                  T.C. Summary Opinion 2003-19



                     UNITED STATES TAX COURT



          PRECISION PINE & TIMBER, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 11951-00S.                 Filed March 12, 2003.


     Lorin D. Porter (an officer), for petitioner.

     Charles B. Burnett, for respondent.



     DEAN, Special Trial Judge:   This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed.    Unless otherwise

indicated, subsequent section references are to the Internal

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

references are to the Tax Court Rules of Practice and Procedure.

The decision to be entered is not reviewable by any other court,

and this opinion should not be cited as authority.
                               - 2 -

     Respondent determined deficiencies of $28,113 and $32,450 in

petitioner's Federal income taxes for fiscal years ending (FYE)

March 31, 1993 and 1996, respectively.   The sole issue for

decision is whether, for FYE March 31, 1996, petitioner properly

deducted losses on its covenants not to compete.   The decision on

the loss deductions determines petitioner's entitlement to a

deduction for a net operating loss carryback to FYE March 31,

1993.

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

The exhibits received into evidence are incorporated herein by

reference.   At the time the petition in this case was filed,

petitioner's corporate offices were located in Heber, Arizona.

                            Background

     Petitioner operates as a commercial logging business in

northern Arizona.   The viability of the logging industry depends

on the availability of harvestable timber.   To ensure an adequate

supply of timber, petitioner began to purchase assets and timber

sales contracts1 from its competitors.

     In September 1987, petitioner leased real property,

including a sawmill, for logging activities from Parker Lumber

Company (Parker).   The Parker lease agreement included a covenant


     1
       For purposes of this opinion, a timber sales contract is a
contract between a landowner and a logging company which
establishes the right of the company to harvest timber on a
specified piece of land, and what the company "was obligated to
do for that timber."
                                 - 3 -

not to compete for a period of 15 years.      The parties allocated

$50,000 of the contract price to the covenant.

     In April 1991, petitioner purchased two timber sales

contracts and some equipment from Reidhead Lumber Company

(Reidhead).   The Reidhead sales agreement included a covenant not

to compete for a period of 6 years.      The parties allocated

$250,000 of the contract price to the covenant.

     In March 1993, petitioner purchased assets related to a

sawmill operation in Payson, Arizona, including two timber sales

contracts and some equipment from Kaibab Industries (Kaibab).

The Kaibab purchase agreement included a covenant not to compete

for a period ending September 1, 2000.      The agreement did not

make any specific allocations of the contract price.      Petitioner,

however, filed a Form 8594, Asset Acquisition Statement, with its

Federal income tax return for FYE March 31, 1994, which allocated

$200,000 of the contract price to the covenant.      Kaibab also

filed a Form 8594, but allocated $0 of the contract price to the

covenant.

     In 1993, the Mexican Spotted Owl was added to the list of

endangered species protected under the Endangered Species Act, 16

U.S.C. secs. 1531-1543 (1994).    In 1995, the United States

District Court for the District of Arizona issued a prohibitory

injunction banning logging operations in northern Arizona and New

Mexico to protect the Mexican Spotted Owl's habitat.
                                - 4 -

     Prior to the listing of the Mexican Spotted Owl, petitioner

operated three sawmills in Arizona.      At one point, there were

approximately 12 private sector mills operating in Arizona.        At

the time of trial, petitioner claimed that it was the only

operating mill in Arizona, and that they were operating on a

"shoestring budget".    Petitioner attributes the collapse of the

Arizona logging industry to the listing of the Mexican Spotted

Owl as an endangered species and the issuance of the prohibitory

injunction.

     The primary sources of timber in northern Arizona are

controlled by the U.S. Forest Service (USFS), which is vested

with specific regulatory powers.   Since the injunction, the USFS

has effectively ceased issuing new timber sales contracts.      Since

the injunction was first issued in 1995 there has been

essentially no logging in Arizona.      While the injunction, at

times, has allowed for minimal logging, there have been no

changes in the USFS regulatory scheme.

     For FYE March 31, 1996, petitioner deducted $185,172 as the

combined balance of the unamortized value of the three covenants

not to compete.   The deduction allowed a net operating loss to be

carried back to FYE March 31, 1993, resulting in additional tax

savings in that year.   Respondent disallowed the entire deduction

and the net operating loss carryback.
                               - 5 -

                             Discussion

     Respondent's position is that petitioner is not justified in

taking loss deductions relating to the unamortized balance of the

noncompetition agreements.   Respondent believes that the

injunction issued by the U.S. District Court of Arizona did not

interfere with the noncompetition agreements, and the correct tax

treatment was to continue to ratably deduct the values of the

noncompetition agreements over their respective lives.

