of property, we have looked to the regulations

promulgated under the estate and gift taxes, see sec.

20.2031-1(b), Estate Tax Regs.; sec. 25.2512-1, Gift Tax

Regs., which provide that the fair market value of an item

of property is the sales price of the item in the market

in which such item is "most commonly sold to the public."

See, e.g., Goldstein v. Commissioner, 89 T.C. 535, 544

(1987); Lio v. Commissioner, supra at 66; Orth v.

Commissioner, 813 F.2d 837 (7th Cir. 1987); Skripak v.

Commissioner, 84 T.C. 285, 321-322 (1985); Anselmo v.

Commissioner, 80 T.C. at 881-882.

     In applying the estate and gift tax regulations to

ascertain the fair market value of an item of property

for purposes of computing the amount of a charitable

contribution deduction, the Court of Appeals in Anselmo

v. Commissioner, 757 F.2d at 1214, noted the following:


          Rules governing valuations for charitable
     contributions of property are distinguishable
     from valuations in the estate and gift context
     because the taxpayer has the opposite incentives
     in the two situations: the taxpayer wants to
     reduce the value of property for estate and gift
     tax purposes but, as here, the taxpayer wishes
     to inflate the value of property for charitable
                           - 111 -

      donation purposes. The estate and gift tax
      regulations are aimed at preventing abusive
      undervaluation of property; the regulations
      governing charitable contributions are not.
      In the usual case, however, there should be no
      distinction between the measure of fair market
      value for estate and gift tax and charitable
      contribution purposes. Cf. Champion v.
      Commissioner, 303 F.2d 887, 892-93 (5th Cir.
      1962). * * *


Thus, the Court of Appeals noted that the estate and gift

tax regulations were not a perfect fit in considering the

charitable deduction in that case because the taxpayers

had an incentive to inflate the value of the property,

whereas "the estate and gift tax regulations are aimed at

preventing abusive undervaluation of property".   Id.    The

same is true in the instant cases.   Nevertheless, we also

agree with the Court of Appeals that "there should be no

distinction between the measure of fair market value".

Id.; see also United States v. Parker, 376 F.2d 402, 408

(5th Cir. 1967); Skripak v. Commissioner, supra at 322 n.

30.   Finally, we agree with the Court of Appeals that

selection of the proper market for valuation purposes is a

question of fact.   See Anselmo v. Commissioner, 757 F.2d

at 1213.

      A sale to the public is a sale to the ultimate

consumer of the property, that is, a sale to one of a

group of persons who do not purchase the item for resale.
                           - 112 -

See, e.g., Goldstein v. Commissioner, supra at 545-546;

Lio v. Commissioner, supra at 70.    In the normal

situation, a sale to the ultimate consumer is a sale to

a retail customer.   See Lio v. Commissioner, 85 T.C. at

66; Anselmo v. Commissioner, 80 T.C. at 882.    This is not

invariably the case, however, because the term "public"

refers to the "customary purchasers" of an item of

property and not necessarily to individual consumers.

Anselmo v. Commissioner, 757 F.2d at 1214.    In Anselmo

the Court of Appeals noted, for example, that the

buying public for live cattle comprises primarily

slaughterhouses, rather than individual consumers.    See

id.   Therefore, in Anselmo, the Court of Appeals agreed

with the finding of this Court that the market for low

quality, unmounted gems was the market in which jewelry

manufacturers and jewelry stores purchase stones to create

jewelry items, rather than the retail market in which

individual purchasers buy finished jewelry.    Similarly, in

Akers v. Commissioner, supra at 246, the court found that

the market for a tract of land containing approximately

1,250 acres was the market for large tracts of over 1,000

acres and not the market for properties averaging less

than a tenth that size.   The court noted that the

"ultimate consumer" of a 50-acre lot "does not normally
                           - 113 -

have the time, inclination, expertise or capital to buy a

tract of land 10 or 20 times as big as the one he wants,

with a view to subdivision and sale of the excess."     Id.

     The above cases may be contrasted with Goldman v.

Commissioner, 388 F.2d 476 (6th Cir. 1967), affg. 46 T.C.

136 (1966), in which the fair market value of 151 bound

volumes of medical journals that had been contributed to a

hospital was at issue.   The court held that the fair market

value should be computed "on the price an ultimate consumer

would pay", i.e., valued at retail, and further held that

"what might be paid by a dealer buying to resell is not a

proper consideration."   Id. at 478.    In Akers v.

Commissioner, 799 F.2d at 247, the court reconciled that

case with the others by noting that, unlike the unmounted

gems in Anselmo and unlike the undivided land in Akers, the

medical journals in Goldman "had already been 'subdivided,'

in effect" and "were ready for immediate sale in the retail

market and were not so expensive as to suggest that no

retail buyer for them could have been found."

     The appropriate market for estimating the value of an

item of property may sometimes be the market in which the

taxpayer purchased the property.     For example, in Lio v.

Commissioner, 85 T.C. 56 (1985), the taxpayers purchased

large quantities of lithographs and donated them to a
                            - 114 -

charitable organization 9 months later, claiming a

charitable deduction of approximately three times the

amount paid, and in Goldstein v. Commissioner, 89 T.C. 535

(1987), the taxpayers purchased posters and other art and

donated them to a charitable organization 4 days later,

claiming a charitable deduction of approximately twice the

present value of the consideration paid.    The taxpayers in

each case asked us to value the property by looking to the

prices charged by galleries and dealers to their retail

customers.    In defining the appropriate market and the

ultimate consumer for the property in those cases, we gave

particular attention to three factors:    (1) Whether the

buyers purchased the item of property for resale; (2)

whether the buyers received special discounts in the

purchase price; and (3) whether the sellers made

substantial sales of the same type of property.    See id.

at 545-546.    We found that the taxpayers had not purchased

the property for resale, they had received no special

discounts, and they had purchased from dealers who were

responsible for a substantial portion of the total retail

sales of the property.    Thus, contrary to the taxpayers'

position, we found that the appropriate market for valuing

the property at issue in both cases was the market in which

the taxpayers had purchased the property, and that the
                            - 115 -

taxpayers were the ultimate consumers of the property.

Accordingly, we looked to the price paid by the taxpayers

as the fair market value of the property.   See also Klaven

v. Commissioner, T.C. Memo. 1993-299; Weiss v. Commis-

sioner, T.C. Memo. 1993-228; Rhode v. Commissioner, T.C.

Memo. 1990-656; Weintrob v. Commissioner, T.C. Memo. 1990-

513, opinion modified T.C. Memo. 1991-67, affd. and

remanded without published opinion sub nom. Wagner v.

Commissioner, 31 F.3d 1175 (3d Cir. 1994); Broad v.

Commissioner, T.C. Memo. 1986-340.

      At the outset of our consideration of the instant

cases, it is helpful to note several points about the

positions of the parties.   First, respondent's appraisers

valued the single-family houses and one condominium unit

on a different basis than they used to value the other 79

condominium units.   According to respondent's brief,

respondent's appraisers valued the single-family houses

acquired by each partnership and one of the condominium

units purchased by EA 83-III on a "retail" basis; that

is:   "As if the properties were purchased separately by

individuals."   Respondent's brief describes the appraisals

of 14 of the single-family houses and the condominium unit

at 4107 Medical Drive as follows:
                           - 116 -

     Respondent's appraisals, which were performed 11
     to 13 years after EA83-XII and EA84-III acquired
     the properties, reflect retail values of the
     houses at 2109, 2111, 2115, and 2117 Avignon
     Drive in Carrollton, the seven houses in Odessa
     [viz, 1612 Hemphill Avenue, 1921 West 17th
     Street, 1728 Coronado Avenue, 1700 Linda Avenue,
     1716 Coronado Avenue, 1916 Hollywood Drive, and
     1720 Coronado Avenue], the two houses at 5411 and
     5419 Heronwood Drive in Humble, the condominium
     at 4107 Medical Drive in San Antonio, the house
     at 4850 W. Ferret Drive in Tucson as if the
     properties were purchased separately by
     individuals. [Emphasis supplied.]


Similarly, respondent's brief describes the appraisals of

the other 12 single-family houses as follows:


     Respondent's appraisals, which were performed 11
     to 13 years after EA83-XII and EA84-III acquired
     the properties, reflect retail values for the
     residences at 2113 Avignon in Carrollton, 13739
     Earlywood Drive and 6402 Ridgecreek Drive in San
     Antonio, and 3518 Tower Hill Lane, 12347
     Northcliffe Manor Drive, 13066 Clarewood Drive,
     6351 S. Briar Bayou, 12231 Carola Forest Drive,
     and 12103, 12107, 12111, and 12115 Kingslake
     Forest Drive in Houston as if purchased
     separately by individuals. [Emphasis supplied.]


     On the other hand, respondent's appraisers valued the

condominium units acquired by each partnership (other than

the condominium unit at 4107 Medical Drive) on a

"wholesale" basis; that is, as if the purchase consisted

"of multiple properties purchased in bulk sales from the

same builder."   Respondent's brief states as follows:
                           - 117 -

          Respondent's appraisals of the 39 units in
     Miami and 40-unit complex in San Antonio, which
     were performed 11 to 13 years after EA83-XII and
     EA84-III acquired the properties, reflect the
     wholesale value of multiple properties purchased
     in bulk sales from the same builder. [Emphasis
     supplied.]


