                           T.C. Memo. 1998-19



                         UNITED STATES TAX COURT



          DOUGLAS A. AND JANET VANDER HEIDE, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 13745-95.                       Filed January 20, 1998.



     Douglas A. and Janet Vander Heide, pro sese.

     Elizabeth P. Flores, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION

     VASQUEZ, Judge:      Respondent determined the following

deficiencies in and additions to petitioners' Federal income

taxes:

                                       Additions to Tax
                               Sec.           Sec.          Sec.
   Year     Deficiency     6653(a)(1)(A) 6653(a)(1)(B)     6661(a)
                                                   1
   1985       $11,055        $552.75                      $2,763.75
                                                   1
   1986        25,573       1,278.65                       6,393.25
     1
         50 percent of the interest due on the deficiency.
                                   - 2 -


     Respondent has also determined increased interest under

section 6621(c).1

     The main issues for decision are:        (1) Whether petitioners

were “protected against loss” within the meaning of section

465(b)(4) with respect to their pro rata share of partnership

debt obligations arising from sale-leaseback transactions engaged

in by a partnership, and (2) whether additions to tax under

sections 6653(a) and 6661(a) and increased interest under section

6621(c) are applicable.

                          FINDINGS OF FACT

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

The stipulation of facts and attached exhibits are incorporated

herein by this reference.    Petitioners both resided in California

when they filed the petition in the instant case.

     Petitioners timely filed joint Federal income tax returns

for the taxable years 1985 and 1986.        Petitioners deducted losses

and investment interest expenses (the claimed deductions)

relating to Hambrose Leasing 1985-4 (the partnership) in the

following amounts:

          Year              Loss           Investment Interest

          1985            $27,985               $1,107
          1986             45,689               14,916




     1
        All section references are to the Internal Revenue Code
in effect for the years in issue. All Rule references are to the
Tax Court Rules of Practice and Procedure.
                                - 3 -


     On May 26, 1995, respondent timely issued two affected item

statutory notices of deficiency to petitioners in which

respondent disallowed the claimed deductions with respect to the

partnership.2

     This case involves two sale-leaseback transactions among the

following entities:   the partnership, which engaged in the

equipment leasing business; Charterhouse Leasing Associates

Limited Partnership (Charterhouse); Hambrose Reserve Ltd.

(Hambrose); M&J Holding Corp. (M&J), the sole shareholder of

Hambrose and the general partner of Charterhouse; CIS Leasing

Corp. (CIS); and Comdisco, Inc. (Comdisco).

The Sale-Leaseback Transactions

     The partnership's leasing transaction involves the sale and

leaseback of various computer equipment that it purchased in 1985

from Hambrose.   Hambrose initially purchased the equipment from

Charterhouse.    Charterhouse purchased the equipment from CIS and

Comdisco, the original purchasers of the equipment.   CIS and

Comdisco purchased the equipment with financing provided by

various third-party lenders and subsequently leased the equipment


     2
        Although the parties stipulated to the timely filing of
the notices, petitioners seem to argue that it is unfair that
notice was not given sooner. However, it is clear that
respondent complied with the statute and that the notices were
timely under sec. 6229(a) and (d) because (1) there was a Final
Partnership Administrative Adjustment (FPAA) issued to the
partnership, (2) a proceeding was instituted in this Court based
on that FPAA, (3) that proceeding was decided on Aug. 3, 1994,
and became final on Nov. 1, 1994, and (4) the notices of
deficiency were mailed within 1 year thereafter on May 26, 1995.
                                - 4 -


to various entities.   With respect to the equipment, a wrap lease

was executed between Hambrose as lessor and Charterhouse as

lessee.    Hambrose assigned the wrap lease to the partnership when

the partnership purchased the equipment.   The partnership

purchased the equipment subject to all liens created at each

stage of the transaction, including the liens of the original

third-party lenders, the wrap lease, and all user leases.    At the

end of the day, the partnership owned the computers, the

operating companies used them, and Charterhouse, Hambrose, and

the partnership traded streams of financing payments and lease

payments.   The transactions are described in more detail as

follows.

