                        T.C. Memo. 2003-296



                      UNITED STATES TAX COURT



                  DONALD L. WALFORD, Petitioner v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6506-86.              Filed October 23, 2003.


     Donald L. Walford, pro se.

     Pamela J. Sewell, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     GOEKE, Judge:   Respondent determined the following

deficiencies in and additions to petitioner’s Federal income

taxes:

                                        Additions to Tax
     Year       Deficiency     Sec. 6651(a)(1)      Sec. 6659(a)

     1980       $28,252.46           ---                    ---
     1981         9,478.52         $521.88              $2,843.55
                              - 2 -



Respondent also determined that the increased rate of interest

under section 6621(d) applied.1   The issues in this case arise

from petitioner’s involvement in a partnership that was to

acquire an energy management system to be installed in a

manufacturing plant.

     After concessions,2 we must decide:    (1) Whether petitioner

is entitled to a deduction of $18,956 related to his limited

partnership interest in Sav-Fuel Associates for the taxable year

1981; (2) whether petitioner is liable for an addition to tax

pursuant to section 6659 of $2,843.55 for the taxable year 1981;

and (3) whether petitioner is liable for the increased rate of

interest under section 6621(d).   We hold that petitioner is not

entitled to the claimed deduction for 1981 because the

partnership he invested in was an activity not engaged in for

profit within the meaning of section 183.    Additionally, we hold

that there was an underpayment of tax of at least $1,000 that was

attributable to a valuation overstatement and that increased

interest applies.

     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure. Subsequent dollar amounts are rounded.
     2
      Respondent concedes that the adjustments to petitioner’s
1980 Federal income tax return are barred by the statute of
limitations under sec. 6501. Petitioner concedes that he is
liable for the addition to tax under sec. 6651(a)(1) on any
deficiency decided by the Court for the taxable year 1981.
                               - 3 -

                          FINDINGS OF FACT

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

The stipulation of facts, the supplemental stipulation of facts,

the stipulation of settled issues, and the attached exhibits are

incorporated herein by this reference.    Petitioner resided in

Boulder, Colorado, at the time he filed his petition.

     In 1980, petitioner invested in Sav-Fuel Associates (Sav-

Fuel), a Connecticut limited partnership.3     During the years in

issue, petitioner, as a limited partner, had a 2.152174-percent

interest in the profits and losses of Sav-Fuel.     The sole general

partner of Sav-Fuel was Winston Frost (Mr. Frost), who held a 1-

percent interest in the profits and losses of the partnership.        A

private placement memorandum (PPM) for Sav-Fuel was distributed

to potential investors.

     The stated purpose of Sav-Fuel was to acquire an energy

management system (EMS) to be installed in the manufacturing

plant of Gould, Inc. (Gould), located in El Monte, California.

The EMS was to include master controllers, control modules, heat

exchangers, fans, valve controls, an automated lighting control

system, and other devices and controls.      The stated function of

the EMS was to provide a technologically advanced yet simple and




     3
      The evidence in the record indicates that Sav-Fuel was
formed on July 1, 1980.
                                 - 4 -

efficient method of energy management to factories, residential,

commercial, motel and hotel facilities.

     Sav-Fuel was to purchase the EMS from Nisona Energy Corp.

(Nisona) sometime around November 1980.    Pursuant to a purchase

agreement, Sav-Fuel was to pay to Nisona a total purchase price

of $10,350,000 for the EMS.   The terms of payment included:   (1)

Payment of $1,058,000 due at closing; (2) a full recourse note of

$287,500, bearing no interest, due on February 28, 1981; and (3)

a nonrecourse note of $9,004,500, bearing an annual interest rate

of 9 percent, due on November 30, 2005.    The nonrecourse note was

payable solely from 80 percent of the gross income actually

received by Sav-Fuel from the use of the EMS.    The PPM does not

state that Sav-Fuel held any asset other than the EMS, and there

is no evidence in the record that Sav-Fuel owned other assets.

The PPM states no other activity for Sav-Fuel than the operations

at issue.

     The PPM states that pursuant to a purchase agreement Nisona

purchased the EMS from Dard Systems, Inc. (Dard), earlier in 1980

for a total purchase price of $9,342,000.    Dard was a Delaware

corporation organized in 1980.    The terms of payment included:

(1) Payment of $337,500 due at closing; and (2) a nonrecourse

note of $9,004,500, bearing an annual interest rate of 9 percent,

due on November 30, 2005.   The PPM states that the nonrecourse

note given by Sav-Fuel to Nisona would be assigned by Nisona to
                                 - 5 -

Dard as collateral for Nisona’s nonrecourse note.    The PPM

further states that Dard purchased the EMS for $337,500 in 1980

from Consumer Energy Funding, Inc. (CEF), an unrelated party.

According to the PPM, CEF was organized in 1980 and had limited

experience in the field of energy management and in the care or

supervision of systems similar to the one being acquired by Sav-

Fuel.

     The PPM states that CEF entered into a user agreement with

Gould dated September 30, 1980.    CEF was to operate and service

the energy management equipment to be installed at the Gould

manufacturing plant.    Under the user agreement between CEF and

Gould, Gould was to pay CEF 50 percent of the gross energy

savings realized from the use of the energy management equipment.

     Sav-Fuel was to enter into a management agreement with CEF

sometime around November 1980.    Pursuant to the agreement, CEF

was to install and manage the EMS in exchange for certain

management fees.   CEF was to retain 15 percent of the amount

received from Gould and was to remit the remaining 85 percent to

Sav-Fuel.   Taking into account Sav-Fuel’s obligation to Nisona,

Sav-Fuel was to be entitled to 8.5 percent of any savings

generated by the EMS.    It is unknown whether the EMS was

installed at Gould’s manufacturing plant and whether it ever

produced substantial energy savings.
                               - 6 -

     Sav-Fuel was promoted by Mr. Frost, Richard Gangel (Mr.