     Second, according to respondent's brief, the

difference between the retail value of each single-family

property, as determined by respondent's appraisers, and

the wholesale value of that property is the amount of the

rental deficit contribution.   Respondent's brief states

as follows:


     because each of the [single family] properties
     was purchased by Epic in purchases involving
     multiple houses from the same builder, a discount
     in the amount of the rental deficit contribution
     of approximately 20% to the retail value is
     appropriate to arrive at the wholesale value of
     each property. * * *


     The above statement echoes the opinion of

respondent's appraisers, Messrs. Dalton and Ramos, who

valued the Reflections condominium complex that was

purchased by EA 84-III.   In a memorandum that accompanied

their appraisal, Messrs. Dalton and Ramos describe the

difference between the wholesale and retail values of

the properties as the amount of the rental deficit

contribution.   The memorandum states as follows:
                          - 118 -

     4.   Another way to view the RDC [i.e., rental
          deficit contribution] is as the difference
          between the properties [sic] retail price
          over its wholesale price. As discussed
          above, the sum of the parts is much greater
          than the whole. By selling the properties
          individually, the owner receives the greater
          retail price, while he would get only a
          wholesale price if he sold all of the
          properties to a single investor in one
          transaction. That is, multiple purchases
          from the same builder demand a wholesale
          price. The discount would be in the range
          of the RDC, or a 20%-25% reduction of the
          retail price of each unit if sold
          separately. The percentage reduction is
          supported in the 40-Unit Condominium Complex
          appraisal (TAB C). The indicated wholesale
          value was estimated at $2,100,000. EPIC
          financed the property based on a projected
          retail sale of the property of $3,000,000.
          The wholesale value is 30% lower than EPIC’s
          projected retail value.

     5.   The 40-Unit Condominium Complex (TAB C) was
          valued at wholesale as this was the market
          for these types of properties. The values
          obtained for the single-family houses in
          TAB's A and B of this report reflect the
          retail fair market value of the properties.
          Multiple sales of single-family houses were
          not plentiful at the date of value and at
          the present date they are very obscure. A
          discount, in the approximate amount of the
          RDC, for each single-family property is
          required if these house were sold wholesale,
          i.e., grouped with a multitude of other
          houses, in one transaction to a single
          investor. The RDC was chosen as a discount
          from retail to wholesale based on the
          discussion presented in (4) above.


     Significantly, respondent does not appear to take

the position that the builder fees and rent advances are
                           - 119 -

additional discounts that must be applied to the retail

value of the property in computing its wholesale value.

In this connection, we note the fact that the builder

fees were treated as having been paid by the seller to

EPIC, as opposed to the partnership, and were reported as

income by EPIC, and the fact that the rent advances were

treated as rents and were included in the gross income of

each partnership.

     In summary, respondent's position is that valuing the

subject properties as if sold to separate individuals

yields the retail value of the properties, whereas valuing

them as if purchased in a bulk sale yields the wholesale

value of the properties.   Furthermore, according to

respondent, the difference between the retail value and the

wholesale value of a particular property is the discount

that EPIC negotiated with each of the sellers, referred to

as the rental deficit contribution.   Both of these

positions are set forth in the memorandum written by

Messrs. Dalton and Ramos, the relevant portion of which is

quoted above.

     Third, the appraisals that were obtained pursuant to

EPIC's contracts with the sellers at the time EA 83-XII and

EA 84-III purchased the subject properties (referred to

herein as the contemporaneous appraisals) valued all of the
                          - 120 -

properties without discount as if each property were

sold separately to an individual purchaser.   To use

respondent's terminology, all of the contemporaneous

appraisals valued the properties, both single-family

houses and condominiums, on a retail basis.   They did

not value the subject properties on a wholesale basis;

that is, as if purchased in bulk by a single person.

     Thus, in valuing the single-family homes and the

condominium unit at 4107 Medical Drive, all of the

appraisers used the retail market.   In valuing the other

79 condominiums, on the other hand, respondent's appraisers

used the wholesale market and the contemporaneous

appraisals used the retail market.

     Fourth, in valuing the subject properties, none of the

parties relies upon the values that were established in the

contracts between EPIC and the sellers of the properties.

Petitioners argue that the transactions were arm's-length

transactions between unrelated parties, but they take the

position that the value of each property is its contract

price, rather than the discounted price that the

partnership actually paid for the property.   On the other

hand, respondent argues that the value of each property is

a discounted price, as determined in respondent's
                           - 121 -

appraisals, but not the discounted price that the

partnership actually paid for the property.

     EPIC negotiated the purchase of the subject properties

on behalf of EA 83-XII and EA 84-III from five developers,

Fox & Jacobs, Raldon, Babcock, U.S. Home, and Pitman &

Japhet.   The contracts between EPIC and each of the sellers

followed a similar pattern.   Each contract set forth a

purchase price for each property, referred to herein as the

contract price, that was based on the prices that the

seller had received from sales of similar properties to

individual retail purchasers.   The contract provided that

the seller would "pay" an amount negotiated between EPIC

and the seller called the rental deficit contribution.    The

seller agreed to "pay" this amount to the purchaser, the

limited partnership.   The contract further provided that

the seller would pay to EPIC a commission of 6.8 percent of

the contract price and, under certain conditions, would

prepay rent to the purchaser.

     In negotiating these contracts with EPIC, each seller

was principally interested in the amount that it would net

after the above discounts and fees.   A representative of

one seller, Babcock, testified that his concern was the

"bottom line" or "minimum number" and that he permitted

EPIC to structure the discounts and fees.
                           - 122 -

     There is nothing in the record of either of the

subject cases to suggest that the business interests of

EPIC and both limited partnerships were not adverse to the

business interests of each of the five developers, nor is

there anything to suggest that EPIC and the partnerships

did not deal with those companies at arm's length.

Respondent does not suggest otherwise.   In asserting that

"the transactions * * * involved related parties",

respondent focuses on EMI, the company affiliated with EPIC

that originated the loans, and on CAG, the affiliated

appraisal company that obtained contemporaneous appraisals

in many cases.   The activities of those companies, however,

did not establish the prices of the properties.    That was

done through negotiation between EPIC, the willing buyer,

and each of the five developers, the willing seller.

     Generally, where there is evidence that parties having

adverse economic interests have dealt at arm's length and

have assigned a value to certain property, that evidence is

viewed as the most reliable basis for a determination of

fair market value of the property.   See, e.g., Siegel v.

Commissioner, 78 T.C. at 687; Narver v. Commissioner, 75

T.C. at 97; McShain v. Commissioner, 71 T.C. at 1004;

Ambassador Apts., Inc. v. Commissioner, 50 T.C. 236, 243-

244 (1968), affd. 406 F.2d 288 (2d Cir. 1969).    In the
                                         - 123 -

instant cases, the values assigned to the properties at

issue under EPIC's contracts with the sellers are the

discounted purchase prices paid for the properties.                                 To use

respondent's terminology, these values are the wholesale

values of the properties.                 The following schedule shows the

aggregate contract prices of the properties purchased by

each partnership, less the aggregate rental deficit

contributions, the aggregate builder fees, and the

aggregate rent advances and compares the net amount to

respondent's valuation:
                                                  Single
              EA 83-XII Properties                Family        Condos             Total

Aggregate contract prices                      $880,595       $3,020,700     $3,901,295
  Less: Aggregate rental deficit contributions   67,643          587,676        655,319
  Less: Aggregate builder fees                   55,993          205,408        261,401
  Less: Aggregate rent advances                  17,557           68,625         86,182

Contract prices less discounts, fees,
  & advances                                      739,402      2,158,991         2,898,393

Respondent's valuation                            858,600      1,800,000         2,658,600


                                                  Single
              EA 84-XII Properties                Family1       Condos             Total

Aggregate contract prices                         908,700      3,048,000     3,956,700
  Less: Aggregate rental deficit contributions    122,873        632,414       755,287
  Less: Aggregate builder fees                     61,792        207,264       269,056
  Less: Aggregate rent advances                    22,425         62,640        85,065

Contract prices less discounts,
 fees, & advances                                 701,610      2,145,682     2,847,292

Respondent's valuation                            789,150      2,100,000     2,889,150

     1
         Includes the condominium at 4107 Medical Drive in San Antonia, Texas.



     Single-Family Houses and the Condominium at 4107
Medical Drive

         As discussed above, all of the appraisals, including

respondent's, valued the single-family houses and the
                           - 124 -

condominium unit at 4107 Medical Drive on a retail basis.

The reason for this in the case of the single-family houses

was suggested in the memorandum of respondent's appraisers,

Messrs. Dalton and Ramos, quoted above, when they stated:

"Multiple sales of single-family houses were not plentiful

at the date of value and at the present date they are very

obscure."   In effect, it appears that there was not a

market for multiple sales of single-family houses in 1982

and 1983 when the properties were purchased.

     Furthermore, respondent used the retail value of the

single-family houses and the condominium unit at 4107

Medical Drive in computing the percentages and arguing that

the aggregate nonrecourse debt exceeded the value of the

properties by 39.40 percent in the case of EA 83-XII and

19.53 percent in the case of EA 84-III.   Respondent does

not argue that the single-family houses and the condominium

unit at 4107 Medical Drive should be valued on a wholesale

basis.   Thus, it appears that respondent agrees with

petitioners that these properties should be valued on a

retail basis.   Accordingly, we shall review the evidence

in the record to determine the retail value of the single-

family houses and the condominium at 4107 Medical Drive.

     The partnerships purchased a total of 26 single-family

houses and the condominium unit at 4107 Medical Drive.    As
                           - 125 -

to 19 of these 27 properties, the difference between the

principal amount of the debt and the fair market value

determined by respondent's appraisers is not material.

This is certainly true in the case of the 12 single-family

properties purchased by EA 83-XII.   According to

respondent's appraisers, the aggregate value of the 12

properties is $858,600, or $22,075 more than the aggregate

principal amount of the loans, $836,525.   Similarly,

according to respondent's appraisers, the difference

between the value of 6 of the 14 single-family properties

and the condominium unit at 4107 Medical Drive purchased

by EA 84-III and the principal amount of the loan is less

than 10 percent.   As to these 19 properties, therefore,

there is no appreciable difference in the result of the

value comparison depending on whether we use respondent's

valuation or the contract prices of the properties.