     The Initial Equipment

     CIS initially purchased, subject to financing from third-

party lenders, certain IBM computer equipment (the initial

equipment), for a total purchase price of $825,150.34.   CIS

leased all of the initial equipment to Harrisburg Hospital,

Danbury Hospital, and Leeds & Northrup, the actual end users of

the equipment.

     The Initial Equipment Purchase--Charterhouse

     The second purchaser3 then paid CIS $494,861--$19,794 in

cash and the balance represented by nonrecourse installment




     3
        The “second purchaser” was someone other than
Charterhouse. The "second purchaser" was never identified in the
partnership's private offering memorandum (POM).
                               - 5 -


obligations of Charterhouse secured by the initial equipment--for

the initial equipment.



     Hambrose Purchase

     On or about March 29, 1985, Hambrose purchased the initial

equipment from the second purchaser, subject to the liens of the

original third-party lenders, the original purchaser, and the

user-leases, for $494,861.   Hambrose paid the $494,861 as

follows:   $24,000 in cash and the balance represented by an

unsecured note.   Concurrently with Hambrose's purchase of the

initial equipment from the second purchaser, the second purchaser

leased back the initial equipment from Hambrose pursuant to a

wrap lease (the initial equipment wrap lease).   The terms of the

initial equipment wrap lease obligated Charterhouse (by

assignment from the second purchaser) to pay four consecutive

annual installments beginning March 31, 1986, in the amount of

$159,886 in rent.   Under the initial equipment wrap lease, the

lessee waived “any right of set-off under state or federal law,

counterclaim, recoupment, defense or other right which Lessee may

have against Lessor or anyone else for any reason whatsoever”.

     The lease agreement contained the following provision:
                                  - 6 -




          18.   Indemnification

          18.1 Lessee will indemnify Lessor and protect,
     defend and hold it harmless from and against any and
     all loss, cost, damage, injury or expense, including,
     without limitation, reasonable attorneys' fees,
     wheresoever and howsoever arising which Lessor or its
     subsidiaries or shareholders, or any of its or their
     directors, officers, agents, employees, stockholders or
     partners, may incur by reason of any breach by Lessee
     of any of the representations by, or obligations of,
     Lessee contained in this Lease or in any way relating
     to or arising out of this Lease, the Equipment, claims
     of holders of the Lien or Underlying Leases; * * *

     The Initial Equipment Purchase--The Partnership

     On or around March 29, 1985, the partnership purchased the

initial equipment from Hambrose for $494,861 subject to all liens

of the third-party lenders and Hambrose, the user leases, and the

initial equipment wrap lease.     The partnership paid for the

initial equipment as follows:     $1,000 cash on the closing in

November 1985, $28,000 cash by December 31, 1985, and $465,861

represented by a note (the partnership note) secured by the

initial equipment payable in four consecutive annual installments

of $159,886 with the first installment due on March 31, 1986.

The partnership note contained the following provision

(hereinafter the deferral provision):

          5.1 Deferral. Maker [the Partnership] shall have
     the right to defer payment of the Principal Amount and
     interest as the same becomes due under this Note if and
     to the extent any amount of rent or other sums due to
     Maker under an agreement of even date (the "Lease"),
     between Charterhouse Equipment Associates Limited
     Partnership ("Charterhouse"), as lessee, and Maker, as
     lessor is not received by Maker as the same becomes due
                                 - 7 -


     (the "Past Due Sum"). The amount of principal and
     interest so deferred will become due and payable at
     such time as, and to the extent that, Maker receives
     from Charterhouse the Past Due Sum; provided, however,
     that no interest shall accrue on the principal and
     interest payments so deferred; provided, further,
     however, that the amount of interest and principal so
     deferred shall become due and payable on Jan. 1, 1992;
     whether or not Maker shall have received the Past Due
     Sum on or before such date.

In conjunction with the partnership's purchase of the initial

equipment, Hambrose assigned the initial equipment wrap lease to

the partnership.



Additional Equipment

     CIS and Comdisco purchased additional IBM equipment (the

additional equipment).   They financed the purchase of the

additional equipment, amounting to $15,175,231, through eight

different third-party lenders.    All of the additional equipment

was leased by CIS and Comdisco to eight actual end users of the

equipment.