Gangel), David Dworsky (Mr. Dworsky), Nisona, and Dard.    The

promoters have entered into other partnerships that have

attempted to sell and/or commercially exploit computerized energy

management systems similar to that of Sav-Fuel.4   At the time of

the offering, Nisona was recently organized and had minimal

experience in the sale of computerized energy management systems.

Mr. Gangel (and/or trusts on behalf of his family) owned Nisona.

Execusport, Inc.,5 and Mr. Gangel (and/or trusts on behalf of Mr.

Gangel’s family) equally controlled Dard.   Mr. Frost had acted as

a general partner in other partnerships that had purchased

similar energy management systems from entities affiliated with

Nisona and Mr. Gangel.   At the time of the offering, Mr. Dworsky

was the president and sole shareholder of CEF.

     The promoters distributed the PPM to potential investors.

The PPM states that the offering consists of 23 units of limited

partnership interests each requiring a cash payment of $49,900 on

the purchase of an interest6 and the balance of $12,500 by a full



     4
      Another EMS-related activity involving Mr. Frost was the
subject of Gianaris v. Commissioner, T.C. Memo. 1992-642.
     5
      The record does not indicate whether any of the promoters
were affiliated with Execusport, Inc.
     6
      Assuming all 23 units were sold to investors, the total of
the initial cash payments of $49,900 equaled $1,147,700. Of this
amount, $55,200 was intended for legal costs, $13,800 was for
compensation of Mr. Frost, and $20,700 was for working capital.
                                 - 7 -

recourse promissory note due January 31, 1981.7   The PPM states

in multiple places that the offering involves a high degree of

risk and should be considered only by investors who can afford to

lose their entire investment.    Each prospective investor in Sav-

Fuel was required to show that he had a net worth (excluding

home, home furnishings, and automobiles) of at least $250,000 and

one-half of his annual income would be subject to tax in the 49-

percent or higher tax bracket.

     The PPM contains assumptions and projections of economic

consequences for the years 1980 to 2005.   The PPM made the

following assumptions:   (1) Total cash contributed by the

partners would be $1,380,000; (2) Gould consumed 11,011,620

kilowatt hours of electricity and 20,664 units of kilowatt demand

at a total cost of $565,761 for the 12-month period beginning

August 1979 through July 1980; (3) the useful life of the EMS

would be 25 years; (4) the estimated reduction in fuel consumed

by Gould would be 20 percent per year; (5) as a result of the 20

percent estimated reduction, Gould would save $135,000 annually

and Sav-Fuel would receive 50 percent, or $67,500, of this amount

before payment of the 15-percent management fee to CEF; and (6)

the inflation in energy costs was 20 percent per year.   On the



     7
      Assuming all 23 units were sold to investors, the total of
the $12,500 payments required by Jan. 31, 1981, equals $287,500,
the same amount as the recourse note due from Sav-Fuel to Nisona
on Feb. 28, 1981.
                                 - 8 -

basis of these assumptions, the economic projections show a net

cashflow of $2,453,398.   The income projections in the PPM are

not discounted to present value.

     According to the PPM, depreciation on the EMS was expected

to total $1,478,571 for 1980.    This was based on Sav-Fuel’s use

of the Class Life Asset Depreciation Range method to depreciate

the EMS on a double declining basis over 7 years.      The PPM also

states that the partnership anticipated approximately $2,070,000

in 1980 for investment tax credits and energy credits.

     The PPM states that to the extent that fuel prices do not

continue to increase through 2005 at the rate projected, Sav-Fuel

will be unable to achieve the gross income and return to its

limited partners as set forth in its economic projections.      The

PPM also recognizes that the development of new processes or

technology could result in the possible obsolescence of the EMS.

     Over 30 of the past 35 years, petitioner has worked as a

stockbroker and investment banker.       At the time of his investment

in Sav-Fuel, petitioner had no knowledge of the partnership other

than that obtained from reviewing the PPM.      Petitioner has no

personal knowledge of the EMS.

     Petitioner and his former wife’s jointly filed 1981 Federal

income tax return was mailed to respondent on March 11, 1983.       On

the return, petitioner claimed a deduction of $18,956, his

distributive share of the partnership losses from Sav-Fuel.      The
                               - 9 -

claimed deduction was based on the depreciation of the EMS.    By

notice of deficiency, respondent disallowed the claimed

deduction, determined that petitioner was liable for additions to

tax under sections 6651(a)(1) and 6659(a), and determined that

increased interest applied under section 6621(d) because the 1981

deficiency was a substantial underpayment attributable to a tax-

motivated transaction.   Petitioner timely filed a petition to

this Court seeking a redetermination.

                              OPINION

     The primary issue for decision is whether petitioner is

entitled to deduct the loss attributable to his investment in

Sav-Fuel.   Deductions are a matter of legislative grace, and the

taxpayer bears the burden of establishing the entitlement to any

deduction claimed.8   INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440

(1934).   In order to satisfy this burden, petitioner must

establish that the EMS-related activity was engaged in for profit

within the meaning of section 183.




     8
      Sec. 7491, which is effective for court proceedings arising
in connection with examinations commencing after July 22, 1998,
provides rules that shift the burden of proof to the Commissioner
in certain circumstances and place on the Commissioner the burden
of production with respect to penalties and additions to tax.
Sec. 7491 is inapplicable to this case because the examination
began before July 23, 1998.
                              - 10 -

I.   Profit Motive

     Section 183(a) generally disallows deductions attributable

to activities not engaged in for profit.    The Court of Appeals

for the Tenth Circuit, to which an appeal in this case would

normally lie, has stated that the proper test for determining the

required profit motive is whether “profit was the dominant or

primary objective of the venture.”     Hildebrand v. Commissioner,

28 F.3d 1024, 1027 (10th Cir. 1994), affg. Krause v.

Commissioner, 99 T.C. 132 (1992); see also Keeler v.

Commissioner, 243 F.3d 1212, 1220 (10th Cir. 2001), affg. Leema

Enters., Inc. v. Commissioner, T.C. Memo. 1999-18.        Whether an

activity was engaged in for profit is a factual determination to

be resolved on the basis of all the surrounding facts and

circumstances.   Hildebrand v. Commissioner, supra at 1026; Finoli

v. Commissioner, 86 T.C. 697, 722 (1986).

