                  T.C. Summary Opinion 2010-136



                       UNITED STATES TAX COURT



         RANDY M. AND CARMENE M. JAVORSKI, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 2107-09S.              Filed September 13, 2010.



     Gary C. Randall and James J. Workland, for petitioners.

     Robert V. Boeshaar, for respondent.



     VASQUEZ, Judge:    This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code (Code) in

effect when the petition was filed.1   Pursuant to section

7463(b), the decision to be entered is not reviewable by any




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

other court, and this opinion shall not be treated as precedent

for any other case.

     Respondent determined a $27,228 deficiency2 in petitioners’

2005 Federal income tax and a $5,445.60 accuracy-related penalty

under section 6662(a).   After concessions,3 the issues for

decision are whether petitioners are entitled to:    (1) A bad debt

deduction under section 166 of $382,000; (2) a capital loss

deduction for a worthless security under section 165(g); (3) a

deduction of $10,000 as an ordinary and necessary business

expense under section 162; and (4) a deduction for interest



     2
        The deficiency includes self-employment   tax of $10,592.
Respondent also allowed petitioners a deduction   for self-
employment tax of $5,296. These issues involve    computational
matters to be resolved in the parties’ Rule 155   computations
consistent with the Court’s opinion. See secs.    164(f), 1401,
1402.

     Respondent made adjustments to petitioners’ deductions for
medical/dental expenses and miscellaneous itemized deductions,
because after adjustments to petitioners’ gross income, the
amounts did not exceed the 7.5- and 2-percent floors of secs.
213(a) and 67(a), respectively. Respondent also disallowed
petitioners’ claimed net operating loss. These issues involve
computational matters to be resolved in the parties’ Rule 155
computations consistent with the Court’s opinion. See secs.
67(a), 172(c) and (d), 213(a).
     3
        Respondent concedes that petitioners are not liable for
the accuracy-related penalty under sec. 6662(a). Petitioners
concede that the initial $150,000 equity investment in Lucca
Interiors, Inc., discussed infra, for which a stock certificate
was issued does not give rise to a bad debt deduction. Finally,
the parties agree that petitioners are entitled to the following
expenses: (1) $1,692 for supplies; (2) $3,773 for meals and
entertainment; (3) $5,018 for travel; (4) $965 for gifts; and (5)
$2,657 for telephone/pager.
                               - 3 -

payments totaling $31,709 under section 163 as either interest

accrued in connection with a trade or business or as qualified

residence interest.

                            Background

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

The stipulations of fact and the attached exhibits are

incorporated herein by this reference.   Petitioners resided in

Washington State when the petition was filed.

     In 2005 and for the past 20 years Randy Javorski

(petitioner) has worked as an independent manufacturers sales

representative for 10 to 12 furniture and lighting manufacturers,

including Design Institute of America (DIA).    In this capacity

petitioner received commissions when he arranged sales between

furniture stores and manufacturers he represented.

     Petitioner had long considered opening a furniture store,

and, in 2002, petitioner met with Stephan Eberle (Mr. Eberle) to

discuss this possibility.   Together, petitioner and Mr. Eberle

drafted a basic business plan for what became Lucca Interiors,

Inc. (Lucca).   Lucca was organized as a Canadian corporation that

owned and operated a furniture store in Vancouver, British

Columbia.

     Petitioner had dual motives for establishing Lucca.    One

reason was to fill a niche in the Vancouver furniture market.

The second reason was to establish a client (i.e., Lucca) that
                                 - 4 -

would purchase furniture from manufacturers petitioner

represented.   Petitioner earned a commission whenever he arranged

transactions between Lucca and manufacturers he represented.

Petitioner anticipated earning steady commissions with the

creation of Lucca because he believed Lucca would consistently

purchase goods through him.   Lucca purchased much of its

merchandise, including goods from DIA, through petitioner.

     Petitioner contributed $150,0004 to Lucca in exchange for a

49-percent ownership interest.    He obtained the funds to

incorporate Lucca by opening a line of credit5 (LOC 5278) with

Washington Mutual that had a maximum credit line of $280,000.