     Petitioner argues that the downturn in the local logging

industry, due to the Mexican Spotted Owl's addition to the

endangered species list and the ensuing injunction issued by the

district court, makes the noncompetition agreements economically

useless because of reasonably foreseeable economic changes due to

legislative or regulatory action.    Petitioner argues that it is

entitled to its loss deductions in FYE March 31, 1996, and the

loss carryback to FYE March 31, 1993, pursuant to section 167 and

its governing regulations.   Specifically, petitioner cites

1.167(a)-9, Income Tax Regs., as authority for its deductions.

     Respondent argues that section 1.167(a)-8, Income Tax Regs.,

controls the outcome of this case.     Respondent argues that

because petitioner alleges that the obsolescence in this case was

sudden, the penultimate sentence of 1.167(a)-9, Income Tax Regs.,

shifts the analysis to section 1.167(a)-8, Income Tax Regs.

Basing his position on ABCO Oil Corp. v. Commissioner, T.C. Memo.
                                - 6 -

1990-40, respondent argues that the requirements of section

1.167(a)-8, Income Tax Regs., are not met under the facts of this

case.

     Deductions are a matter of legislative grace.   They are

allowable only if there is clear statutory authority providing

therefor.   New Colonial Ice Co. v. Commissioner, 292 U.S. 435,

440 (1934).

     Generally, section 167(a) allows a taxpayer to take

depreciation deductions for property used in its trade or

business.   The term "property" includes intangibles such as

covenants not to compete, and the rules for the allowance of

amortization deductions for intangibles are set forth in section

1.167(a)-3, Income Tax Regs.2   Citizens & S. Corp. v.

Commissioner, 91 T.C. 463, 479 (1988), affd. per curiam 919 F.2d

1492 (11th Cir. 1990).   To conclude that an intangible asset is

amortizable it must have a determinable value and a limited

useful life.   Newark Morning Ledger Co. v. United States, 507

U.S. 546, 556 n.9 (1993).   Because a covenant not to compete is

an intangible asset with a limited useful life it may be

amortized over the course of its life.   Warsaw Photographic


     2
       Sec. 197, Amortization of Goodwill and Certain other
Intangibles, generally applies with respect to property acquired
after Aug. 10, 1993. See Omnibus Budget Reconciliation Act of
1993, Pub. L. 103-66, sec. 13261(g), 107 Stat. 540; see also
Spencer v. Commissioner, 110 T.C. 62, 87 n.30 (1998), affd.
without published opinion 194 F.3d 1324 (11th Cir. 1999).
                               - 7 -

Associates, Inc. v. Commissioner, 84 T.C. 21, 48 (1985); O'Dell &

Co. v. Commissioner, 61 T.C. 461, 467 (1974).   Because each of

petitioner's covenants not to compete was entered into prior to

the effective date of current section 197, we must apply the law

as in effect for property acquired prior to August 11, 1993.

     Section 1.167(a)-9, Income Tax Regs., provides that the

depreciation allowance includes an allowance for "normal"

obsolescence.   If the taxpayer shows that the estimated useful

life previously used should be shortened by reason of

obsolescence greater than had been assumed in computing the

useful life, a change to the new and shorter life will be

permitted.

     "Extraordinary obsolescence" however, refers to the sudden

loss or termination of the usefulness of depreciable property

caused by some unexpected and unforeseen external force.

Extraordinary obsolescence results in either the shortening of

previously determined useful life if the obsolescence occurs over

a period greater than 1 taxable year, or in a loss if the useful

life is completely and suddenly terminated within 1 taxable year.

Coors Porcelain Co. v. Commissioner, 52 T.C. 682, 689-692 (1969),

affd. 429 F.2d 1 (10th Cir. 1970); sec. 1.167(a)-8, -9, Income

Tax Regs.

     Section 1.167(a)-9, Income Tax Regs., applies in situations

where a taxpayer seeks to shorten the useful life of an
                                    - 8 -

amortizable asset due to any of a variety of factors including

"legislative or regulatory action."         The regulation is

controlling only when assets become obsolete over a period of

time greater than 1 year.     Id.     Assuming that petitioner's

noncompetition agreements became obsolete as a result of a

"sudden" event, the 1995 prohibitory injunction, the Court must

look elsewhere for guidance.