     The single-family residences as to which, according to

respondent's appraisers, there is a material difference

between the value of the property, and the principal amount

of the debt are the following:
                               - 126 -

EA 84-III
                                         Respondent's
            Property            Loan        Value       Loan ÷ Value

     3518 Tower Hill Ln.       $60,550    $55,000          110.09
     12347 Northcliff Manor     55,575     45,000          123.50
     13066 Clarewood Dr.        54,150     48,000          112.81
     6351 S. Briar Bayou Dr.    58,425     47,000          124.31
     12103 Kingslake Forest     57,475     46,000          124.95
     12107 Kingslake Forest     47,975     38,000          126.25
     12111 Kingslake Forest     53,200     40,000          133.00
     12115 Kingslake Forest     60,800     52,000          116.92


     Petitioners' evidence regarding the above eight

properties includes contemporaneous appraisals of the

properties and testimony of the appraiser, Mr. Paul Lang,

regarding the general nature of his appraisals for EPIC.

Mr. Lang is a licensed real estate appraiser in the State

of Texas and a senior resident associate (SRA) of the

Appraisal Institute.      He appraised each of the subject

eight properties at the time EA 84-III purchased it in

1983.

     Mr. Lang's appraisals of the above single-family

properties were made on FHLMC/FNMA forms, as required by

EPIC's contract with the seller, U.S. Home.         Those forms

state as follows:      "This appraisal is based upon the * * *

market value definition * * * stated in FHLMC Form 439

(Rev. 10/78) and FNMA Form 1004B (Rev. 10/78)".         That

definition of market value is as follows:


     DEFINITION OF MARKET VALUE: The highest price in
     terms of money which a property will bring, in a
     competitive and open market under all conditions
                          - 127 -

     requisite to a fair sale, the buyer and seller,
     each acting prudently, knowledgeably and assuming
     the price is not affected by undue stimulus.
     Implicit in this definition is the consummation
     of a sale as of a specified date and the passing
     of title from seller to buyer under conditions
     whereby: (1) buyer and seller are typically
     motivated; (2) both parties are well informed
     or well advised, and each acting in what he
     considers his own best interest; (3) a reasonable
     time is allowed for exposure in the open market;
     (4) payment is made in cash or its equivalent;
     (5) financing, if any, is on terms generally
     available in the community at the specified date
     and typical for the property type in its locale;
     (6) the price represents a normal consideration
     for the property sold unaffected by special
     financing amounts and/or terms, services, fees,
     costs, or credits incurred in the transaction.
     ("Real Estate Appraisal Terminology," published
     1975.)


     Mr. Lang used both the sales comparison and the cost

approach in valuing the subject properties.   In the case of

each of the properties, Mr. Lang concluded that the market

value of the property was equal to its contract price.   At

trial, Mr. Lang testified that his appraisals were

independent and objective, and that he had inspected each

of the properties at the time of the appraisal.   The

appraisal forms provide support for this testimony.

Mr. Lang made notations on the appraisal forms describing

specific work on certain of the properties that had to be

completed for the valuation to be accurate.   Mr. Lang

testified that the copies of his appraisals which are in
                          - 128 -

evidence are incomplete in that there is no map showing the

comparable sales used in his analysis.   The addresses and

sale prices for the properties that he used as comparables

appear on the forms.

     Respondent's appraiser, Mr. Charles Brown, a valuation

engineer employed by the Internal Revenue Service,

appraised a number of single-family properties purchased by

EA 84-III, including the eight properties listed above.    At

the time of his testimony, Mr. Brown had applied for but

had not received the Appraisal Institute's designation as

SRA, and he was not licensed as a real estate appraiser in

Texas.

     The definition of fair market value used by Mr. Brown

is the following:


     The most probable price, as of a specified date,
     in cash, in terms equivalent to cash, or in other
     precisely revealed terms, for which the specified
     property rights should sell after reasonable
     exposure in a competitive market under all
     conditions requisite to a fair sale, with the
     buyer and seller acting prudently, knowledgeably,
     and for self-interest, and assuming that neither
     is under undue duress.


Thus, Mr. Lang's appraisals are based upon a definition

of market value formulated in terms of "the highest price",

as contained on the FHLMC/FNMA forms, and Mr. Brown's
                            - 129 -

appraisals are based upon a definition of market value

formulated in terms of "the most probable price".

     We note that the definition of market value of real

property formulated in terms of "the most probable price",

as contained on the FHLMC/FNMA forms, was not used in

FHLMC/FNMA forms until 1986.   Announcement 86-11, made by

FNMA on April 24, 1986, describes the new wording of the

definition, effective for appraisals completed on and after

July 1, 1986, as follows:


     It also defines the market value as the "most
     probable price which a property should bring
     * * *" as opposed to the "highest price which a
     property will bring * * *" in the old version.
     This change recognizes that the market value of
     a property usually falls within a range and that
     the indicated value is an estimate which should
     not necessarily be at the highest portion of
     that range. [Emphasis supplied.]


     Mr. Brown's report states generally that the value of

single-family residences in the Houston, Texas, area

decreased significantly after 1983.   His report states as

follows:


     These homes closely followed the prevalent
     Houston area real estate trends during the early
     1980's. Values increased dramatically until 1983
     when values declined sharply for the next 3 to 6
     years.
                            - 130 -

     Mr. Brown appraised the houses in 1995, 12 years after

the sales at issue, using both the comparable sales and

cost methods.    Mr. Brown testified that he inspected the

exterior of each house appraised, and that he reviewed the

records at the Harris County Appraisal District and at Baca

Landata, a company located in Houston, Texas, which assists

taxpayers in dealing with the Harris County Appraisal

District.

     Mr. Brown's approach is illustrated by his appraisal

of the property at 3518 Tower Hill Lane.    That property

is located on a cul-de-sac in the Northcliffe Manor

subdivision approximately 12 miles northwest of downtown

Houston.    It consists of a 1,331-square-foot house and

garage built in 1983 on a 5,775-square-foot lot.

     Mr. Brown employed the comparable sales approach and

the cost approach to value this property.    He identified

four comparable sales, two sales of comparable houses in

1983 and two sales in 1987.    He then used a "comparable

sales adjustment grid" to adjust the sale price of each of

the comparables to account for differences in the date of

sale, location, lot size, size of the improvements, and

year built.    After determining the adjusted fair market

value of each of the comparables, Mr. Brown divided the

adjusted value of each property by the square footage of
                           - 131 -

the improvements to arrive at the fair market value per

square foot of the comparable.

     For example, Mr. Brown determined that the fair market

values per square foot of the two comparable sales in 1983

were $56.21 and $54.40.   He found that the fair market

values per square foot of the two comparable sales in 1987

were $40.98 and $38.14.   Mr. Brown then chose the

relatively low value of $40 per square foot as the market

value in 1983 of the subject house, referred to in the

appraisal report as Tract I.   Mr. Brown's report explains

his choice as follows:


     After the adjustments are made, the fair market
     value of Tract I falls in the range of $38 to $56
     per square foot in 1983. Since Tract I is one of
     the largest homes in the subdivision, it shall
     command a loan value per square foot, say $40.


We note that the size of the improvements was already taken

into account in the comparable sales adjustment grid.

     Mr. Brown multiplies this value by the square footage

of the improvements on Tract I and estimates that the fair

market value of the property, on the basis of the sales

comparison approach, is $53,200.     After further adjusting

the value   by his estimate of the cost to reproduce the

house, Mr. Brown's final estimate of the fair market value

of the property is $55,000.
                           - 132 -

     It appears that Mr. Brown's appraisal is too low.     One

of the comparable sales in 1983 is a house located on the

same cul-de-sac as the subject property, 3510 Tower Hill

Lane.   That property was 116 square feet smaller and was

sold for $64,400 ($53 per square foot) to an unrelated

buyer in the same month that the partnership purchased the

subject property.   This is $9,400 more than Mr. Brown's

appraised value of its larger neighbor.    Similarly, a

second comparable that was 173 square feet smaller than

the subject property sold in September 1983 for $62,500.

     In valuing the 11 properties that are the subject of

his report, Mr. Brown used a total of 15 comparable sales,

8 from 1983, 1 from 1982, and 6 from 1987.    In applying the

comparable sales approach, Mr. Brown followed the same

approach in valuing the 11 properties.    As to each of the

properties, he reviewed three to five of the comparables.

He adjusted the sales prices of the comparables for age,

location, and size, as described above, and computed an

adjusted fair market value per square foot of the

comparable.   He then selected a value per square foot that

represented his opinion of the fair market value of the

subject property.

     Set out below is a summary, for each of the subject

properties, of the fair market values per square foot of
                                                  - 133 -

the comparables that were sold in 1982 or 1983, the fair

market values per square foot of the comparables that were

sold in 1987, and the fair market value per square foot

that was selected by Mr. Brown as the value of the subject

property:
                                       Adjusted FMV Per Sq. Ft. of       Adjusted FMV Per Sq. Ft.    Subject Property
 EA 84-III Properties     Tract      Comparable Sales in 1982 & 1983   of Comparable Sales in 1987   FMV Per Sq. Ft.


3518 Tower Hill Ln.           I         $54.40     $56.21      -0-            $40.98      $38.14             $40
12347 Northcliff Manor Dr.    II         44.73      48.64      -0-             35.89       31.77              35
13066 Clarewood Dr.           III        50.40      38.35      -0-             32.43        -0-               35
6351 S. Briar Bayou Dr.       IV         52.91      42.66      -0-             34.07        -0-               30
12231 Carola Forest Dr.       V          48.97      56.18    $57.12            30.87       35.31              40
12115 Kings Lake Forest Dr.   VI         49.47      56.82     57.70            31.20       35.63              35
12111 Kings Lake Forest Dr.   VII        44.70      51.60     52.51            28.29       32.27              35
12107 Kings Lake Forest Dr.   VIII       44.70      51.60     52.51            28.29       32.27              35
12103 Kings Lake Forest Dr.   IX         47.09      56.82     55.06            29.78       33.95              35
5419 Heronwood Dr.            X          45.88      48.00      -0-             32.31        -0-               35
5411 Heronwood Dr.            XI         45.88      48.00      -0-             33.95        -0-               35




It is readily apparent that, in every case, Mr. Brown

selected a fair market value per square foot that is

roughly equivalent to the value of the comparable sales in

1987 and is substantially below the value of the comparable

sales in 1982 and 1983.                          In doing so, we believe that

Mr. Brown gave undue weight to the comparable sales in 1987

that took place after the value of the subject properties

had "declined sharply".