     Charterhouse Purchase

     The second purchaser acquired the additional equipment from

CIS and Comdisco in two separate purchase transactions.    All

rights and obligations under these transactions were subsequently

assigned to Charterhouse.    The second purchaser paid, in the

aggregate, cash of $1,004,538 and installment notes totaling
                                  - 8 -


$11,089,447.   According to the POM, these notes were nonrecourse

obligations of Charterhouse.

     Hambrose Purchase

     Hambrose purchased the additional equipment from

Charterhouse for $11,064,696, subject to all other liens and

leases including the liens of the original third-party lenders,

CIS and Comdisco, and user leases.        Hambrose paid for the

additional equipment as follows:     $1,200,000 in cash and a

$9,864,696 installment note.   This note was unsecured and payable

in seven annual installments, the first, in 1986, of $206,473 and

the remaining six installments of $2,477,681.        Concurrently with

Hambrose's purchase of the additional equipment from

Charterhouse, Charterhouse leased back the additional equipment

from Hambrose pursuant to a wrap lease (the additional equipment

wrap lease).   The additional equipment wrap lease called for the

following annual fixed rental payments:

     Year            Unit Minimum             Unit Maximum

     1985                    $0                       $0
     1986               206,473                  413,091
     1987             2,477,681                4,957,116
     1988             2,477,681                4,957,116
     1989             2,477,681                4,957,116
     1990             2,477,681                4,957,116
     1991             2,477,681                4,957,116
     1992             2,477,681                4,957,116

     Partnership Purchase

     The partnership purchased the additional equipment from

Hambrose for $11,064,696 subject to all other liens and leases

including those of the original third-party lenders, the original
                               - 9 -


purchasers, and Hambrose.   The partnership paid for the

additional equipment as follows:   $1,106,470 in cash and a

$9,958,226 installment note secured by the additional equipment.

The note was payable in eight installments with the first

installment of $644,530 due at closing.    Thereafter, the payments

were as follows:

                  Year          Amount

                  1986          $206,473
                  1987         2,477,681
                  1988         2,477,681
                  1989         2,477,681
                  1990         2,477,681
                  1991         2,477,681
                  1992         2,477,681

This note contained a deferral provision similar to the one

discussed, supra, for the note used to purchase the initial

equipment.   Hambrose assigned the additional equipment wrap lease

to the partnership pursuant to its purchase of the additional

equipment.

     The partnership's purchases of the initial equipment and the

additional equipment were subject to all liens created at each

stage of the transaction, including the liens of the original

third-party lenders, the wrap lease, and all user leases.

The Partnership

     Investments in the partnership were offered through a POM.

The partnership offered 100 units of partnership interests at a

price of $40,000 each, payable in full in cash or in the amount

of $8,500 in cash and two $15,750 notes bearing 12-percent
                                           - 10 -


interest, one payable on February 3, 1986, and the other on

February 2, 1987.

       As a condition of becoming a limited partner, the

partnership required an investor to assume recourse debt of

$114,805 per partnership unit purchased, which represented his or

her proportionate share of the note executed by the partnership

in connection with the purchase of the additional equipment.                           The

partnership anticipated that the obligation assumed by the

limited partners pertained to the last installments of the

partnership note, due between January 1, 1990, and January 1,

1992.

       The POM included the following projection of tax benefits

per partnership unit for the first years of the transaction:



                               50 Unit Minimum                   100 Unit Maximum
                        Projected     Loss as a Percent   Projected     Loss as a Percent
Year   Investment       Tax Loss        of Investment     Tax Loss        of Investment

1985        $8,500       $30,170          355              $30,173          355
           1
1986         15,750       47,223          300               47,378          301
           1
1987         15,750       45,247          287               45,539          289
1988          -0-         18,437                            18,868
1989          -0-         13,728                            12,847

  Total        40,000    154,805          387              154,805          387
       1
           Does not include interest at 12 percent per annum.