     The taxpayer’s objective must be to achieve an economic

profit independent of tax considerations.     Hulter v.

Commissioner, 91 T.C. 371, 393 (1988); Gianaris v. Commissioner,

T.C. Memo. 1992-642.   Because petitioner is claiming his

deduction through a partnership, the profit objective is

determined at the partnership level.     Cannon v. Commissioner, 949

F.2d 345, 349 (10th Cir. 1991), affg. T.C. Memo. 1990-148; Hulter

v. Commissioner, supra at 393; Brannen v. Commissioner, 78 T.C.

471, 505 (1982), affd. 722 F.2d 695 (11th Cir. 1984).       In making
                               - 11 -

the determination, we generally look to the actions and expertise

of the promoters and the general partner of the partnership.

Peat Oil & Gas Associates v. Commissioner, 100 T.C. 271, 276

(1993); Hulter v. Commissioner, supra at 393; Fox v.

Commissioner, 80 T.C. 972, 1007-1008 (1983), affd. without

published opinion 742 F.2d 1441 (2d Cir. 1984); Gianaris v.

Commissioner, supra.

     As explained below, there are several reasons to support our

holding that the EMS-related activity was not engaged in with a

dominant or primary objective of making a profit.    These include:

(1) The grossly inflated sale price of the EMS; (2) the lack of

profit objective reflected by the actions and lack of expertise

of the promoters and general partner of Sav-Fuel; and (3) the

lack of a profit objective under the factors contained in section

1.183(a)-2, Income Tax Regs.   Additionally, applying the approach

used in Gianaris v. Commissioner, supra, we find that there was

no reasonable possibility of a profit independent of tax

considerations because the discounted cashflows (disregarding tax

considerations) would have been negative.   We explain our

findings in detail below.

     A.   Sale Price of EMS

     A hallmark of an economically distorted tax shelter is a

purported transfer of ownership at a grossly inflated sale price.

Soriano v. Commissioner, 90 T.C. 44, 54 (1988).     Generally, the
                                   - 12 -

purchaser makes a small cash payment and executes a nonrecourse

note for the remaining purchase price.       Id.   In this type of

situation, the transaction is so economically infeasible or

lacking in economic substance that the investor’s primary or sole

motivation for entering into the transaction is the tax benefits

(e.g., artificially inflated depreciation deductions and

investment tax credits).     Id.    The fair market value of the

underlying asset will not conceivably support the purchase price,

and the nonrecourse debt practically ensures that the price will

not be paid.   Id.   For these reasons, prior opinions of this

Court and of other courts have focused on fair market value of

the property and the character of financing for purposes of

evaluating profit objective.       Id.; Rose v. Commissioner, 88 T.C.

386, 412-414 (1987), affd. 868 F.2d 851 (6th Cir. 1989).

     Fair market value is the price that would be reached by a

willing buyer and willing seller where neither is under any

compulsion to buy or sell.     Chiu v. Commissioner, 84 T.C. 722,

730 (1985); Gianaris v. Commissioner, supra.        Previous sales of

the same property without subsequent events affecting value are

generally strong indicators of fair market value.        Tripp v.

Commissioner, 337 F.2d 432, 434-435 (7th Cir. 1964), affg. T.C.

Memo. 1963-244; Chiu v. Commissioner, supra at 734-735; Estate of

Scull v. Commissioner, T.C. Memo. 1994-211; Brigham v.

Commissioner, T.C. Memo. 1992-413.
                                - 13 -

     In the instant case, the PPM states that the EMS was

purchased by Dard from CEF, an unrelated party, for $337,000 in

1980.     That same year, Nisona purchased the EMS from Dard for

$9,342,000, and Sav-Fuel purchased the EMS from Nisona for

$10,350,000.     The price paid by Sav-Fuel for the EMS in 1980 was

over 3,000 percent greater than the price paid by Dard for the

same property in the same year.9    There is no evidence in the

record and petitioner has offered no explanation as to the

massive difference in the purchase price of the EMS.      Indeed,

petitioner concedes on brief that the price Sav-Fuel paid for the

EMS was “excessive” and contends that a more plausible value for

the EMS was $5 million.     Petitioner testified at trial that he

performed his own valuation analysis of the EMS after respondent

disallowed the deductions.     In making this argument as to the

appropriate value of the EMS, petitioner relies on evidence that

was not admitted into the record.10

     It is clear that both Sav-Fuel and Nisona grossly overpaid

for the EMS and that these gross overpayments were intentionally




     9
        10,350,000 ÷ 337,000 = 30.71, or 3,071 percent.
     10
      Petitioner attached to his posttrial brief an affidavit
from a certified public accountant as to the value of the EMS.
However, this affidavit was not previously stipulated or offered
and admitted into evidence at trial. Accordingly, petitioner is
not entitled to rely on the affidavit as support for his
argument. Other than this affidavit, petitioner presented no
other documents supporting his valuation of the EMS.
                                   - 14 -

made to achieve grossly inflated tax benefits.11        If Sav-Fuel’s

dominant or primary objective was to achieve a profit, it would

not have purchased the EMS at such a grossly inflated price.

     The method of financing used in the EMS transactions also

indicates that Sav-Fuel lacked the requisite profit objective.

In purchasing the EMS, Nisona made a cash payment to Dard of only

$337,000 and financed the remainder of the purchase price with a

nonrecourse note.        The cash payment neatly coincides with the

full price paid to CEF, the unrelated party.         Similarly, Sav-Fuel

financed $9,004,500 of the purchase price with a nonrecourse

note, which Nisona was to assign to Dard as collateral for its

note.        Both notes were not due for 25 years.   The sole source of

repayment of the nonrecourse note from Sav-Fuel to Nisona was

revenues received by Sav-Fuel from CEF under the management

agreement.        These revenues were based on the gross energy savings

realized from the use of the energy management equipment.

However, it is unclear from the record whether the EMS was

actually installed at Gould and whether there were any energy

savings.