        For the above reasons, in comparing the fair market

value of the property and the principal amount of the debt,

we will treat the amount set forth in the contemporaneous

appraisal of the property made by Mr. Lang as the fair
                              - 134 -

market value of each of the eight properties as of

September 1983.


     Condominiums

     Unlike the single-family residences, it appears that

there was both a retail market and a wholesale market for

condominiums at the time the partnerships purchased the

condominium units at issue in these cases.     Respondent's

principal expert witness, Dr. Richard Hewitt III, wrote an

article in 1980, in which he described a "double-tiered

market" for condominiums.     Hewitt, "Condominium/Developed

Lot Discounting Concepts...Again", 46 Real Estate Appraiser

and Analyst (Jan.--Feb. 1980).     Dr. Hewitt noted that in

valuing condominiums some persons advocated using the gross

sellout amount, the sum of the retail sale prices of the

condominiums, as the market value, while others advocated

using a discounted or wholesale value.     See id.   According

to Dr. Hewitt:    "both are correct under certain

circumstances".     Id.   Dr. Hewitt wrote the following:


     Numerous questions continue to arise relative to
     what exactly is market value for condominium/
     developed lots. Certain advocates promote the
     idea that gross sellout (summation of retail
     sales prices) constitutes market value, whereas
     others have advocated the use of discounted
     value (or wholesale value). Actually, both are
     correct under certain circumstances due to what
     can best be described as a double-tiered market
                             - 135 -

     phenomenon. The two-tier participants consist
     of end-product users (final condominium unit
     owners or final single family dwelling
     purchasers) and "interim" purchasers. It is the
     basic purchase motivation and investment goal
     differentials between these two tiers that result
     in dramatically different actual price; hence,
     value levels. The general misunderstanding of
     these differentials also serves as a major
     stumbling block to the proper appraisal of, and
     underwriting of loans for, such projects. In
     view of this, the estimate of market value first
     requires a clear recognition of value to whom.
     [Id.]


     Petitioners take the position that the fair market

value of the condominium units purchased by each

partnership is equal to the sum of the contract prices of

the units, as determined by the contemporaneous appraisals.

As discussed above, the contemporaneous appraisals valued

each condominium unit individually, principally using the

comparable sales approach.    Thus, using the terminology

suggested by respondent and Messrs. Dalton and Ramos, as

discussed above, the contemporaneous appraisals valued the

condominium units purchased by EA 83-XII and EA 84-III in

the retail market.   Adding together the contract prices of

the individual units to derive the value of the condominium

complex is the "gross sellout" approach referred to in

the portion of Dr. Hewitt's article quoted above.    On that

basis, the fair market value of the 39 units in Paseos

Castellanos that were purchased by EA 83-XII in December
                           - 136 -

1982 is $3,020,700, or $151,075 more than the aggregate

principal amount of the promissory notes issued by EA 83-

XII to purchase those properties.    Similarly, on that

basis, the fair market value of the 40 units composing the

Reflections condominium complex that were purchased by EA

84-III in September 1983 is $3,048,000 or $457,800 more

than the aggregate principal amount of the promissory notes

issued by EA 84-III to purchase those units.

     Respondent contends that the condominium units

purchased by each partnership should be valued on a

discounted or wholesale basis.   On that basis, respondent

contends, the aggregate fair market value of the 39 units

in Paseos Castellanos purchased by EA 83-XII is $1,800,000,

or $1,069,625 less than the aggregate principal amount of

the promissory notes issued by EA 83-XII.    In support

thereof, respondent relies on the appraisal report prepared

by Mr. Harold Mogul.

     Mr. Mogul's report states that the highest and best

use of the 39 condominium units is "the use for which the

complex was originally designed and constructed:

Residential Condominium Development."    The report begins

by determining "the total retail sales potential" of the

units.   Mr. Mogul did this by looking to the prices

received for 23 units in the same condominium complex that
                           - 137 -

were sold to buyers other than EPIC.   Treating these

"retail" sales as comparables, Mr. Mogul determined the

retail sales potential of the subject 39 condominium units

to be $2,962,000.

     From the total retail sales potential, Mr. Mogul

deducted anticipated expenses over a 30-month absorption

period in the aggregate amount of $797,971, and he

discounted the annual net income to arrive at a wholesale

value of the subject condominium units of $1,800,000.

Respondent acknowledges on brief that Mr. Mogul doubled

real estate taxes and association fees in his computations

and that using the correct amounts would increase the

present worth of the 39 condominium units under Mr. Mogul's

discounted cash-flow analysis to $1,856,576.

     In passing, we note that a representative of Babcock

Co. testified at trial that the contract prices of the

subject 39 units in Paseos Castellanos were based upon the

prices of actual sales of similar units to members of the

public.   Mr. Mogul's appraisal tends to support that

testimony.   The total retail sales potential of the units,

as determined by Mr. Mogul, $2,962,000, differs from the

aggregate contract prices of the units, $3,020,700, by

$58,700 or less than 2 percent.
                            - 138 -

       Respondent contends that on a discounted or wholesale

basis the aggregate fair market value of the 40 units of

the Reflections condominium complex that were purchased by

EA 84-III is $2,100,000 or $490,200 less than the aggregate

principal amount of the promissory notes issued by EA 84-

III.    In support thereof, respondent relies on the

appraisal report prepared by Mr. David B. Dalton, an

appraiser employed by the Internal Revenue Service, and by

Mr. Mark D. Ramos, an Internal Revenue Service engineer.

       Messrs. Dalton and Ramos considered the highest and

best use of the 40 condominium units in the long term to

be "the possible sale of the units individually or as a

whole".    They considered the short-term highest and best

use of the condominium units to be "as apartment units to

exploit a possible cash-flow from the residential rental

income of the forty units."    In their appraisal, Messrs.

Dalton and Ramos used the comparable sales approach to

arrive at the "wholesale value" of the units, $2,100,000,

based upon the sale of one apartment building with 36

units.    This is an entirely different method than the

discounted retail sales method used by Mr. Mogul.

       In applying the sales comparison approach to the

subject property, Messrs. Dalton and Ramos reviewed four

buildings in the same general area that were sold in 1983.
                           - 139 -

Three of the buildings were substantially larger than the

Reflections both in the number of units and in square

footage, and the appraisers chose not to use those sales

because the size differences "would require a large upward

adjustment to bring them comparable to the subject."    The

fourth comparable, the one on which they based their

appraisal, involved the sale of an apartment with 36 units

that "was purchased for conversion to condominiums" and as

of "December 1994, 12 of the 36 units [had] been

converted."

     The sale price of the apartment building, $1,650,000,

divided by the number of apartments, 36, works out to a

price per unit of approximately $45,800.   Respondent's

appraisers note that the Reflections has a more desirable

setting, with a view of a lake, than the comparable and

has approximately three-fourths of an acre more land.

Accordingly, the appraisers increased the price per unit

to $52,500, an increase of $6,700 per unit, to account

for these differences.   Their report, however, does not

explain how this adjustment was determined.   Respondent's

appraisers made no adjustment for the fact that the

comparable was approximately 3 years old at the time of

the time of the sale, whereas the Reflections had just

been built.
                           - 140 -

     In passing, we note that their appraisal of the 40

units of the Reflections condominium complex is accompanied

by a memorandum, discussed above, in which Messrs. Dalton

and Ramos point out that this "wholesale value is 30

percent lower than EPIC's projected retail value" of the

condominiums, "$3,000,000", and they suggest that the two

values are within the range of what would be expected.

Messrs. Dalton and Ramos also state that EPIC over-

leveraged the condominiums "by financing the properties at

their retail price", and they note that "EPIC financed the

Condo’s at $3,000,000".   Thus, their memorandum implies

that the sum of the retail values of the condominium units

is $3,000,000 or $48,000 less than the sum of the contract

prices of the condominiums, $3,048,000.

     It is evident from the above that the threshold

question in these cases is whether the condominiums should

be valued on a retail basis or on a wholesale basis.    If we

decide that the condominiums should be valued in the retail

market, then it appears that the fair market value of the

condominiums exceeds the amount of debt.   This is true

whether we base the retail values of the properties on the

contract prices, as argued by petitioners, or the retail

prices implied in the reports of respondent's appraisers.

On the other hand, if we decide that the condominiums
                             - 141 -

should be valued in the wholesale market, then it appears

that the fair market value of the condominiums is less

than the amount of debt.   This is true whether we base the

wholesale values on the amounts set forth in respondent's

appraisals or the prices that each partnership actually

paid for the condominiums.    As the court noted in Anselmo

v. Commissioner, 757 F.2d at 1213:     "The selection of the

relevant market at a given time for appraisal purposes is

tantamount to selecting the price."    That is certainly true

in this case.

     None of the appraisers who testified in these cases

considered this issue.   Mr. Seph Pomerantz, who prepared

the contemporaneous appraisals of the 39 units in Paseos

Castellanos, testified that his firm was asked to appraise

the units individually and not in bulk.    He further

testified that he would not have completed his appraisals

in the same fashion if he had been asked for a bulk

appraisal.

     Similarly, Mr. Mogul's letter transmitting his

appraisal report to respondent's counsel states that the

report was made for the purpose of estimating the fair

market value of the 39 condominium units in Paseos

Castellanos as of December 30, 1982, "assuming sale of

thirty-nine units to a single purchaser."    Thus, as he
                            - 142 -

further stated during his testimony, Mr. Mogul appraised

the condominium units as property to be held by a single

investor, or "entrepreneur".