Mr. Eberle did not contribute any capital to the venture at this

time or any other, but he received the remaining 51 percent of

the stock for his role as Lucca’s manager.    In 2003 Lucca opened

its doors for business.6




     4
        All of petitioner’s transfers to Lucca were drawn from
one of three lines of credit that he opened.
     5
        Every line of credit petitioner used to transfer funds to
Lucca was issued to both petitioner and Mrs. Javorski. However,
the lines of credit were used only by petitioner in connection
with Lucca. Thus, we will refer only to petitioner opening lines
of credit.
     6
        Petitioner continued to transact business with other
furniture stores after Lucca was formed and never considered
himself an employee of Lucca. During the first year Lucca
conducted business approximately 5 to 10 percent of petitioner’s
sales as a representative were to Lucca.
                                - 5 -

     To meet Lucca’s operating costs and obligations to

creditors, petitioner continued to draw money on LOC 5278.   On

July 8, 28, and 30, 2003, petitioner transferred $50,000,

$10,000, and $40,000, respectively, to Lucca.   On September 5,

2003, petitioner transferred another $30,000 to Lucca.

     Petitioner needed additional funds to meet Lucca’s financial

demands.   In September 2003 petitioner opened a second line of

credit (LOC 7826) secured by petitioners’ rental property.   On or

about September 15, 2003, petitioner transferred $120,300.87 to

Lucca.

     Lucca’s financial prospects quickly diminished in 2004.    By

that time customers had stopped visiting the store, and Lucca

needed to find new clientele.   Lucca had incurred many debts and

needed more money to meet its obligations.   To further finance

Lucca’s operations, petitioner transferred $28,890.25 to Lucca on

or about March 19, 2004, and $40,000 on or about June 10, 2004.

     By September 2004 petitioner had almost exceeded his LOC

5278 credit limit, so petitioner replaced LOC 5278 with LOC 3789,

which was secured by petitioners’ principal residence, on or

about September 27, 2004.   Petitioner used LOC 3789 to satisfy

the balance of LOC 5278 and transferred $40,000 to Lucca on or

about September 27, 2004.

     Lucca accumulated a $30,000 debt for goods purchased from

DIA in 2004.   DIA knew of petitioner’s relationship to Lucca and
                               - 6 -

encouraged petitioner to sell DIA’s products to Lucca.   However,

as Lucca’s debt climbed, DIA withheld special orders from Lucca

until DIA received payment for its goods.   In order to release

the special orders petitioner made two payments totaling

$2,249.10 to DIA in November 2004.

     While the $2,249.10 payment was enough to release the

special orders, DIA sought more money from Lucca to reduce

Lucca’s debt.   Lucca’s indebtedness to DIA in 2004 prompted DIA’s

president to call petitioner and threaten him with the

possibility of losing his position as DIA’s representative if

Lucca did not satisfy its debt.   In response, petitioner paid DIA

$10,000 on January 20, 2005, to further reduce the amount of

Lucca’s debt to DIA and to maintain his position as DIA’s

representative.

     Unfortunately for petitioner, Lucca was not successful and

filed for bankruptcy on March 15, 2005.   Lucca’s assets were

assigned to the bankruptcy trustee, MacKay & Company, Ltd.

(MacKay), on March 15, 2005.

     MacKay prepared a preliminary report on March 15, 2005,

regarding the administration of Lucca’s estate.   The report

stated:   “It appears that there will be no distribution to

unsecured creditors”.   Petitioner never pursued a claim against

Lucca during the bankruptcy proceedings to recover any of his
                               - 7 -

payments, but, as MacKay’s preliminary report suggests, recovery

for unsecured creditors appeared unlikely.

     On April 28, 2006, MacKay prepared the Notice of Final

Dividend and Application for Discharge of Trustee for Lucca.

MacKay found that there were no funds available for distribution.

Lucca was dissolved on July 31, 2006.

     In 2005 petitioners paid mortgage interest of $14,444 for

funds borrowed from LOC 7826 and $17,264 for funds borrowed from

LOC 3789.

     With the exception of petitioner’s $150,000 initial

contribution to Lucca, for which Lucca issued stock to

petitioner, petitioners did not provide any documentation that

explained how petitioner or Lucca treated the remaining $382,000

petitioner transferred to Lucca (i.e., as a loan or a

contribution).   Lucca recorded the transfers by writing down in

its records that it received cash from petitioner.   However, we

do not know anything more about the records because they were

unavailable.   Furthermore, petitioner expected to recover his

transfers only in the event that Lucca became profitable.

                            Discussion

     Deductions are a matter of legislative grace, and taxpayers

bear the burden of proving entitlement to the deductions claimed.

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
                               - 8 -

Petitioners do not allege, nor do we find, that section 7491(a)

applies.