     When an amortizable asset becomes obsolete within 1 taxable

year, a taxpayer may be entitled to a loss deduction.           Keller

Street Dev. Co. v. Commissioner, 323 F.2d 166, 171 (9th Cir.

1963), affg. in part, and revg. in part 37 T.C. 559 (1961); Moise

v. Burnet, 52 F.2d 1071 (9th Cir. 1931); Coors Porcelain Co. v.

Commissioner, supra at 692.    The appropriate statutory provision

for the allowance of a loss deduction for extraordinary

obsolescence of a depreciable asset occurring within 1 year is

section 165(a).   See sec. 1.165-1, Income Tax Regs.        Generally,

section 1.167(a)-8, Income Tax Regs., provides the rules

governing the recognition, amount, and basis for gain or loss

resulting from the sudden termination of the usefulness of

depreciable assets.   Coors Porcelain Co. v. Commissioner, supra

at 692; secs. 1.165-2(c) and 1.167(a)-8(a), -9, Income Tax Regs.

     Section 165(a) allows a deduction for any loss sustained

during the taxable year and not compensated for by insurance or

otherwise.   To be allowable as a deduction under section 165(a),
                               - 9 -

a loss must be evidenced by a closed and completed transaction,

fixed by identifiable events, and actually sustained during the

taxable year.   Echols v. Commissioner, 950 F.2d 209, 211 (5th

Cir. 1991), affg. per curiam 935 F.2d 703 (1991), revg. and

remanding 93 T.C. 553 (1989); sec. 1.165-1(b), (d)(1), Income Tax

Regs.   Substance and not mere form shall govern in determining a

deductible loss.   See Cottage Sav. Association v. Commissioner,

499 U.S. 554, 567-568 (1991); Boehm v. Commissioner, 326 U.S.

287, 292 (1945).

     Section 165(g) allows as a deduction any loss sustained

during a single taxable year from any security which has become

worthless during that year.   For other assets, section 1.167(a)-

8, Income Tax Regs., typically requires that the asset be

"retired".   Taxpayers, however, are entitled to a loss deduction

for assets which are not securities that have not been "retired"

but have become worthless during the tax year in question.

Echols v. Commissioner, 950 F.2d 209, 211 (5th Cir. 1991).

Taxpayers are entitled to loss deductions for depreciable

intangible assets such as licenses and noncompetition agreements.

See Estate of Wood v. Commissioner, 823 F.2d 1553 (9th Cir.

1987), affg. T.C. Memo. 1985-517; Oak Harbor Freight Lines, Inc.

v. Commissioner, T.C. Memo. 1999-291.   Taxpayers are entitled to

take loss deductions under section 165 "not only for assets that

the taxpayer has abandoned, with or without their having become
                                - 10 -

worthless, but also for assets that have become worthless, with

or without having been abandoned."       Echols v. Commissioner, supra

at 211 n.1.

     Whether the noncompetition agreements became worthless

during FYE March 31, 1996, is a question of fact.      See Boehm v.

Commissioner, supra at 293.     The general requirement that losses

be deducted in the year in which they are sustained calls for a

practical, not a legal, test.    See Lucas v. Am. Code Co., 280

U.S. 445, 449 (1930).   In Echols v. Commissioner, supra at 213,

the court stated:

     the test for worthlessness is a combination of
     subjective and objective indicia: a subjective
     determination by the taxpayer of the fact and the year
     of worthlessness to him, and the existence of objective
     factors reflecting completed transaction(s) and
     identifiable event(s) in the year in question--not
     limited, however, to transactions and events that rise
     to the level of divestiture of title or legal
     abandonment.


See also Middleton v. Commissioner, 77 T.C. 310, 322 (1981)

(there is no requirement that a taxpayer relinquish title in

order to establish a loss if such loss is reasonably certain in

fact and ascertainable in amount), affd. per curiam 693 F.2d 124

(11th Cir. 1982).

     To determine whether a taxpayer is eligible for a loss

deduction pursuant to section 1.165-1(d)(1), Income Tax Regs.,

the focus of this Court's analysis must be on objective events

confirming the taxpayer's subjective determination that the asset
                                - 11 -

was in fact worthless in the year the losses were claimed.

Echols v. Commissioner, supra at 212-213.