     Finally, Mr. Dalton, who appraised the 40 units of the

Reflections, testified at trial that his "assignment [from

respondent] was, how much should EPIC have paid for this

property."    In the memorandum attached to their appraisal,

Messrs. Dalton and Ramos make the following statement:


     The fair market value of the properties acquired
     by Epic Associates 84-III is based on the market
     place in which they were acquired, the wholesale
     market. As such, the fair market value is the
     price paid by Epic Associates 84-III to the
     seller, without regard to any RDC (rental deficit
     contribution) or other supposed Builder Rebate.


They do not explain why the fair market value of the

properties acquired by EA 84-III must be determined in "the

market place in which they were acquired, the wholesale

market" when, as they also recognize, EA 84-III purchased the

properties for resale and received special discounts in the

purchase price from the sellers.

     The report of respondent's principal expert witness,

Dr. Richard Hewitt III, does not explicitly discuss the

appropriate market for determining the value of the subject

properties.   Dr. Hewitt's report does suggest that the
                            - 143 -

value of the subject properties must be based upon the bulk

purchase price, the wholesale price, rather than the value of

each single unit because:


     The potential market risk [to each partnership] is
     actually related to multiple units and not a
     single unit as would be unrealistically reflected
     by the EPIC/CAG approach of solely obtaining
     individual unit appraisals.


In his testimony, Dr. Hewitt elaborated on that concept as

follows:


     What I was illustrating in the report is that
     if you look at the way Epic appraised the
     properties, they specifically, by the directive of
     their captive appraisal group, dictated that the
     appraisals be done on an individual basis, despite
     the reality that their purchases were done in
     bulk.

          And what I am saying is is [sic] that
     discount was represented because of the fact that
     they, in fact, had a risk exposure relating to a
     bulk purchase, so they paid a fair price for
     buying 50, 60, 150 or 200.

          They may have–and I am trying to illustrate,
     which is really the difficult concept in this
     whole Epic matter-–is there is a significant
     difference between the one-house-at-a-time
     appraisal versus the risk, the portfolio risk
     of having 50, having 100, having 250.


On the basis of that statement, respondent asks the Court to

make the following finding of fact:
                           - 144 -

     Because market risk for EA83-XII and EA84-III
     related to multiple units acquired in bulk sales
     and not single units acquired in separate
     transactions and the appraisals obtained by Epic
     for the properties were only on an individual
     basis using market and cost approaches, the
     separate appraisals for each property did not
     realistically reflect the market risk or value
     to EA83-XII and 84-III. [Emphasis supplied.]


     We agree with Dr. Hewitt that each partnership made

bulk purchases of the properties and received special

discounts from the sellers and that each partnership

undoubtedly paid a fair price for the properties that it

purchased.   We agree with Dr. Hewitt that each partnership

purchased the properties for resale.   As Dr. Hewitt stated:


     Someone buying, in the case of Epic, 40, 100, 200
     homes at a pop, obviously, is not going to live
     in those homes. The intent from a typical market
     purchaser's standpoint, if you were to buy a
     hundred homes, would be to resell those.


We further agree with Dr. Hewitt that the contemporaneous

appraisals valuing each property individually do not

reflect the bulk purchases made by each partnership.

     The question that we must decide, however, is whether,

for purposes of determining the bona fides of the subject

indebtedness, the fair market value of the properties must

be determined in the wholesale market, the market in which

the partnerships purchased the properties, or the retail
                           - 145 -

market, the market in which the partnerships planned to

resell the properties.   The thrust of respondent's position

is that the fair market value of the properties, as stated

by Messrs. Dalton and Ramos:   "is based on the marketplace

in which they were acquired, the wholesale market."

Neither respondent nor respondent's witnesses provide a

reason why this must be the case.

     During his testimony, Dr. Hewitt touched on the

appropriate market for valuing property and, contrary to

respondent's position, his testimony suggests that the

subject properties should be valued in the retail market.

On cross-examination, Dr. Hewitt answered a number of

questions from petitioners' representative about the value

of a bag of peanuts as purchased by an individual, on the

one hand, or the value of the same bag of peanuts as

purchased by a bulk purchaser, such as an airline, on the

other hand.   On redirect, the following exchange took place

between Dr. Hewitt and respondent's attorney:


     Q.        Mr. Hewitt, you and Mr. Griffith talked
          about buying peanuts, where he could go buy
          one bag of peanuts and Delta could go buy
          another bag of peanuts. Let's do this
          example: You could go to the grocery store
          where a bottle of Coca-cola sells for 50
          cents a bottle, and you can buy a six-pack
          for $2.
                           - 146 -

               You bought a six-pack. Do you value
          your acquisition at $2 or $3?

     A.        Of course not. You would value it
          based on what you paid for it, because it
          takes into account the discount. The only
          way you could achieve the higher number
          would be to go into the soda-dispensing
          business and sell out individual Cokes to
          individual users of one Coke after another.


Dr. Hewitt's response suggests that the purchaser must

value the property on the basis of the amount paid,

unless the purchaser is a person who is in the business

of reselling the property, like each of the subject

partnerships, and receives a discount from the seller.

In such a case, the purchaser is entitled to value the

property at the resale value; i.e., $3 in the hypothetical

example posited by respondent's counsel, or $1 more than

the buyer paid for the property.

     Dr. Hewitt's testimony on this point is consistent

with the cases, discussed above, involving the

determination of the appropriate market to use in

estimating the value of an item of property.   See, e.g.,

Goldstein v. Commissioner, 89 T.C. at 544-546; Lio v.

Commissioner, 85 T.C. at 66; Anselmo v. Commissioner, 80

T.C. at 882-883.   Under those cases, the fair market value

of an item of property is its sale price in the market in
                             - 147 -

which it is "most commonly sold to the public" in the sense

of the "customary purchasers" of the property.     Anselmo v.

Commissioner, 757 F.2d at 1212-1214.

     It is evident that the subject condominium units were

ready for immediate sale to individual purchasers and that

individual purchasers were among the "customary purchasers"

of condominiums.   It is also evident that neither

partnership was the ultimate consumer of the condominiums.

The partnerships purchased the condominiums in bulk

purchases and received substantial discounts from the

sellers, the developers of the properties.   The

partnerships purchased the condominiums for the purpose of

reselling them to owner occupants after leasing them for a

period of time.    See Goldstein v. Commissioner, supra at

545-546.   Therefore, on the basis of the facts of the

instant cases, we find that the retail market was the

appropriate market to use in estimating the fair market

value of the condominiums.

     Furthermore, in the instant cases, retail valuation of

the condominium units appears to have been approved by the

marketplace.   As discussed in the findings of fact, the

specific loans at issue were initially made by EMI, which

originated the loans and continued to service them; but the

loans were insured by private mortgage insurance companies
                           - 148 -

and were sold to unrelated lenders in the secondary

mortgage market.   Tricor and RMIC are the private mortgage

insurance companies that issued mortgage insurance covering

the loans at issue in the instant cases.

     The information submitted as part of Dr. Hewitt's

report confirms, as one would suspect, that the private

mortgage insurers thoroughly investigated EPIC's business

and were particularly careful to investigate the risks

relating to the values of the properties that EPIC

syndicated.   That information also shows that the private

mortgage insurers had occasion to review appraisals

submitted by EPIC in connection with its application for

mortgage insurance and, in some cases, the private mortgage

insurers ordered spot appraisals to compare with EPIC's

appraisals.   It would be readily evident from reviewing the

contemporaneous appraisals that EPIC had valued each of the

condominiums and other residential properties purchased by

its limited partnerships on an individual or retail basis

and not on a discounted or wholesale basis.   Therefore,

the record suggests that the private mortgage insurers knew

or had reason to know that EPIC valued the properties that

it purchased on a retail, rather than on a wholesale,

basis.   We do not mean to suggest that the private mortgage
                          - 149 -

insurers gave advance approval to the specific loans at

issue in these cases or to any other loans but only that

the private mortgage insurers knew that EPIC valued the

properties on a retail basis.

     Respondent argues that we should disregard the actions

of the private mortgage insurers and secondary lenders on

the ground that there is no evidence that the mortgage

insurers and secondary lenders performed due diligence.

Respondent argues that they "ignored or did not understand

the realities of the EPIC transactions."   We disagree.

While the record does not show what due diligence was

conducted by or on behalf of the secondary lenders,

Dr. Hewitt's testimony and the material submitted with

Dr. Hewitt's report confirm that the private mortgage

insurers conducted due diligence with respect to the EPIC

loans, including risk assessments, spot appraisals, and

other forms of due diligence and, in fact, two companies,

MGIC and CMAC, ceased insuring EPIC loans after spot

appraisals disclosed values that were lower than the values

shown on the EPIC's appraisals.
                           - 150 -

     Retail Valuation of the Subject Properties

     Respondent's appraisers valued the 26 single-family

houses and the condominium unit at 4107 Medical Drive in

the retail market.   As discussed above, in the case of 19

of these properties the difference between respondent's

value and the contract price of the property is not

material.   As to those properties, we have used

respondent's values in comparing the aggregate fair market

value of the properties to the aggregate principal amount

of the debt.   As to 8 of these 27 properties, as discussed

above, we do not agree with respondent's appraisals and,

for purpose of making the value comparison required in

these cases, we accept the values established by the

contemporaneous appraisals.

     As to the 39 units of Paseos Castellanos purchased by

EA 83-XII and the 40 units of the Reflections purchased by

EA 84-III, respondent's appraisers used the wholesale

market, rather than the retail market, to value the units.