I.   Section 166 Business Bad Debt Deduction

      Section 166(a) provides as a general rule that a deduction

shall be allowed for any debt which becomes worthless within the

taxable year.   Only a bona fide debt can be deducted, however.    A

bona fide debt arises when a debtor-creditor relationship is

formed because of an unconditional, valid, and enforceable

obligation to pay a fixed or determinable sum of money.    Boatner

v. Commissioner, T.C. Memo. 1997-379, affd. without published

opinion 164 F.3d 629 (9th Cir. 1998); sec. 1.166-1(c), Income Tax

Regs.   A gift or contribution to capital shall not be considered

a debt for purposes of section 166.    Kean v. Commissioner, 91

T.C. 575, 594 (1988); sec. 1.166-1(c), Income Tax Regs.

      Petitioners argue that the transfers totaling $382,000,

including amounts paid directly to Lucca or on its behalf, were

loans and not equity investments.   The question of whether

transfers of funds to closely held corporations constitute debt

or equity must be decided on the basis of all the relevant facts

and circumstances.   Dixie Dairies Corp. v. Commissioner, 74 T.C.

476, 493 (1980).   Taxpayers generally bear the burden of proving

that the transfers constituted loans and not equity investments.

Rule 142(a).
                               - 9 -

      Courts look to the following nonexclusive factors to

evaluate the nature of transfers of funds to closely held

corporations:   (1) The names given to the certificates evidencing

the indebtedness; (2) the presence or absence of a maturity date;

(3) the source of the payments; (4) the right to enforce the

payment of principal and interest; (5) participation in

management; (6) a status equal to or inferior to that of regular

corporate creditors; (7) the intent of the parties; (8) “thin” or

adequate capitalization; (9) identity of interest between

creditor and stockholder; (10) payment of interest only out of

“dividend” money; and (11) the ability of the corporation to

obtain loans from outside lending institutions.   Bauer v.

Commissioner, 748 F.2d 1365, 1368 (9th Cir. 1984) (citing A.R.

Lantz Co. v. United States, 424 F.2d 1330, 1333 (9th Cir. 1970)),

revg. T.C. Memo. 1983-120.

     These factors serve only as aids in evaluating whether

transfers of funds to closely held corporations should be

regarded as capital contributions or as bona fide loans.     Fin Hay

Realty Co. v. United States, 398 F.2d 694, 697 (3d Cir. 1968).

No single factor is controlling.   Dixie Dairies Corp. v.

Commissioner, supra at 493.   However, the ultimate question is

whether there was a genuine intention to create a debt, with a

reasonable expectation of repayment, and whether that intention

comported with the economic reality of creating a debtor-creditor
                               - 10 -

relationship.    Litton Bus. Sys., Inc. v. Commissioner, 61 T.C.

367, 377 (1973).

     Transfers to closely held corporations by controlling

shareholders are subject to heightened scrutiny, and labels

attached to such transfers by the controlling shareholders

through bookkeeping entries or testimony have limited

significance unless these labels are supported by objective

evidence.7   Fin Hay Realty Co. v. United States, supra at 697;

Dixie Dairies Corp. v. Commissioner, supra at 495; see also Bauer

v. Commissioner, supra at 1367-1368; A.R. Lantz Co. v. United

States, supra.

     Rather than analyze in this opinion the facts here involved

in light of every factor on the debt-equity checklists, we

confine our discussion to those points we find most pertinent.

     First, petitioners’ posttransaction characterization of the

transfers totaling $382,000 as loans is undermined by the lack of

any formal indicia of bona fide debt.   For example, petitioner’s

transfers to Lucca were not accompanied by a note specifying a

maturity date, an interest rate, or a repayment schedule.    A

second factor that weighs against a debtor-creditor relationship


     7
        While petitioner was not the controlling shareholder on
account of his minority ownership interest, he effectively
controlled Lucca. Mr. Eberle was the active manager, but his
decisions were subject to petitioner’s approval; and petitioner
had contributed all of the operating capital. Consequently, we
will closely scrutinize petitioner’s characterization of his
transfers.
                                - 11 -

is petitioner’s continued investment in a struggling company

without receiving any security interest in the company.     “It is

unreasonable to conclude that * * * a prudent creditor would

continue to make unsecured loans to a debtor with expectation of

repayment.”    Dodd v. Commissioner, 298 F.2d 570, 578 (4th Cir.

1962), affg. T.C. Memo. 1961-8.     Third, petitioner’s expectation

of recouping his transfers only in the event that Lucca became

successful undermines the “valid and enforceable obligation”

element.     See sec. 1.166-1(c), Income Tax Regs.   Finally,

petitioners provided no documentary evidence that Lucca treated

the transfers as loans on its books.8

     Despite the absence of formal aspects that typically denote

a bona fide debt, petitioners contend that this case is analogous

to Johnson v. Commissioner, T.C. Memo. 1977-436, and,

consequently, their transfers should be characterized as bona

fide debt.    We disagree.