     The evidence in the record reflects that the grossly

inflated purchase price and the nature of the nonrecourse



        11
      Even if we were to accept petitioner’s unsupported
valuation for the EMS of $5 million, this amount is still almost
1,500 percent greater than the price paid by Dard to CEF for the
EMS (5,000,000 ÷ 337,000 = 14.84, or 1,484 percent).
                              - 15 -

financing used in this case were means of ensuring that Sav-Fuel

would generate artificially inflated tax benefits while at the

same time virtually assuring that it would never repay the note

in full.   This leads to the logical conclusion that the EMS-

related activity was entered into primarily or solely for tax

benefits, and not with the dominant or primary objective of

making a profit.

     B.    Actions and Expertise of Promoters and General Partner
           of Sav-Fuel

     The promoters of Sav-Fuel were Messrs. Frost, Dworsky, and

Gangel and the corporations Nisona and Dard.   Mr. Frost, who is

deceased, was also the general partner of Sav-Fuel.   Mr. Dworsky

was the president and sole shareholder of CEF, the company

responsible for maintaining and managing the EMS.

     Neither Mr. Dworsky nor Mr. Gangel nor any representatives

of Dard or Nisona testified at trial to explain the purpose of

the EMS-related activity of Sav-Fuel.   We have previously noted

that the failure to introduce the testimony of available

witnesses who purportedly possess knowledge about certain

relevant facts provides a sufficient basis to infer that the

testimony of those witnesses would not have been favorable.     See,

e.g., Petzoldt v. Commissioner, 92 T.C. 661, 691 (1989); Pollack

v. Commissioner, 47 T.C. 92, 108 (1966), affd. 392 F.2d 409 (5th

Cir. 1968); Wichita Terminal Elevator Co. v. Commissioner, 6 T.C.

1158, 1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947); Medlin v.
                             - 16 -

Commissioner, T.C. Memo. 2003-224.    The evidence in the record

does not support a finding that the actions and expertise of the

promoters were consistent with the profit objective required

under section 183.

     C.   Objective Factors Listed in the Regulations

     Section 1.183-2(b), Income Tax Regs., sets forth a list of

nine nonexclusive factors to be considered in determining whether

an activity was engaged in for profit:   (1) The extent to which

the taxpayer carries on the activity in a businesslike manner;

(2) the taxpayer’s expertise or reliance on the advice of

experts; (3) the time and effort the taxpayer expends in carrying

on the activity; (4) the expectation that the assets used in the

activity may appreciate in value; (5) the taxpayer’s success in

similar activities; (6) the taxpayer’s history of income or loss

from the activity; (7) the amount of occasional profits, if any;

(8) the taxpayer’s financial status; and (9) the elements of

personal pleasure or recreation.   Not all of these factors are

applicable in every case, and no one factor is controlling.     Id.

Because not all the factors are applicable in this case, we will

not enter into a detailed analysis of each factor; rather, we

briefly address why application of the relevant factors further

supports a finding that Sav-Fuel lacked the requisite profit

motive.
                              - 17 -

     The evidence in the record does not support a finding that

Sav-Fuel was operated in a businesslike manner.   Other than the

PPM, no books, records, or financial statements for Sav-Fuel were

offered into evidence by petitioner, and it is unclear whether

any existed.   Petitioner contends he believes that the EMS was

installed at Gould’s manufacturing plant and produced substantial

energy savings, but he is not sure.    There is no evidence in the

record that Messrs. Frost and Gangel had any previous involvement

with energy savings activities other than the similar EMS tax

shelters in Gianaris v. Commissioner, T.C. Memo. 1992-642, and

Gangel v. Commissioner, T.C. Memo. 1991-358.

     There is no evidence indicating how much time and effort was

expended in carrying on the EMS-related activity.   The evidence

in the record does not demonstrate that it was reasonably

expected that the EMS would appreciate in value, and as

previously discussed, the record indicates that the purchase

price for the EMS was grossly inflated.   There is no evidence

that Sav-Fuel had any previous experience in similar activities.

Indeed, like Nisona and Dard, Sav-Fuel was formed only shortly

before the purported transactions occurred.    There is no evidence

that Sav-Fuel ever earned profits from the EMS-related activity.

The above facts again demonstrate that the requisite profit

objective was lacking.
                             - 18 -

     On brief, petitioner implies that the relevant inquiry is

whether he had the requisite profit objective.    As explained

earlier, in the partnership context, the determination of profit

objective is made at the partnership level.     Cannon v.

Commissioner, 949 F.2d at 349; Hulter v. Commissioner, 91 T.C. at

393; Brannen v. Commissioner, 78 T.C. at 505.    However, the

result would be the same even if the profit objective was

examined from petitioner’s standpoint.   The evidence in the

record reflects that petitioner, an experienced investor, did not

take the time to do an independent investigation of the

assumptions contained in the PPM or otherwise take any action to

verify the profitability of the EMS-related activity.       The

parties stipulated that at the time of his investment in Sav-

Fuel, petitioner had no knowledge of the partnership other than

the information he obtained from review of the PPM.    At trial,

petitioner admitted that he did not perform an independent

valuation analysis of the EMS until after he learned that

respondent had disallowed his claimed deductions.    On the basis

of petitioner’s failure to undertake these steps, we find it

implausible that he had the dominant or primary objective of

making a profit.

     D.   Present Value Analysis

     Although we have already found that Sav-Fuel was not engaged

in the EMS-related activity for profit and therefore petitioner
                             - 19 -

is not entitled to the claimed deductions, we explain why

applying an economic analysis based on the projected future

cashflows of the partnership further supports our finding.     We

have previously used a present value analysis in similar

situations to determine whether an activity was engaged in for

profit within the meaning of section 183.   See Soriano v.

Commissioner, 90 T.C. at 54-57; Gianaris v. Commissioner, supra;

Keenan v. Commissioner, T.C. Memo. 1989-300.