However, the aggregate retail value of the 39 units of

Paseos Castellanos is implied in Mr. Mogul's appraisal

report when he finds that the total retail sales potential

of the units is $2,962,000.   Similarly, the aggregate

retail value of the 40 units of the Reflections is implied

by Messrs. Dalton and Ramos in the memorandum that
                                    - 151 -

accompanied their appraisal report when they referred to

$3,000,000 as the "retail price" of the units.               In

comparing the aggregate fair market value of the properties

to the aggregate principal amount of the debt, we shall use

the retail values of the condominiums implied in the

reports of respondent's appraisers.

          The following schedules show the aggregate retail

value of the properties purchased by each partnership as

compared to the aggregate debt:

EA 83-XII Properties              Loan        Value   Loan ÷ Value

 1612 Hemphill Ave.             $54,525     $57,400      94.99
 1921 W. 17th St.                51,300      54,000      95.00
 1728 Coronado Ave.              51,300      54,000      95.00
 1700 Linda Ave.                 54,050      56,900      94.99
 1716 Coronado Ave.              54,050      56,900      94.99
 1916 Hollywood Dr.              53,200      56,000      95.00
 1720 Coronado Ave.              56,425      59,400      94.99
 2109 Avignon Dr.                84,525      84,000     100.63
 2111 Avignon Dr.                85,025      85,000     100.03
 2113 Avignon Dr.                95,475      91,000     104.92
 2115 Avignon Dr.                95,475     100,500      95.00
 2117 Avignon Dr.               101,175     106,500      95.00
 Paseos Castellanos           2,869,625   2,962,000      96.88

   Total                      3,706,150   3,823,600      96.93



   EA 84-XII Properties           Loan        Value   Loan ÷ Value

5419 Heronwood Dr.              $51,300     $58,000      88.45
5411 Heronwood Dr.               61,750      65,000      95.00
3518 Tower Hill Lane             60,550      63,750      94.98
12347 Northcliff Manor Dr.       55,575      58,500      95.00
13066 Clarewood Dr.              54,150      57,000      95.00
6351 S. Briar Bayou Dr.          58,425      61,500      95.00
12103 Kings Lake Forest Dr.      57,475      60,500      95.00
12107 Kings Lake Forest Dr.      47,975      50,500      95.00
12111 Kings Lake Forest Dr.      53,200      56,000      95.00
12115 Kings Lake Forest Dr.      60,800      64,000      95.00
12231 Carola Forest Dr.          56,050      54,000     103.80
4850 West Ferret Dr.             67,450      71,200      94.73
4107 Medical Dr.                 56,950      56,400     100.98
13739 Earlywood Dr.              60,800      57,600     105.56
6402 Ridgecreek Dr.              60,800      55,950     108.67
The Reflections               2,590,200   3,000,000      86.34

  Total                       3,453,450   3,889,900      88.78
                           - 152 -

As shown above, on a retail basis, the aggregate fair

market value of the subject properties exceeds the

aggregate amount of the debt.   Accordingly, on the basis

of the record of these cases, we find that the debt

incurred by each partnership in purchasing the subject

properties is bona fide indebtedness.


Points Amortization

     Both partnerships paid loan origination fees to EMI

equal to 4 percent of the principal amounts of the first

mortgage loans.   This amounted to $148,246 in the case of

EA 83-XII and $138,138 in the case of EA 84-III.   These

fees were nonrefundable and were similar in amount to

origination fees charged by other lenders.   As discussed

above, they were paid in connection with bona fide

indebtedness.   Accordingly, we agree with petitioners that

these fees are deductible ratably over the life of the

first mortgage loans.   See Von Muff v. Commissioner, T.C.

Memo. 1983-514.


Profit Motive

     Respondent determined in the subject notices of

FPAA that the activity conducted by each partnership, EA

83-XII and EA 84-III, during each of the years in issue,

was an "activity not engaged in for profit" within the
                            - 153 -

meaning of section 183.    Thus, in effect, respondent

determined that the activity of each partnership was an

"activity other than one with respect to which deductions

are allowable for the taxable year under section 162 or

under paragraph (1) or (2) of section 212."     Sec. 183(c).

       Petitioners do not contend that the partnerships are

entitled to deductions under section 212.     Accordingly, we

must redetermine whether EA 83-XII and EA 84-III are

entitled to deductions under section 162 during the taxable

years in issue.    See Brannen v. Commissioner, 722 F.2d at

704.

       Section 162(a) provides for the deduction of all

ordinary and necessary expenses paid or incurred during the

taxable year in carrying on a trade or business.      See sec.

162(a).    It is settled that in order to constitute the

carrying on of a trade or business under section 162(a),

the activity must be entered into in good faith with

the dominant hope and interest of realizing a profit.

See, e.g., Brannen v. Commissioner, supra at 704; Siegel

v. Commissioner, 78 T.C. at 698.      As we have noted in many

cases, the taxpayer must show that he or she had an "actual

and honest objective of making a profit."     E.g., Marine

v. Commissioner, 92 T.C. 958, 988 (1989); Hulter v.

Commissioner, 91 T.C. 371, 392-393 (1988); Dreicer v.
                           - 154 -

Commissioner, 78 T.C. 642, 645 (1982), affd. without

opinion 702 F.2d 1205 (D.C. Cir. 1983).     For this purpose,

the term "profit" means economic profit independent of tax

consequences.   E.g., Ronnen v. Commissioner, 90 T.C. 74, 88

(1988); Herrick v. Commissioner, 85 T.C. 237, 255 (1985).

     Generally, in the case of an activity to which section

183 applies, the deductions attributable to the activity

are grouped into two categories:     Those that would be

allowable "without regard to whether or not such activity

is engaged in for profit" and those that would be allowable

"only if such activity were engaged in for profit."     Sec.

183(b).   Paragraph (1) of section 183(b) allows a taxpayer

to take the deductions in the first category without limit,

but paragraph (2) of section 183(b) limits the aggregate

amount of the deductions in the second category, i.e.,

deductions which are allowable only if the activity is

engaged in for profit, "to the extent that the gross income

derived from such activity for the taxable year exceeds the

deductions allowable by reason of paragraph (1)."     Sec.

183(b)(2).

     The depreciation deductions claimed by each

partnership under section 167 are allowed only if the

expenses were incurred in connection with an activity

that constitutes a trade or business of the taxpayer.
                            - 155 -

See sec. 167(a)(1).    Thus, if section 183 applies to the

activities of EA 83-XII and EA 84-III, the depreciation

deductions would be subject to limitation under section

183(b)(2).

     On the other hand, the interest deductions claimed by

each partnership under section 163(a) are not subject to

the trade or business requirement.    However, the notices

of FPAA determined that the activity of neither partnership

was engaged in for profit, with the result that "all

interest expenses relative to this activity are not

allowable as deductions against ordinary income, but are

separately stated items subject to the investment interest

limitations."    The notices of deficiency thus take the

position that, if section 183 applies to the activities of

each partnership, then the interest expense incurred with

respect to the partnership's activities will be treated as

interest on investment indebtedness and will be subject to

the rules prescribed by section 163(d) limiting the

allowable deduction before the limitation under section 183

is computed.    See sec. 1.183-1(b)(1)(i), Income Tax Regs.

     In the case of a limited partnership, the profit

motive determination under section 183 is made at the

partnership level.    See, e.g., Brannen v. Commissioner, 722

F.2d 695 (11th Cir. 1984); Fox v. Commissioner, 80 T.C. 972
                            - 156 -

(1983); Feldman v. Commissioner, T.C. Memo. 1993-17, affd.

20 F.3d 1128 (11th Cir. 1994).    Therefore, in the instant

cases, we look to the actions of the general partner, EPIC,

to determine whether both of the partnerships are subject

to section 183.

     The determination whether an activity is engaged in

for profit is to be made by reference to objective

standards, taking into account all of the facts and

circumstances of each case.    See sec. 1.183-2(a), Income

Tax Regs.   No one factor is determinative in making this

determination.    See sec. 1.183-2(b), Income Tax Regs.

Greater weight is to be given to objective facts than to

the taxpayer's statement of his or her interest.     See sec.

1.183-2(a), Income Tax Regs.

     As a preliminary matter, we note that none of the

parties to these cases contends that either partnership

conducted more than one activity.     See generally sec.

1.183-1(d)(3), Income Tax Regs.    For example, no party

contends that the holding of the residential properties for

appreciation and the renting of those properties by either

partnership were separate activities for purposes of

section 183.

     The regulations list the following nine factors that

should be taken into account in determining whether an
                           - 157 -

activity was engaged in for profit:   (1) The manner in

which the taxpayer carries on the activity; (2) the

expertise of the taxpayer or his advisers; (3) the time

and effort expended by the taxpayer in carrying on the

activity; (4) the expectations that assets used in the

activity may appreciate in value; (5) the success of the

taxpayer in carrying on other similar or dissimilar

activities; (6) the taxpayer's history of income or losses

with respect to the activity; (7) the amount of occasional

profits, if any, which are earned; (8) the financial status

of the taxpayer; and (9) any elements of personal pleasure

or recreation.   See sec. 1.183-2(b), Income Tax Regs.

     The properties purchased by EA 83-XII and EA 84-III

were highly leveraged and produced operating losses.     The

offering memorandum issued by each partnership disclosed

the fact that the partnership would incur such operating

losses and that the properties had to appreciate in value

in order for an investor to realize a profit.   The offering

memorandum issued for EA 83-XII projected a break-even

appreciation rate of 7.99 percent, and the offering memo-

randum for EA 84-III projected a break-even appreciation

rate of 9.15 percent.   The appreciation rates required for

a profit were high, but there is nothing in the record of
                             - 158 -

these cases to show that, as of the initiation of either

partnership, such appreciation rates could not be achieved.

For example, respondent's appraiser, Mr. Charles D. Brown,

testified that in Houston, Texas, property values increased

during 1981, 1982, and 1983, even though interest rates

were increasing.   He testified that if interest rates had

dropped, then the real estate market in Houston "would have

gone even more ballistic."