     First, in Johnson, the taxpayer provided the Court with

minutes from two board of directors meetings that not only

discussed the need to repay but later ratified the corporation’s

obligation to repay any advances.     Second, the taxpayer in that

case demonstrated that the corporation that made the transfers

recorded them as accounts receivable and the corporation



     8
        We note as an additional factor that petitioner did not
file a claim in Lucca’s bankruptcy proceeding.
                              - 12 -

receiving the transfers recorded them as accounts payable.

Third, the payments were characterized by the Court as bona fide

debt only so long as a reasonable expectation of repayment

existed.   Once the taxpayer’s expectation of repayment became

unreasonable because of the corporation’s unlikely chance of

recovery, the Court characterized the transfers as equity

investments.   Id.

     It is true that this case resembles Johnson in the sense

that no note was executed, no repayment schedule was set, and no

interest rate was attached to the transfers.   However, other

factors in Johnson, which are not present in petitioners’ case,

clearly denoted the parties’ intent to create a bona fide debt

and an enforceable obligation to repay the transfers.   Id.

     Here, the only evidence of bona fide debt was petitioner’s

self-serving testimony that he expected to be repaid for his

transfers and that Lucca was obligated to repay them.   Lucca did

not register the transfers as accounts payable.   Lucca’s business

had already withered by 2004, yet petitioner continued to make

transfers to Lucca throughout the year.   With little to no

business in 2004, it was unreasonable for petitioner to expect

repayment of his transfers.

     Petitioners did not provide business records or

corroborating testimony that would objectively reveal

petitioner’s or Lucca’s intent.   Applying heightened scrutiny to
                               - 13 -

this case because petitioner is so closely connected to Lucca, we

find that petitioner’s testimony alone is insufficient to

characterize the transfers as loans.    Therefore, without formal

elements typically evincing a debt instrument and objective

evidence supporting petitioners’ characterization of the

transfers, we find that petitioner’s transfers to Lucca were not

bona fide debt.   Consequently, petitioners are not entitled to a

bad debt deduction under section 166.

II.   Section 165(g) Worthless Security Deduction

      As we found above, petitioner’s transfers constituted

equity, not debt.   Petitioners argue that they are entitled to

deduct as a capital loss for a worthless security in 2005 the

amount of petitioner’s basis in his Lucca stock.    Respondent

argues that, to the extent petitioner’s Lucca stock became

worthless, it did not do so until 2006.

      Under section 165(g), securities which are capital assets

that become worthless during a taxable year are “treated as a

loss from the sale or exchange, on the last day of the taxable

year, of a capital asset.”   Sec. 165(g)(1).9   For purposes of

section 165(g), the term “security” includes a share of stock in

a corporation.    Sec. 165(g)(2)(A).




      9
        Sec. 1244 does not apply to petitioners’ stock because
Lucca is not a domestic corporation.
                                 - 14 -

     For a taxpayer to qualify for a capital loss deduction under

section 165(g), a stock interest in a corporation must be wholly

worthless.   Sec. 1.165-5(c), Income Tax Regs.    Whether the stock

interest in the corporation is worthless and the taxable year in

which such worthlessness occurred are questions of fact with

respect to which petitioners generally bear the burden of proof.

See Rule 142(a); Boehm v. Commissioner, 326 U.S. 287, 294 (1945);

Welch v. Helvering, 290 U.S. at 115.      Stock is worthless if it

has neither liquidating value nor potential value.      Austin Co. v.

Commissioner, 71 T.C. 955, 970 (1979).     A corporation’s stock has

liquidating value if its assets exceed its liabilities.        Id.   A

corporation’s stock has potential value if there is a reasonable

expectation that it will become valuable in the future.        Morton

v. Commissioner, 38 B.T.A. 1270, 1278 (1938), affd. 112 F.2d 320

(7th Cir. 1940).   A corporation’s stock may be worthless if the

corporation declares bankruptcy, ceases to operate, liquidates,

or has a receiver appointed, because these events can destroy the

stock’s potential value.   Id.