     For example, in Gianaris, we examined the economic

projections and income assumptions of a partnership engaged in a

similar EMS-related activity and found that there was no

reasonable possibility of a profit independent of tax

considerations because the discounted cashflows (disregarding tax

considerations) would have been negative.   We explained the use

of a present value analysis to determine profit objective as

follows:

          Generally, a financial investment will require one
     or more cash payments and will produce one or more cash
     returns. Net present value (net cash-flow) is the sum
     of the initial investment (a negative cash-flow) plus
     the present values of future cash-flows (which may be
     either negative or positive). If net present value is
     positive, the investment is profitable, and a profit-
     seeking investor would pursue it. If net present value
     is zero, the investment is neither profitable nor
     unprofitable, and a profit-seeking investor would be
     indifferent to it. If net present value is negative,
     the investment is unprofitable, and a profit-seeking
     investor would avoid it. [Id.; fn. refs. omitted.]
                               - 20 -

     Petitioner is aware of the approach used in Gianaris;

however, he contends that the result in this case differs because

the economic projections demonstrate that the requisite profit

objective existed.   As an initial matter, we emphasize that

calculating net present value by using the assumptions and

figures from the PPM results in a negative present value after

discounting future cashflows by applying the risk-free rate of

return (without applying any risk premiums) and disregarding tax

considerations.   The only way that petitioner can overcome this

fact is by manipulating some of the assumptions contained in the

PPM, most notably by arguing that the EMS had a longer useful

life.

     The PPM contains assumptions and projections, some of which

the parties do not dispute.   Additionally, both parties submitted

expert reports in support of their respective positions.     While

we are not bound by the opinion of any expert witness, we may

accept or reject expert testimony, using our own judgment.

Helvering v. Natl. Grocery Co., 304 U.S. 282, 295 (1938); Estate

of Newhouse v. Commissioner, 94 T.C. 193, 217 (1990).      Generally,

we disregard expert testimony that states legal conclusions

and/or does not assist the Court to understand the evidence or

determine a fact in issue.    See, e.g., Sunoco, Inc. v.

Commissioner, 118 T.C. 181, 183 (2002); Laureys v. Commissioner,
                                - 21 -

92 T.C. 101, 126-129 (1989); FPL Group, Inc. v. Commissioner,

T.C. Memo. 2002-92.

     In this case, the figures necessary for the present value

analysis include:    (1) The initial cash expenditure; (2) the

annual energy bill of Gould, the end user of the EMS; (3) the

useful life of the EMS; (4) the anticipated energy savings; (5)

the inflation of energy costs; and (6) the appropriate discount

rate.   See, e.g., Soriano v. Commissioner, supra at 55.    These

figures are then used in the present value analysis described in

Gianaris to arrive at the net present value of the investment in

Sav-Fuel.    For the reasons set forth below, after examining the

expert reports and other evidence in the record and assuming

certain figures most favorable to petitioner, we conclude that

the results confirm that Sav-Fuel lacked any reasonable

possibility of a profit independent of tax considerations because

its discounted cashflows (disregarding tax considerations) would

have been negative.

            1.    Cash Expenditure

     The PPM states that Sav-Fuel was offering 23 limited

partnership units at a cost of $62,400 per unit.    Investors were

required to contribute $49,900 of the cost in 1980 and $12,500 in

1981.   For each unit sold, $2,400 was designated as payment of

legal costs.     Therefore, the total cash received by Sav-Fuel for

investment was intended to be $1,380,000.    Of this amount,
                               - 22 -

$1,092,500 was to be received by Sav-Fuel in 1980 and $287,500

was to be received in 1981.

            2.   Annual Energy Bill of CEF

     The PPM assumed that Gould consumed 11,011,620 kilowatt

hours of electricity and 20,664 units of kilowatt demand at a

total cost of $565,761 for the 12-month period August 1979

through July 1980.    These figures are important for purposes of

determining the projected annual income of Sav-Fuel on the basis

of the amount of annual energy savings by Gould.    Neither party

has disputed these assumptions and, applying these assumptions,

both parties’ experts arrived at approximately the same amount of

projected income for the period 1980 through 2005.

            3.   Useful Life of the EMS

     The economic projections in the PPM assume a useful life of

25 years.    Respondent assumes arguendo that the EMS had a useful

life of 25 years.    Petitioner contends that the EMS had a useful

life exceeding 30 years and submitted different projections using

a useful life of 26 to 30 years.

     Petitioner relies on the report and testimony of Michael

Jinnette (Mr. Jinnette) for purposes of establishing the useful

life of the EMS.    Mr. Jinnette earned a bachelor of education

degree from Colorado State University in 1973 and took some

computer science courses while attending the university.    After

graduation, Mr. Jinnette taught vocational electronics and
                                - 23 -

computer science courses at the Community College of Denver for 5

years and then worked as a software development engineer until

1984.     Mr. Jinnette currently builds software that communicates

with energy meters and building controllers, and he claims to be

familiar with the design, installation, and maintenance of

various energy management systems and their related software and

hardware components.12

     The stated purpose of Mr. Jinnette’s report was to provide

his opinion on the reasonable lifespan of commercial grade energy

management equipment such as the equipment described in the Sav-

Fuel PPM.     However, other than a paragraph setting forth Mr.

Jinnette’s qualifications, the report contains only two short

paragraphs setting forth the basis for his opinion and

conclusion.     The report states that Mr. Jinnette has personal

knowledge of energy management equipment similar to that

described in the Sav-Fuel PPM and that he gained this knowledge

through his personal involvement in the installation and

maintenance of software for equipment of a similar age and type.

On the basis of this personal knowledge, Mr. Jinnette opines that

“it is reasonable to assume that, if properly maintained, energy

management equipment of a type and function similar to that

described in the Sav Fuel PPM would remain operational for a


     12
      At trial, the Court qualified Mr. Jinnette as an expert
for purposes of assisting the Court to understand the nature of
the energy management equipment.
                              - 24 -

period exceeding thirty (30) years at a minimum.”   The report

contains no other facts or data showing the basis for Mr.