     Moreover, in an internal memorandum, prepared in late

1983 or early 1984, a member of EPIC's management noted

that "since 1964, mortgage rates have averaged 2.75% above

the inflation rate" and "appreciation rates have also

averaged 2.09% above the inflation rate."    On the basis of

these relationships, the memorandum concludes that EPIC's

"partnerships could be expected to generate positive

economic benefits".   The memorandum also notes that there

have been periods, notably 1980, 1981, and 1982, when home

price appreciation performed below average, relative to

inflation and interest rates.

     Respondent takes the position that neither EPIC nor

any of its limited partnerships, including EA 83-XII and EA

84-III, ever intended to realize a profit.    Respondent's

position is that EPIC formed EA 83-XII and EA 84-III and

other limited partnerships in order to "satisfy its
                           - 159 -

ravenous appetite for funds necessary to support its real

estate empire."   According to respondent, the centerpiece

of EPIC's "scheme" involved overmortgaging the properties

purchased by each partnership "by obtaining inflated,

defective appraisals to support nominal purchase prices

that permitted EPIC to generate substantial builder fees,

rental deficit contributions, and rental advances".

Respondent also contends that EPIC's projected break-even

appreciation rates of 7.99 percent and 9.15 percent "were

approximately twice as high as the actual appreciation

rates from 1980 to 1985" and that EPIC failed to disclose

its inability to sell the properties of older partnerships,

the adverse market conditions in the housing industry, the

re-syndications of properties from "matured" partnerships

into new properties, the use of defective appraisals to

arrive at inflated values, the purchase of properties for

partnerships from EPIC subsidiaries, the nature and use of

the "sweep" account, and the payment and appraisal fee for

property not purchased by EA 83-XII.   We disagree.

     Under respondent's view of the facts, EPIC was

interested only in obtaining lump-sum payments from new

property acquisitions and the fees attributable to those

new properties.   Respondent ignores the fact that EPIC's

business of syndicating real estate partnerships depended
                           - 160 -

upon the perceived success of the limited partnerships that

it syndicated.   As a result, EPIC advanced a high

percentage of the lump-sum payments and fees that it

realized from the acquisition of new properties to satisfy

the obligations of older partnerships, and thus to make

sure that none of the partnerships defaulted on its

obligations.   In choosing to make those advances and

prevent any default, the management of EPIC continued to

believe that it could carry the properties until interest

rates decreased and the real estate market turned around.

Respondent also ignores the fact that EPIC was entitled to

25 percent of the net profits from the sale of properties,

so-called back-end appreciation.     Mr. Clayton McQuistion,

an important member of EPIC's management, referred to this

as "a gigantic profit opportunity".

     Based upon the record of these cases, we find that

EPIC, acting as the general partner of both EA 83-XII and

EA 84-III, engaged in the activities of both partnerships

with an actual and honest objective of making a profit.


EPIC's Advances to EA 83-XII and EA 84-III

     As mentioned above, respondent determined in the

subject notices of FPAA that the deductions for interest

claimed by each partnership with respect to the unsecured
                           - 161 -

advances made by EPIC were not allowed on the ground that

any such interest expenses were not paid or accrued on

bona fide indebtedness.   Respondent cites Hambuechen v.

Commissioner, 43 T.C. 90 (1964), and invites the Court

to test whether the advances in this case are valid

indebtedness in accordance with the holding of that case.

Hambuechen involved an advance of money to a partnership

by a limited partner.   In that case, we noted that the

question whether a transaction created a debtor-creditor

relationship for tax purposes is a question of fact.     See

id. at 98.   We applied the same factual analysis used to

resolve debt-equity issues in the context of a corporation

and its stockholders, and we held that the subject advance

constituted a capital contribution, rather than a loan.

See Kingbay v. Commissioner, 46 T.C. 147, 154-155 (1966).

     Petitioners argue that the advances in this case

constitute bona fide indebtedness rather than equity.     In

support of that argument, petitioners review each of the

13 factors that were taken into account by the court in

Estate of Mixon v. United States, 464 F.2d 394, 402 (5th

Cir. 1972), in determining whether the advances in that

case constituted debt or equity.     Those factors are the

following:
                           - 162 -

     (1) the names given to the certificates
     evidencing the indebtedness; (2) the presence or
     absence of a fixed maturity date; (3) the source
     of payments; (4) the right to enforce payment of
     principal and interest; (5) participation in
     management flowing as a result; (6) the status of
     the contribution in relation to regular corporate
     creditors; (7) the intent of the parties; (8)
     "thin" or adequate capitalization; (9) identity
     of interest between creditor and stockholder;
     (10) source of interest payments; (11) the
     ability of the corporation to obtain loans from
     outside lending institutions; (12) the extent to
     which the advance was used to acquire capital
     assets; and (13) the failure of the debtor to
     repay on the due date or to seek a postponement.


See also Stinnett's Pontiac Serv., Inc. v. Commissioner,

730 F.2d 634 (11th Cir. 1984), affg. T.C. Memo. 1982-314,

applying the same 13 factors.

     Some of the above factors support respondent's

position that the advances are equity.   For example, there

was no fixed maturity date for repayment of the advances,

and the only realistic source of repayment was from gains

from the sale of partnership properties.   Furthermore, it

is unlikely that either partnership could have obtained

credit on the same basis from outside sources.

     Other factors support petitioners' position that the

advances are debt.   For example, the partnership agreement

governing each partnership treats the unsecured advances as

indebtedness, establishes an interest rate, and gives EPIC

the right to collect payment of the advances from the
                            - 163 -

partnership.   Furthermore, the advances were

disproportionate to EPIC's interest in the partnership.

     Certain other factors do not clearly indicate that the

advances were either debt or equity.    For example, EPIC

did not receive increased management control over either

partnership by reason of the advances, but, as general

partner, EPIC already exercised full management control of

both partnerships.    Similarly, it appears that the advances

were used for all partnership needs.

     We believe that the weight of the evidence tips in

favor of finding that the subject unsecured advances are

equity when we consider the intent of the parties.    In our

view, EPIC's management placed these funds at the risk of

the business and had no reasonable expectation of repayment

without regard to the success of all of the partnerships.

As discussed above, EPIC's management anticipated that EA

83-XII and EA 84-III would have surplus cash during their

early lives but that each partnership eventually would

incur operating deficits and would need to receive advances

from EPIC in order to avoid defaults.

     Other than the sale of a partnership's properties, a

partnership had only four sources of cash to fund these

operating deficits:    Capital contributions by the limited

partners, partnership income consisting primarily of rental
                           - 164 -

income, builder rebates, and general partner advances.

EPIC's management realized that its ability to remain in

business would be hurt if any of its limited partnerships

defaulted on an obligation.   EPIC's management recognized

that EPIC had to advance funds to its partnerships.   EPIC's

management also recognized that the advances would not

realistically be repaid until and unless the properties

were sold at a profit.   An internal memorandum prepared

sometime after September 1983 states as follows:


     To the extent anticipated operating deficits are
     greater than depreciation (5.3% of purchase
     price), one half of this deficit must be funded
     by sources other than limited partner contribu-
     tions. To the extent we initially over-estimate
     partnership income in the offerings, all of the
     increased operating deficit will come from the
     general partner.


On the basis of the testimony at trial and the above, we

find that EPIC's advances to both partnerships were in the

nature of equity rather than indebtedness.   Accordingly,

any "interest" attributable to such advances claimed as a

deduction by either partnership for any of the years in

issue is not allowable under section 163(a).
                             - 165 -

     Sixteen Promissory Notes Each in the Principal Amount
of $5,000

     As mentioned above, EA 84-III issued 16 promissory

notes payable to CSL each in the principal amount of $5,000

and dated February 1, 1985.    Each promissory note was

secured by a deed of trust also dated February 1, 1985, in

favor of CSL.   Eleven of the deeds of trust purport to have

been filed on September 6, 1985, with the County Clerk of

Harris County, Texas.   Five of the deeds of trust do not

appear to have been filed.

     In the bankruptcy filing that was made on behalf of EA

84-III, CSL is listed as a secured creditor with respect to

16 promissory notes in the aggregate amount of $80,000.

The filing also states that accrued interest in the amount

of $4,000 is payable to CSL as a secured creditor.

     At trial, respondent introduced appraisals of the

subject 16 properties as of February 1, 1985, and

respondent argues on brief that the appraisals demonstrate

that the value of the underlying properties declined or did

not appreciate enough to support the new debt.    Set out

below is a list of the 16 properties that shows the sum of

the original purchase money indebtedness, plus $5,000, the

value of each such property on February 1, 1985, as
                               - 166 -

determined by respondent's appraisers, and the difference

between those amounts:

  EA 84-111 Properties        Loan + $5,000   Value 2/1/85   Difference

5419 Heronwood Dr.              $56,300        $55,000       -$1,300
5411 Heronwood Dr.               66,750         62,000        -4,750
3518 Tower Hill Lane             65,550         50,000       -15,550
12347 Northcliff Manor Dr.       60,575         42,000       -18,575
13066 Clarewood Dr.              59,150         46,000       -13,150
6351 S. Briar Bayou Dr.          63,425         45,000       -18,425
12103 Kings Lake Forest Dr.      62,475         44,000       -18,475
12107 Kings Lake Forest Dr.      52,975         36,000       -16,975
12111 Kings Lake Forest Dr.      58,200         38,000       -20,200
12115 Kings Lake Forest Dr.      65,800         48,000       -17,800
12231 Carola Forest Dr.          61,050         50,000       -11,050
4850 West Ferret Dr.             72,450         74,287         1,837
4107 Medical Dr.                 61,950         58,846        -3,104
13739 Earlywood Dr.              65,800         60,098        -5,702
6402 Ridgecreek Dr.              65,800         58,324        -7,476
The Reflections, unit 101        69,755         54,790       -14,965

 Total                        1,008,005        822,345       -185,660


     In the case of the property at 4850 West Ferret Drive,

it appears, according to respondent's evidence, that the

value of the property as of February 1, 1985, $74,287,

exceeds the amount of the indebtedness, $72,450.