Petitioner's4 Decision to Invest

       On or about November 21, 1985, petitioner executed

subscription documents to purchase one unit in the partnership,




       4
        References to petitioner in the singular refer to Douglas
A. Vander Heide.
                              - 11 -


for which he paid a total of $40,000 in cash.    The amount of

recourse debt which petitioner assumed totaled $114,805.

     Prior to investing in the partnership, petitioner had never

invested in an equipment leasing transaction.    Petitioner spoke

to his accountant, Joseph R. Levin, three times about his

investment in the partnership.   Petitioner never spoke to Barry

Goldwater, Jr., the general partner of the partnership, Herman

Finesod, the chairman of the board of Hambrose Reserve, or James

Harber or Ron Finerty, the other officers of Hambrose Reserve,

about this investment.   Petitioner received the subscription

documents on November 21, 1985, the day he signed them.

     Petitioner understood that the rents from Charterhouse would

be used to offset debt payments to Hambrose.    He was not

concerned about the end-users because they were big companies.

Petitioner understood that the partnership's promissory note on

which he assumed personal liability would be paid in 1992.    The

partnership never asked petitioner for additional contributions.

     Petitioner knew that the investment would create tax losses,

and he had seen a schedule of projected tax losses for each

taxable year.   Petitioner expected the investment to yield

phantom income in the third or fourth year.    Petitioner knew that

phantom income is not an actual cash distribution.

                              OPINION

At-Risk

     We must now decide whether petitioners were at risk for

their assumed liability in the context of the sale-leaseback
                               - 12 -


transactions.   Because respondent first raised the at-risk issue

in the answer, respondent bears the burden of proof and so

concedes on brief.

     Section 465(a) provides that deductions with respect to the

type of leasing activity represented by this case are only

allowable to the extent of the amount for which the taxpayer is

at risk.    Generally, a taxpayer will, subject to the exception in

section 465(b)(4), discussed below, be considered at risk for the

amount of any cash investment.   Sec. 465(b)(1)(A).   Also, a

taxpayer will be considered at risk for the amounts borrowed with

respect to the activity, to the extent that the taxpayer is

personally liable for the repayment of such amounts.    Sec.

465(b)(2)(A).

     Respondent concedes that the partnership's transactions had

a business purpose with economic substance, were engaged in for

profit, and that the partnership's equipment was correctly

valued.    Respondent also concedes that petitioners were at risk

in the amount of their $40,000 cash investment.   Nevertheless,

respondent contends that petitioners were not at risk for the

amount of assumed partnership debt under section 465(b)(4) which

provides:

          (4) Exception.--Notwithstanding any other
     provision of this section, a taxpayer shall not be
     considered at risk with respect to amounts protected
     against loss through nonrecourse financing, guarantees,
     stop loss agreements, or other similar arrangements.
                                - 13 -


Respondent does not contend that petitioners were protected by

guaranties or stop loss agreements, but rather by nonrecourse

financing and “other similar arrangements”.

     When analyzing a transaction under section 465(b)(4), we use

the “realistic possibility” or “economic reality” test set forth

in American Principals Leasing Corp. v. United States, 904 F.2d

477, 483 (9th Cir. 1990) (sometimes cited as Baldwin v. United

States), and approved by this Court in Levien v. Commissioner,

103 T.C. 120, 126 (1994), affd. without published opinion 77 F.3d

497 (11th Cir. 1996).

     This test asks "whether there is any realistic possibility

that the taxpayer ultimately will be subject to economic loss on

the investment at issue."    Levien v. Commissioner, supra at 126.

In applying this standard, we are guided by the substance of the

transaction, not its form.    Id. at 129.   We look not to any

single factor, id. at 127, but to whether the combination of

factors and characteristics of the transaction rises to the level

of an “other similar arrangement” with the effect of protecting

petitioners against risk.

     Unfortunately in this case, both parties have had to deal

with a lack of documentation.    We find, however, no significant

difference between the facts of this case and those of Estate of

Bradley v. Commissioner, T.C. Memo. 1997-341 (concerning a

partner in the Hambrose Leasing 1984-5 partnership).
                                - 14 -


     Respondent first stresses the circular nature of the

payments--the partnership's debt payments to Hambrose were

exactly offset by the rental payments it received from

Charterhouse.   This circularity is set forth in the stipulation

of facts as well as the POM.    As we have previously held,

circular payments do not per se constitute “other similar

arrangements” for purposes of section 465(b)(4).    Krause v.