Jinnette’s opinion.13

     At trial, Mr. Jinnette testified that he currently works

with similar equipment and that he recently worked on equipment

that was installed in the early 1980s.   He furthered testified

that the type of equipment at issue is industrial grade equipment

designed to last for 20 to 30 years, and it typically does if it

is properly maintained.   These were the only reasons Mr. Jinnette

gave as the basis for his opinion that the useful life of the EMS

exceeded 30 years.

     We are not persuaded by Mr. Jinnette’s report and his

opinion that the useful life of the EMS purchased by Sav-Fuel

exceeded 30 years.   Mr. Jinnette cited no authority, facts, or

data, other than his personal belief, to establish the useful

life of the EMS.   His testimony at trial did not provide a

sufficient basis for the conclusion reached in his report.    Mr.



     13
      Under Rule 143(f)(1), expert reports are required to state
the witness’s opinion and the facts or data on which the opinion
is based and must set forth in detail the reasons for the
conclusion. Additional direct testimony with respect to the
report may be allowed to clarify or emphasize matters in the
report, to cover matters arising after the preparation of the
report, or otherwise at the discretion of the Court. Id. At
trial, the Court told petitioner that Mr. Jinnette’s report
basically stated his opinion without providing an explanation as
to how the conclusion was reached and suggested that petitioner
elicit more information with respect to the basis for Mr.
Jinnette’s opinion.
                               - 25 -

Jinnette admitted that he had never seen the EMS purchased by

Sav-Fuel and that he was not familiar with the design of the EMS

involved in this case.14   Mr. Jinnette acknowledged that some of

the equipment could have become obsolete over the years.

Therefore, we assign no weight to Mr. Jinnette’s conclusion

regarding the useful life of the EMS and instead base our

analysis on the assumption in the PPM that the EMS had a useful

life of 25 years.   This is the useful life projected at the time

the limited partnership interests in Sav-Fuel were offered to

investors.

          4.   Anticipated Energy Savings

     The PPM assumes that the savings in electrical energy costs

to Gould would be 20 percent of its annual energy bill.

Respondent does not challenge this assumption, and both parties’

experts relied on this assumption for purposes of determining

projected income.

          5.   Inflation Rate of Energy Costs

     The PPM assumes that the inflation in energy costs would be

20 percent per year.   Petitioner contends that there were energy

supply shortages around 1980, and that it was not unreasonable at


     14
       We note that the evidence in the record includes a letter
from Mr. Jinnette stating that properly maintained industrial
equipment of the same type as the EMS has a useful life of 10
years to more than 20 years. This is seemingly inconsistent with
petitioner’s assertions and Mr. Jinnette’s statements in his
report and at trial that the EMS had a useful life of at least 30
years.
                              - 26 -

that time to project an average annual increase of 20 percent for

the foreseeable future and for purposes of calculating profit

potentials for energy investments.     Respondent disagrees with the

20-percent rate and contends that the highest rate of inflation

in energy costs would have been 18.5 percent.

     Respondent relies on the report and testimony of Dr. Mark

Rodekohr (Dr. Rodekohr), the director of the Energy Markets and

Contingency Information Division at the Energy Information

Administration, U.S. Department of Energy.    Dr. Rodekohr received

a bachelor of science degree in economics in 1970 from the

University of Delaware and a Ph.D. in economics from the

University of Colorado in 1974.   Dr. Rodekohr has 30 years’

experience in forecasting and analysis of energy issues for the

Department of Energy.   His background includes experience in the

analysis of energy prices, demand, household energy expenditures,

international energy issues, and natural gas supply and demand

issues.

     In his report, Dr. Rodekohr stated that he had reviewed

projections of electricity prices in the commercial and

industrial sectors that were available in 1980.    The projections

he used were taken from the Energy Information Administration’s

Annual Energy Outlook 1980, and he represented that these

projections have generally been available annually from 1974 to

the present.   On the basis of the data contained in the
                              - 27 -

projections, Dr. Rodekohr stated that it was reasonable to assume

a real price increase of 5 percent per year.15   To account for

inflation, Dr. Rodekohr reviewed the consumer price index and

added 13.5 percent to the 5-percent increase rate because he felt

that it would have been reasonable to expect that amount of

increase in inflation for 1980.16

     Although respondent has presented persuasive evidence that

the annual percentage increase in energy costs would not exceed

18.5 percent, we will apply the 20-percent rate and energy cost

amounts assumed in the PPM and advocated by petitioner.     As

explained below, even after we apply the higher rate, the net

cashflow (disregarding tax considerations) is negative.17




     15
      Dr. Rodekohr noted that this assumption was generous in
that for the commercial sector the average annual rate of
increase in prices was 1.4 percent per year between 1978 and 1995
and for the industrial sector it was 2.5 percent per year. He
stated that the 5-percent figure he used was the highest average
annual change between any two periods included in the
projections.
     16
      Dr. Rodekohr noted that 13.5 percent was the highest rate
experienced during the years 1979 to 1981. He represented that
the inflation rates for the years 1979 and 1981 were 11.3 percent
and 10.3 percent, respectively.
     17
      The higher the annual rate of increase in energy costs,
the higher the savings rate would be and the more cash Sav-Fuel
would receive under its arrangement with Gould and CEF.
Conversely, a lower annual rate of increase in energy costs would
result in less savings and cashflow each year, yielding a lower
overall net present value.
                                - 28 -

           6.   Discount Rate

     The parties generally disagree as to the appropriate

discount rate to apply.   Petitioner claims that the appropriate

rate is 15 percent while respondent contends that it is 18.96

percent.   The parties rely on expert reports and our opinion in

Gianaris v. Commissioner, T.C. Memo. 1992-642.

     In Gianaris, we stated that the experts in that case had

testified and the taxpayers had not challenged that long-term

U.S. Government bonds yielded, on average, about 11.5 or 11.6

percent in 1980 and 13 percent in 1982.    We felt that a premium,

above the benchmark rate of return on U.S. Government debt, was

necessary to compensate for the additional risk involved in the

partnerships.   We stated that profit-seeking investors in similar

EMS tax shelters would reasonably have required a rate of return

of no less than 15 percent.     However, for purposes of making our

calculations, we assumed discount rates equal to the rate of

return on U.S. Government debt because if the investments did not

show profit at those interest rates, then they would not show

profit at the higher rates it could be assumed a profit-seeking

investor would demand.