     Petitioner’s stock in Lucca became worthless in 2005 because

Lucca lacked liquidating and potential value.     Lucca filed for

bankruptcy on March 15, 2005.     On the same day MacKay was

appointed as Lucca’s bankruptcy trustee.     MacKay found that

Lucca’s liabilities exceeded its assets.     Thus, there was no

liquidating value.   Moreover, Lucca had no prospects of
                                - 15 -

recovering from its financial problems and had decided to

dissolve.    Consequently, petitioner could not reasonably expect

the stock to gain any future value.      Therefore, petitioners are

entitled to a deduction for worthless securities equal to

petitioner’s adjusted basis in his Lucca stock.10

III.    Section 162(a) Deduction for $10,000

       Taxpayers are allowed a deduction for ordinary and necessary

expenses paid or incurred in carrying on a trade or business.

Sec. 162(a).    Whether an expenditure is ordinary and necessary is

generally a question of fact.    Commissioner v. Heininger, 320

U.S. 467, 475 (1943).    Generally, for an expenditure to be an

ordinary and necessary business expense, the taxpayer must show a

bona fide business purpose for the expenditure; there must be a

proximate relationship between the expenditure and the business

of the taxpayer.    Challenge Manufacturing Co. v. Commissioner, 37

T.C. 650 (1962); Henry v. Commissioner, 36 T.C. 879 (1961).

       To be “necessary” within the meaning of section 162, an

expense needs to be “appropriate and helpful” to the taxpayer’s



       10
        The basis for determining the amount of the deduction
for any loss shall be the adjusted basis provided in sec. 1011
for determining the loss from the sale or other disposition of
property. Sec. 165(b). Petitioner’s cost basis in his Lucca
stock, presumably $150,000, was increased by the amounts
described above that he subsequently contributed to Lucca. See
sec. 1016(a); Commissioner v. Fink, 483 U.S. 89, 94 (1987) (a
shareholder is entitled to increase the basis of his shares by
the amount of cash contributed to the corporation’s capital, even
if the other shareholders make no contribution at all).
                               - 16 -

business.    Welch v. Helvering, supra at 113.   The requirement

that an expense be “ordinary” connotes that “the transaction

which gives rise to it must be of common or frequent occurrence

in the type of business involved.”      Deputy v. du Pont, 308 U.S.

488, 495 (1940) (citing Welch v. Helvering, supra at 114).

     Petitioners argue that the $10,000 payment to DIA on behalf

of Lucca was an ordinary and necessary business expense.      A

taxpayer generally may not deduct the payment of another person’s

expense.    See Deputy v. du Pont, supra; Dietrick v. Commissioner,

881 F.2d 336 (6th Cir. 1989), affg. T.C. Memo. 1988-180; Betson

v. Commissioner, 802 F.2d 365, 368 (9th Cir. 1986) (shareholder’s

payment of corporate obligation is not ordinary and necessary

under section 162(a)), affg. in part and revg. in part T.C. Memo.

1984-264; Lohrke v. Commissioner, 48 T.C. 679 (1967).      However,

where a taxpayer can show that the payment of another’s expense

protected or promoted the taxpayer’s own business, then such

payment may be deductible.   Square D Co. v. Commissioner, 121

T.C. 168, 200 (2003); Hood v. Commissioner, 115 T.C. 172, 180-181

(2000); Lohrke v. Commissioner, supra at 688.     Typically in these

circumstances, the original obligor is unable to make payment,

and the taxpayer satisfies the obligation to protect or promote

his interests.   See Hood v. Commissioner, supra at 181.

     Petitioner’s payment to DIA was made expressly for the

preservation of his own business.    Petitioner earned commissions
                               - 17 -

from DIA whenever a furniture store bought DIA’s products through

him.    In 2005 Lucca owed approximately $30,000 for goods

purchased from DIA through petitioner.      Despite petitioner’s and

Mr. Eberle’s best efforts, Lucca did not recover from its

financial problems and, as a result, Lucca could not pay its

debts to DIA.

       To recover a portion of Lucca’s debts to DIA, DIA’s

president threatened petitioner with the possibility of losing

his position as DIA’s representative.      In order to avoid losing

his position with DIA, a manufacturer that was important to him,

he paid DIA $10,000.

       Moreover, Lucca had little prospect of recovery because it

could not attract business.    The $10,000 payment on Lucca’s

behalf would have little impact on Lucca’s debts to its

creditors.    Hence, the $10,000 payment was primarily for the

preservation of petitioner’s business as a representative.

       Had petitioner lost DIA’s business, he would have lost a

significant portion of his income.      Therefore, petitioner paid

DIA to protect his business as a representative.      Consequently,

petitioners are entitled to deduct the $10,000 payment under

section 162(a).