Commissioner, 92 T.C. 1003, 1024 (1989).    Nevertheless, they are

a factor to be considered.     Levien v. Commissioner, supra at 126.

     Not only were the debt and rental payments matching in

amount and timing, but the flow of payments was circular.     It

would thus appear to make no difference whether the parties made

the payments or not, so long as each of the parties in the circle

did the same thing.   The circularity of the payments, when

combined with the common ownership of Charterhouse and Hambrose,

provides little economic incentive for Hambrose to pursue the

limited partners for their share of the debt in the event of a

default.

     Respondent also contends that the deferral provisions

operated to protect petitioner against loss.    The sale or re-

leasing of the equipment at the end of the transactions, which

could have provided funds to satisfy deferred liabilities, was

viewed as a significant source of return on investment.     It is

clear that debt obligations payable in the future are included in

the amount for which a partner is considered personally liable
                                - 15 -


for purposes of section 465(b)(2).       Melvin v. Commissioner, 88

T.C. 63, 73 (1987), affd. 894 F.2d 1072 (9th Cir. 1990).       Thus,

we cannot simultaneously propose a rule that the deferral of debt

obligations into the future represents per se an “other similar

arrangement” for section 465(b)(4).       The presence of deferral

provisions, however, is another factor to be considered in

deciding whether a taxpayer is protected against loss.       See

Santulli v. Commissioner, T.C. Memo. 1995-458.

     The instant transaction is similar to the equipment leasing

transaction in Hayes v. Commissioner, T.C. Memo. 1995-151.         Hayes

involved sale-leaseback transactions by and between the Hambrose

Leasing-5 Partnership, Charterhouse, and Hambrose Reserve.         As in

the instant case, Hayes involved circularity of payments and that

partnership's deferral provisions.       Applying the realistic

probability test in Hayes, we held that the taxpayers were not at

risk under section 465(b)(4).    We stated the following:

     Moreover, there were co-extensive provisions for
     delaying the rental payments and the payment of the
     purchase price installments for the years 1987 through
     1990. Furthermore, the responsibility of M & J, as the
     general partner of Charterhouse, for the rent payments
     provided an important assurance that the rents, which
     would be the source of the payments by the partnership
     to Hambrose Reserve, would be paid. Id.

     The ultimate decision whether the taxpayer is protected

against loss “rests upon the substance of the transactions in

light of all the facts and circumstances.”       Wag-A-Bag, Inc. v.

Commissioner, T.C. Memo. 1992-581.
                               - 16 -


     We think the circularity of payments, the deferral

provisions, and the similarity of ownership among the entities,

when taken together, are sufficient to satisfy respondent's

burden that petitioner, while nominally “personally liable” for

the assumed liabilities under section 465(b)(2), effectively was

immunized from any realistic possibility of suffering an economic

loss under section 465(b)(4), was not at risk, and is not

entitled to the deductions in question.    Levien v. Commissioner,

supra at 120.   We so hold.

Additions

     Section 6621(c)

     Respondent seeks increased interest pursuant to section

6621(c).    That section provides for an increase in the interest

rate to 120 percent of the statutory rate on underpayments of tax

if a substantial understatement is due to a tax-motivated

transaction.    Certain transactions are deemed to be “tax

motivated” by section 6621(c)(3), including any loss disallowed

under section 465(a).    Sec. 6621(c)(3)(A)(ii).

     Since we have concluded that the loss deductions in issue

are disallowed under section 465(a), it follows that the

activities were tax motivated under section 6621(c)(3).      We

therefore sustain respondent on this issue.

     Section 6653(a) (Negligence)

     Respondent has determined an addition to tax under section

6653(a) for negligence.    Section 6653(a)(1) (section
                                - 17 -


6653(a)(1)(A) for 1986) provides that if any part of any

underpayment of tax is due to negligence or intentional disregard

of rules or regulations, there shall be added to the tax an

amount equal to 5 percent of the underpayment.    Section

6653(a)(2) (section 6653(a)(1)(B) for 1986) provides for an

addition to tax in the amount of 50 percent of the interest

payable on the portion of the underpayment of tax attributable to

negligence.