     Petitioner relies in part on our statements in Gianaris as a

basis for his contention that the appropriate discount rate is 15

percent.   In further support of his position, petitioner

presented the report and testimony of Douglas J. Horvey (Mr.
                              - 29 -

Horvey), a certified public accountant (C.P.A.).   Mr. Horvey has

a degree in accounting from Metropolitan State College of Denver

and has been a C.P.A. since 1984.   Mr. Horvey represents that he

is familiar with the cashflow analysis used by respondent and has

used that and similar analyses as part of his work over the

years.

     One of the stated purposes of Mr. Horvey’s report was to

provide an opinion as to the appropriate discount rate to be

applied to a present value analysis of an investment in an entity

such as Sav-Fuel.   Mr. Horvey felt that a profit-motivated

investor participating in any type of speculative investment

would seek a risk-adjusted rate of return greater than the 11.5-

percent risk-free rate used in Gianaris.   In his opinion, a 15-

percent adjusted rate of return was reasonable if the required

risk adjustment was 125 percent of the risk-free rate of return.

However, Mr. Horvey provided separate calculations of net present

value using discount rates of 11.5 percent, 12 percent, 13

percent, 14 percent, 15 percent, and 16 percent.

     Mr. Horvey’s calculation of net present value uses many of

the same figures and assumptions as the calculation contained in

the attached appendix.   However, Mr. Horvey carried the cashflow

analysis through June 30, 2030, the anticipated dissolution date

of Sav-Fuel.   As explained earlier, we have assumed consistent

with the PPM that the useful life of the EMS was 25 years.    The
                                - 30 -

evidence in the record reflects that this was the partnership’s

only asset and source of income.    Thus, the proper net present

value analysis in this case should be for a term of 25 years.

Although Mr. Horvey’s calculations are helpful through the year

2005, his ultimate conclusion based on a 50-year cashflow

analysis is misplaced.

     Respondent’s argument that the appropriate discount rate to

apply is 18.96 percent is based on the report and testimony of

Ken D. Howell (Mr. Howell), a petroleum engineer.    Mr. Howell is

currently responsible for conducting independent examinations of

tax returns filed by large organizations.    His duties require

knowledge of engineering valuation principles, tax law, and

industry practice, and for the last 12 years he has prepared

written technical and valuation reports to taxpayers.

     Mr. Howell used the buildup method18 to arrive at a discount

rate he felt was appropriate.    Mr. Howell stated that the average

rate of return on a 20-year U.S. Government bond in 1980 was

11.36 percent (which would be the risk-free rate of return for

1980).    Mr. Howell felt that it was appropriate to add an equity

risk premium to this figure to arrive at the discount rate.

Using historical data published in Stocks, Bonds, Bills, and



     18
      According to Mr. Howell, the buildup method is an additive
model in which the return on an asset is estimated as the sum of
a risk-free rate and appropriate risk premiums, such as equity
risk and firm size risk.
                                - 31 -

Inflation by Ibbotson Associates, Mr. Howell applied an equity

risk premium of 7.6 percent for 1980, resulting in a discount

rate of 18.96 percent.

     After reviewing the expert reports and testimony, as well as

our opinion in Gianaris, we feel that it is appropriate to apply

an 11.5-percent discount rate despite the fact that a more

realistic rate is 15 percent.    This is consistent with our

approach in Gianaris.

          7.   Analysis

     On the basis of the undisputed assumptions in the PPM and

our findings above (including application of a discount rate of

11.5 percent),19 we have calculated the net present values, as of

1980, of Sav-Fuel’s up-front payments and net receipts (taking

into account further payments to Nisona and all other fees).20



     19
      Again, we note that we have made certain assumptions most
favorable to petitioner and that using more realistic assumptions
and figures would result in a significantly lower net present
value. See, e.g., Gianaris v. Commissioner, T.C. Memo. 1992-642.
     20
      In Gianaris v. Commissioner, supra at n.7, we explained
the determination of present value as follows:

          To determine the present value of a single future
     payment, the amount of that payment is divided by the
     sum (1 + i)n, where i equals the appropriate interest
     (discount) rate and n equals the number of periods
     (amount of time) to be taken into account. PV = CF /
     (1 + i)n. (CF stands for “cash flow”.)

We explained the determination of net present value as follows:
“At a given interest (discount) rate, NPV = CF0 + CF1 /(1+i)1 +
CF2 /(1+i)2 + * * * + CFn /(i +1)n.” Id. at n.8.
                               - 32 -

Because our calculations show that the net present value, as of

1980, of the up-front payments exceeds the net present value of

net receipts by $178,656, we have determined Sav-Fuel’s net

cashflow to be negative $178,656.    The details of our conclusion

are contained in the attached appendix.    Our finding of a

projected negative cashflow (disregarding tax considerations)

demonstrates that Sav-Fuel could not reasonably have hoped to

recoup its investment in the EMS, much less earn an economic

profit independent of tax considerations.

II.    Addition to Tax Under Section 6659(a)

       Under section 6659, a graduated addition to tax is imposed

when an individual has an underpayment of tax of at least $1,000

that is attributable to a valuation overstatement.    Sec. 6659(a),

(d).    A valuation overstatement exists if the value of any

property, or the adjusted basis of any property, claimed on any

return exceeds 150 percent of the amount determined to be the

correct valuation or adjusted basis.    Sec. 6659(c)(1).   If the

claimed valuation exceeds 250 percent of the correct value, the

addition is equal to 30 percent of the underpayment.    Sec.

6659(b).

       Petitioner’s claimed loss deduction was related to the value

of the EMS.    As discussed earlier, the PPM states that Sav-Fuel

purchased the EMS from Nisona in 1980 for $10,350,000, despite

the fact that an earlier sale in 1980 of the EMS between
                               - 33 -

unrelated parties was for $337,000.     On brief, petitioner relies

on evidence not admitted into the record and his own self-serving

statements in arguing that the value of the EMS was actually $5

million.   We do not accept petitioner’s unsupported claim that

the EMS was actually worth $5 million, which we note is still

less than half of the $10,350,000 claimed value of the property.