IV.    Section 163 Deduction of $31,709 of Interest Payments

       Section 163(a) allows a deduction for all interest paid or

accrued within the taxable year on indebtedness.      However,
                               - 18 -

section 163(h) disallows deductions of personal interest accrued

during the taxable year in the case of a taxpayer other than a

corporation.   Personal interest is any interest allowable as a

deduction other than interest listed in section 163(h)(2).

Petitioners argue that their interest is either interest paid or

accrued on indebtedness that is properly allocable to a trade or

business or qualified residence interest, and therefore it is not

personal interest.   See sec. 163(h)(2)(A), (D).

     A.     Deduction of Interest Properly Allocable to a Trade or
            Business

     For petitioners to deduct interest under section

163(h)(2)(A), the interest expense must be “properly allocable to

a trade or business”.   Section 1.163-8T, Temporary Income Tax

Regs., 52 Fed. Reg. 24999 (July 2, 1987), provides the rules for

the allocation of interest expense for purposes of section

163(h).11   Robinson v. Commissioner, 119 T.C. 44, 70 (2002).

Debt is allocated to expenditures in accordance with the use of

the debt proceeds.    Sec. 1.163-8T(c)(1), Temporary Income Tax

Regs., 52 Fed. Reg. 25000 (July 2, 1987).    In general, interest

expense accruing on a debt during any period is allocated to

expenditures in the same manner as the debt is allocated.




     11
        Temporary regulations are entitled to the same weight as
final regulations. See Peterson Marital Trust v. Commissioner,
102 T.C. 790, 797 (1994), affd. 78 F.3d 795 (2d Cir. 1996); Truck
& Equip. Corp. v. Commissioner, 98 T.C. 141, 149 (1992).
                              - 19 -

     As we found above, the circumstances surrounding the $10,000

payment that petitioner made directly to DIA was for the purpose

of protecting and promoting his business as a representative.

Thus, the interest paid or accrued on $10,000 of indebtedness is

properly allocable to petitioner’s business as a representative.

Consequently, petitioner is entitled to deduct the amount of

interest attributable to $10,000 of indebtedness.

     The remaining interest paid or accrued on petitioners’

indebtedness may not be deducted as interest accrued in

connection with petitioner’s business as a representative.

Petitioner contributed the remaining funds to Lucca to meet its

operating costs.   Thus, the remaining interest that he paid on

the indebtedness is properly allocable to Lucca’s business, not

to his business as a representative.     That being the case,

petitioners are not entitled to deduct the remaining interest

under section 163(h)(2)(A).

     B.   Deduction of Interest as Qualified Residence Interest

     Petitioners’ alternative argument is that the interest paid

on the loans is qualified residence interest.     To be deductible

as qualified residence interest, petitioners’ indebtedness must

be either interest paid or accrued on acquisition indebtedness or

interest paid or accrued on home equity indebtedness during the

taxable year.   See sec. 163(h)(3)(A).
                                - 20 -

          1.     Acquisition Indebtedness

     “Acquisition indebtedness” means any indebtedness which is

incurred in acquiring, constructing, or substantially improving

any qualified residence of the taxpayer, and is secured by such

residence.     Sec. 163(h)(3)(B).

     The funds petitioner borrowed were either contributed to

Lucca or were used to pay Lucca’s debts to DIA.     Consequently,

petitioners’ interest was not paid or accrued on indebtedness

used to acquire, construct, or substantially improve a qualified

residence.

          2.     Home Equity Indebtedness

     “Home equity indebtedness” means any indebtedness (other

than acquisition indebtedness) secured by a qualified residence

to the extent the aggregate amount of such indebtedness does not

exceed the fair market value of such qualified residence reduced

by the amount of acquisition indebtedness with respect to such

residence.     Sec. 163(h)(3)(C).

     Petitioners have not provided any information regarding the

fair market value of either the principal residence or the rental

property, nor have they provided any documents illustrating the

amount of acquisition indebtedness, if any, attached to either of

the two properties.     Consequently, without values to calculate

whether the indebtedness exceeded the fair market value minus

acquisition indebtedness, petitioners may not deduct their
                             - 21 -

interest payments as home equity indebtedness.   See sec. 6001;

sec. 1.6001-1(a), (e), Income Tax Regs.

     In reaching our holdings herein, we have considered all

arguments made by the parties, and to the extent not mentioned

above, we find them to be irrelevant or without merit.

     To reflect the foregoing,


                                          Decision will be entered

                                   under Rule 155.