     Negligence is defined as the lack of due care or failure to

do what an ordinarily prudent person would do under the

circumstances.     Zmuda v. Commissioner, 731 F.2d 1417, 1422 (9th

Cir. 1984), affg. 79 T.C. 714 (1982).    Negligence also includes

any failure to make a reasonable attempt to comply with the

provisions of the internal revenue laws.    Sec. 6653(a)(3).

Petitioner bears the burden of proving that respondent's

determinations are in error.    Rule 142(a).

     Reasonable and good faith reliance on the advice of an

accountant or attorney may offer relief from the imposition of

the negligence addition.     United States v. Boyle, 469 U.S. 241,

250-251 (1985).    Reliance on professional advice, however, is not

an absolute defense to negligence, but rather a factor to be

considered.   Freytag v. Commissioner, 89 T.C. 849, 888 (1987),

affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991).

     Petitioner initially received the POM from his accountant,

Joseph R. Levin.    Additionally, petitioner had three

conversations with Mr. Levin about the partnership.      Mr. Levin
                              - 18 -


prepared petitioners' joint Federal income tax return for the

1985 tax year.   Additionally, petitioners had John P. Schneider,

a certified public accountant, prepare their joint Federal income

tax return for the 1986 tax year.   We also note that at the time

petitioners made their investment, as our subsequent discussion

in respect of the addition to tax under section 6661 reveals,

most of the pertinent decisions had not been handed down so that

there was at best a shortage of authority setting forth legal

principles governing the tax consequences arising from the at-

risk provisions of section 465.5

     We think the foregoing circumstances meet the standard

established in United States v. Boyle, supra at 251, where the

Supreme Court stated:   “When an accountant or attorney advises a

taxpayer on a matter of tax law, such as whether a liability

exists, it is reasonable for the taxpayer to rely on that

advice.”

     We conclude that petitioners made a reasonable effort to

obtain, and in fact received, appropriate advice in respect of

petitioner's investment, and therefore they were not negligent

within the meaning of section 6653(a).

     Section 6661(a) (Substantial Understatement)

     Respondent has asserted additions to tax under section

6661(a) for substantial understatement.


     5
        See discussion in Andrews v. Commissioner, T.C. Memo.
1985-380 (no negligence under sec. 6653(a) because the fact that
a type of transaction was disapproved by courts not clear at the
time taxpayers entered into transaction).
                              - 19 -


     In this case, resolution of the at-risk issue is based

partly on a conclusion drawn from complex and interrelated

contractual documents.   See Waters v. Commissioner, T.C. Memo.

1991-462, affd. 978 F.2d 1310 (2d Cir. 1992).   The facts of this

case are similar to the facts of a number of other cases in which

taxpayers prevailed and were found by this Court to be at risk

with respect to sale-leaseback transactions.    See, e.g., Levy v.

Commissioner, 91 T.C. 838 (1988); Gefen v. Commissioner, 87 T.C.

1471 (1986); Brady v. Commissioner, T.C. Memo. 1990-626; Emershaw

v. Commissioner, T.C. Memo. 1990-246, affd. 949 F.2d 841 (6th

Cir. 1991).   We have also found that many similarly situated

taxpayers, who did not prevail and were found to be not at risk,

nevertheless had substantial authority for positions taken on

their returns.   See Estate of Bradley v. Commissioner, T.C. Memo.

1997-341; Waters v. Commissioner, supra; Epsten v. Commissioner,

T.C. Memo. 1991-252; Moser v. Commissioner, T.C. Memo. 1989-142,

affd. 914 F.2d 1040 (8th Cir. 1990); B & A Distrib. Co. v.

Commissioner, T.C. Memo. 1988-589.

     On the facts of this case, with regard to the at-risk issue,

we find that there existed substantial authority for petitioners'

return position.   We therefore hold that petitioners are not

liable for the section 6661 additions to tax.

     To reflect the foregoing,

                                                Decision will be

                                         entered under Rule 155.