The contemporaneous sale of the EMS for $337,000 makes it clear

that the claimed valuation of $10,350,000 exceeded 250 percent of

the correct value of the EMS.21

     Under section 6659(e), the Commissioner may waive all or any

part of the addition to tax for a valuation overstatement if the

taxpayer shows that there was a “reasonable basis for the

valuation * * * claimed on the return and that such claim was in

good faith.”   The Commissioner’s waiver is discretionary and

subject to review for abuse of discretion.     Krause v.

Commissioner, 99 T.C. 132, 179 (1992).     Petitioner has not shown

that there was a reasonable basis for the valuation overstatement

of the EMS.    Accordingly, we hold that petitioner is liable for

the addition to tax of 30 percent of the underpayment of tax

under section 6659.




     21
      We note that in order for petitioner to avoid application
of the 30-percent addition under sec. 6659(b), the EMS would have
to have had a minimum correct value of $4,140,000 (10,350,000 ÷
2.50 = 4,140,000). The evidence in the record reflects that the
correct value of the EMS was substantially below this amount.
                                - 34 -

III. Increased Interest Under Section 6621(d)

     As applicable to this case, section 6621(d)(1) provided that

“In the case of interest * * * with respect to any substantial

underpayment attributable to tax motivated transactions, the

annual rate of interest * * * shall be 120 percent of the

adjusted rate”.22   A substantial underpayment attributable to a

tax-motivated transaction is defined as “any underpayment of

taxes * * * which is attributable to 1 or more tax motivated

transactions if the amount of the underpayment for such year so

attributable exceeds $1,000.”    Sec. 6621(d)(2).   The term “tax-

motivated transaction” includes any valuation overstatement

within the meaning of section 6659(c).    Sec. 6621(d)(3)(A)(i).

Additionally, tax-motivated transactions include activities not

engaged in for profit.   Hildebrand v. Commissioner, 28 F.3d at

1028; sec. 301.6621-2T, Q&A-4, Temporary Proced. & Admin. Regs.,


     22
      Sec. 6621(d) was enacted by the Deficit Reduction Act of
1984, Pub. L. 98-369, sec. 144(a), 98 Stat. 682. Sec. 6621(d)
applies with respect to interest accruing after Dec. 31, 1984,
regardless of the date the return was filed. Solowiejczyk v.
Commissioner, 85 T.C. 552, 556 (1985), affd. without published
opinion 795 F.2d 1005 (2d Cir. 1986). The Tax Reform Act of
1986, Pub. L. 99-514, sec. 1511(c), 100 Stat. 2744, redesignated
and amended sec. 6621(d) as sec. 6621(c). Sec. 6621(c) was
repealed by the Omnibus Budget Reconciliation Act of 1989, Pub.
L. 101-239, sec. 7721(b), 103 Stat. 2399, effective for returns
the due date for which is after Dec. 31, 1989. Current sec.
6621(c), which was enacted by the Omnibus Budget Reconciliation
Act of 1990, Pub. L. 101-508, sec. 11341(a), 104 Stat. 1388-470
(effective for purposes of determining interest for periods after
Dec. 31, 1990), applies an additional 2-percent interest rate on
deficiencies attributable to large corporate underpayments of
tax.
                              - 35 -

49 Fed. Reg. 59394 (Dec. 28, 1984).    We have jurisdiction to

determine the portion (if any) of a deficiency which is a

substantial underpayment attributable to a tax-motivated

transaction.   Sec. 6621(d)(4); Law v. Commissioner, 84 T.C. 985,

988 (1985).

     We have found both that there was a valuation overstatement

within the meaning of section 6659(c) and that the EMS-related

activity was not engaged in for profit.    Accordingly, we hold

that petitioner is liable for increased interest under section

6621(d).   See Krause v. Commissioner, supra at 180; Osowski v.

Commissioner, T.C. Memo. 2000-367; Barlow v. Commissioner, T.C.

Memo. 2000-339, affd. 301 F.3d 714 (6th Cir. 2002).


                                      Decision will be entered

                               under Rule 155.
                                 - 36 -

                                APPENDIX

I.     Discounted Receipts

Year                         Projected Nominal        1980 Present
                                  Receipts1                Value2

1980                               -0-                      -0-
1981                             $12,035                  $10,794
1982                              16,524                   13,291
1983                              19,829                   14,305
1984                              23,795                   15,395
1985                              28,554                   16,569
1986                              34,264                   17,832
1987                              41,117                   19,191
1988                              49,341                   20,654
1989                              59,209                   22,229
1990                              71,051                   23,923
1991                              85,261                   25,747
1992                             102,313                   27,710
1993                             122,776                   29,822
1994                             147,331                   32,096
1995                             176,797                   34,542
1996                             212,156                   37,176
1997                             254,588                   40,010
1998                             305,505                   43,060
1999                             366,606                   46,342
2000                             439,927                   49,875
2001                             527,913                   53,677
2002                             633,495                   57,769
2003                             760,194                   62,173
2004                           1,328,433                   97,441
2005                           5,473,399                  360,069
  Total receipts              11,292,413                1,171,692

       1
       This figure takes into account management fees paid to CEF and
payments to Nisona on the nonrecourse note. The amounts and timing
of the principal and interest payments to Nisona are based on the
projections contained in the PPM.
     2
       A discount rate of 11.5 percent is assumed.
                                 - 37 -

II.    Discounted Costs

                                                        1980 Present
Year                        Nominal Costs                   Value1

1980                        ($1,092,500)                ($1,092,500)
1981                           (287,500)                   (257,848)
  Total costs                (1,380,000)                 (1,350,348)
       1
        A discount rate of 11.5 percent is assumed.

III. Discounted Net Cashflow

       Discounted receipts                $1,171,692
       Discounted costs                   (1,350,348)
         Discounted net cashflow            (178,656)