Accordingly, it appears that respondent's evidence shows

that the second trust note secured by that property was

valid indebtedness.      Furthermore, in the case of the

properties at 5419 Heronwood Drive, 5411 Heronwood Drive,

4107 Medical Drive, and 13739 Earlywood Drive, the

difference reflected in respondent's appraisals is not

material.
                             - 167 -

     Petitioners presented no evidence to substantiate the

fair market value of any of the subject properties as of

February 1, 1985.    Petitioners argue that the 16 promissory

notes are, in fact, "unsecured debt" and are bona fide

indebtedness without regard to the value of the property.

Initially, petitioners argued that "the promissory notes

were not recorded until after the bankruptcy filing", and

thus the notes had "no substance in the eyes of the

bankruptcy court."    On the basis of that premise,

petitioners argued:    "respondent should not be allowed to

rely upon defective documents to assert that those notes

represented secured debt".    Petitioners further argued

that the notes should be treated as unsecured debt

"indistinguishable from the unsecured advances which they

replaced."

     In their reply brief, petitioners withdrew the factual

assertion that the 16 promissory notes replaced unsecured

advances made by EPIC.    They continue to take the position

that the validity of the notes should be determined without

regard to the value of the 16 properties in 1985 for either

of two reasons.   First, petitioners argue that the notes

were related to "an $80,000 line of credit from Community"

that is described in respondent's brief as "a nonrecourse

line of credit with Community [CSL] totalling $80,000
                           - 168 -

secured by notes of limited partners", and thus petitioners

contend that the 16 promissory notes were "adequately

secured" without regard to the value of the real estate.

Second, they argue that "the real estate was never legal

security for the promissory notes; therefore, the value of

the real estate in 1985 is irrelevant."   We disagree.

     Each of the 16 promissory notes states that it "is the

Note described in and secured by a Deed of Trust dated

February 1, 1985, on property located in HARRIS COUNTY,

State of TEXAS", and each note sets forth the address of

the property.   Each related deed of trust provides a legal

description and an address of the property securing the

note.   Those documents are complete in and of themselves

and make no reference to "an $80,000 line of credit from

Community".   In form, each of the 16 promissory notes

purports to be secured by one of the 16 properties.

Furthermore, petitioners do not take issue with the premise

of respondent's argument that each of the 16 promissory

notes that was issued by EPIC, the general partner of each

partnership, to CSL, an affiliated savings and loan

associate, is a nonrecourse obligation.   Accordingly, we

agree with respondent that none of the promissory notes can

be treated as bona fide indebtedness unless petitioners

prove that the amount of the debt does not unreasonably
                           - 169 -

exceed the value of the property securing it.   See, e.g.,

Brannen v. Commissioner, 722 F.2d 695 (11th Cir. 1984);

Estate of Franklin v. Commissioner, 544 F.2d 1045 (9th

Cir. 1976).

     As mentioned above, petitioners introduced no evidence

of the value of any of the properties as of February 1,

1985.   There is no evidence to show that the fair market

values of the properties on February 1, 1985, exceed the

aggregate indebtedness secured by the property at that

time, except in the case of the property at 4850 West

Ferret Drive, as to which respondent's evidence shows that

the fair market value exceeds the amount of the debt, and

except in the case of the properties at 5419 Heronwood

Drive, 5411 Heronwood Drive, 4107 Medical Drive, and 13739

Earlywood Drive, as to which the discrepancies between the

fair market value of the property and the amount of the

debt are negligible.   Accordingly, we hereby sustain

respondent's adjustment disallowing any interest deduction

claimed by EA 84-III on its 1985 return attributable to the

remaining 11 promissory notes payable to CSL issued by EA

84-III on February 1, 1985.
                     - 170 -

To reflect the foregoing,


                            Decisions will be entered

                    under Rule 155.
                                         - 171 -

Appendix A                                            EPIC Associates 83-XII
                                                       Schedule D--Pro Forma
                                           Cash-Flow and Taxable Income (Loss) Analysis
                                                       Through June 30, 1987


Application of Funds                               1983          1984          1985          1986           1987          Total
Annual Cash-Flow
Rental Income1
Interest income                                 $229,517.00   $325,246.14   $333,247.08   $356,488.68    $186,475.74 $1,430,974.63
Interest income                                   17,877.95     17,533.96      6,660.78       -0-            -0-         42,072.68
Less: First mortgage payments2                   386,822.00    546,101.64    546,101.64    546,101.64     273,050.82 2,298,177.74
Additional interest payments3                       -0-            -0-           -0-         5,111.18       7,487.36     12,598.54
Taxes                                            34,859.01      51,516.95      55856.44     59,926.95      30,981.10    233,140.45
Insurance                                        15,229.20      22,467.54     24,402.55     26,337.55      13,652.53    102,089.36
Audit fees                                        3,454.27       4,876.62      4,876.62      4,876.62       2,438.31     20,522.44
Maintenance and repairs4                         12,095.85      19,059.93     21,811.80     23,348.69      12,058.57     88,374.84
Property administration fee                      21,675.00      30,600.00     30,600.00     30,600.00      15,300.00    128,775.00

Net cash-flow from operations                   -226,740.38   -331,842.58   -343,741.19   -339,813.95    -168,492.94 -1,410,631.04

Taxable Income (loss) analysis
Net cash-flow from operations                  -226,740.38    -331,842.58   -343,741.19   -339,813.95   -168,492.94   -1,410,631.04
Plus: Mortgage amortization                        -0-            -0-           -0-            -0-           -0-           -0-
Other income recognized5                           -0-            -0-           -0-            -0-           -0-           -0-
Less: Depreciation                             122,625.76     173.118.72    173,118.72     173,118.72     86,559.36      728,541.28
Amortization of mortgage loan fee               11,808.84      16,671.30     16,671.30      16,671.30      8,335.65       70,158.38
Accrued mortgage interest                          -0-            -0-           -0-            -0-           -0-             -0-

Net taxable income                             -361,174.98    -521,632.60   -533,531.21 -529,603.97     -263,387.95   -2,209,330.71


     1
       It is assumed that the Raldon Corp. leases will terminate June 30, 1984. It is assumed that after builder lease
terminations, all properties will be rented out to individuals at 8-percent market value. In order to project the market of
value the properties at the time they are rented out, it is assumed they will appreciate 9 percent per year. For all
rentals to individuals, projected income is reduced by 20 percent to allow for vacancies and rental commissions.
     2
         Loan payments are not expected to increase within the period of these projections.
     3
       Fifteen percent per year on net advances to the partnership. The amount decreases at the beginning of each quarter by
the amount of the quarterly investment minus the Organization Fee. It increases during the year by the amount of the negative
cash-flow. To the extent EPIC owes the partnership money, interest will be paid at 12 percent per year.
     4
       While the houses are leased to the builder, the builder is responsible for all maintenance and repairs.         Thereafter, it
is assumed that these payments will amount of 0.5 percent per year of the original purchase price.
     5
         Not applicable to this partnership.
                                         - 172 -

Appendix B
                                                       EPIC ASSOCIATES 84-III
                                                        Schedule D-–Pro Forma
                                           Cash-Flow and Taxable Income (Loss) Analysis
                                             October 1, 1983 Through December 31, 1987

Application of funds                          1983          1984           1985           1986       1987        Total
Annual cash-flow

Gross rental income from individuals        $83,640      $294,341         $315,619   $338,435      $362,901    $1,394,936

Less: Rental commissions                      5,305        27,885           25,250     27,075        29,032       114,547
    Vacancy                                    -0-         69,169           37,874     40,612        43,548       191,203
Net rental income from individuals1          78,335       197,287          252,495    270,748       290,321     1,089,186
Interest income on partnership funds
    Lent to EPIC                              5,937         6,888            -0-        -0-           -0-          12,824
Less: First mortgage payments2              128,155       504,374          502,217    502,217       502,217     2,139,182
Interest expenses on funds lent by
    EPIC to the partnership3                   -0-          2,325           24,056     53,197       80,733       160,312
Taxes                                        20,003        73,836           79,274     85,004       91,149       349,266
Insurance                                     3,620        10,705            9,299      9,972       10,693        44,289
Home owner association dues                     333         2,069            4,359      4,674        5,012        16,446
Audit fees                                    1,250         4,986            4,946      4,946        4,946        21,074
Maintenance and repairs4                     10,225        49,170           21,597     23,158       24,832       139,359
Miscellaneous                                 5,444          -0-             -0-         -0-          -0-          5,444
Property administration fee                   8,250        33,000           33,000     33,000       33,000       140,250

Net cash-flow from operations               -103,384     -476,291         -426,253   -445,421     -462,262    -1,913,611

Taxable income (loss) analysis

Net cash-flow from operations               -103,384      -476,291        -426,253   -445,421      462,262    -1,913,611
Less: Depreciation                            42,686       170,741         170,742    170,742      170,742       725,653
Amortization of mortgage loan fee              3,453        13,814          13,814     13,814       13,814        58,709
Net taxable income                          -149,524      -660,846        -610,809   -629,976     -646,818    -2,697,972


     1
       The year 1983 and the first three quarters of 1984 contain actual operating history; thereafter, it is assumed that the
rent will increase 7 percent per year. During the period that the properties are assumed to be rented to individual tenants,
projected income is reduced by 8 percent to allow for rental commissions and 12 percent yearly to allow for vacancies.
     2
         Loan payments are not expected to increase during this period.
     3
       Fifteen percent per year on net advances by EPIC to the partnership. The amount decreases at the beginning of each
quarter by the amount of the quarterly investment minus the Organization Fee. It increases during the year by the amount of
the negative cash-flow. To the extent EPIC owes the Partnership money, interest will be paid at 12 percent per year.
     4
         It is assumed that these expenses will amount to 0.5 percent per year of current property value.