     Closed and completed transactions and identifiable events

are not limited to divestitures of title or abandonment, the

taxpayer need not be a "party" to the events or transactions, and

the events or transactions need not directly involve the asset in

question.   Id. at 213.    The requirement of worthlessness is a "de

minimis rule that the taxpayer does not have to prove that a

given asset is absolutely, positively without any value

whatsoever."   Echols v. Commissioner, 935 F.2d 703, 708 n.2 (5th

Cir. 1991), revg. and remanding 93 T.C. 553 (1989).    A taxpayer

must make a reasonable showing that the asset was in fact

valueless to him at the time selected by the taxpayer--not that

its fair market value necessarily fell to or below zero in that

year.   Id. at 708.

     We decide this case without regard to the burden of proof.

Accordingly, we need not decide whether section 7491(a)(1) is

applicable in this case.    See Higbee v. Commissioner, 116 T.C.

438 (2001).

     Respondent's position appears to be that no objective

factors reflect completed transactions and identifiable events

that establish worthlessness of the covenants not to compete in

FYE March 31, 1996.   The Court disagrees.
                               - 12 -

     In A.J. Indus., Inc. v. United States, 503 F.2d 660, 670

(9th Cir. 1974), the court concluded that "the subjective

judgment of the taxpayer * * * as to whether the business assets

[of the taxpayer] will in the future have value is entitled to

great weight and a court is not justified in substituting its

business judgment for a reasonable, well-founded judgment of the

taxpayer."

     The first prong of the worthlessness test requires that the

Court determine whether the taxpayer made a subjective

determination that the asset in question was worthless in the tax

year in question.    Id.

     The 1993 addition of the Mexican Spotted Owl to the

endangered species list created circumstances which made the

continuation of logging in northern Arizona economically

unfeasible.   When the district court issued its 1995 injunction,

petitioner determined that no additional timber sales contracts

would be issued.    Consequently, petitioner concluded that the

injunction had effectively eliminated competition in the Arizona

logging industry.    Once the injunction took effect, Arizona's

timber supply was essentially cut off.    Without an adequate

supply of timber, the Arizona logging industry collapsed.

     Once petitioner concluded that competition and supply had

been judicially eliminated, it determined that its covenants not

to compete were worthless.    It is the practical worthlessness of
                              - 13 -

the covenants and not the bare possibility of what might happen

in the uncertain future that is the important factor.    Lucas v.

American Code Co., supra; Henley v. United States, 184 Ct. Cl.

315, 396 F.2d 956, 962 (1968).   The tax laws do not require a

taxpayer to be an incorrigible optimist.   United States v. S.S.

White Dental Manufacturing Co., 274 U.S. 398, 403 (1927).

     For the tax year of the injunction, petitioner's corporate

tax return for FYE March 31, 1996, reflected this subjective

determination by reporting the unamortized amounts as a loss.

The Court is satisfied that petitioner made the subjective

determination that its covenants not to compete were worthless in

FYE March 31, 1996, and that it no longer assigned any value to

them.

     The second prong of the worthlessness test requires

taxpayers to show a closed and completed transaction and an

identifiable event evidencing the destruction of an asset's

value.   Assets may not be considered worthless, even when they

have no liquidated value, if there is a reasonable hope and

expectation that they will become valuable in the future.    See

Lawson v. Commissioner, 42 B.T.A. 1103, 1108 (1940).    But, "such

hope and expectation may be foreclosed by the happening of

certain events such as the bankruptcy, cessation from doing

business, or liquidation of the corporation, or the appointment

of a receiver for it."   Morton v. Commissioner, 38 B.T.A. 1270,
                                - 14 -

1278 (1938), affd. 112 F.2d 320 (7th Cir. 1940).      These events

are considered identifiable because they would be known by

everyone interested in the business of the corporation.      The

essential element for tax purposes is that a particular event

destroyed the potential value of the asset.     Id.

     In 1995, as a result of the Mexican Spotted Owl's addition

to the endangered species list, the U.S. District Court of

Arizona issued a prohibitory injunction banning logging in areas

serving as the owl's habitat.    Once the injunction was issued,

there were no additional timber sales contracts to compete for

and logging companies were unable to continue work on their

existing contracts.   In 1995, there was no reasonable hope or

expectation that the injunction on logging would be lifted within

the period remaining on the noncompetition agreements because

there was no reason to assume that the owl would be removed from

the endangered species list.

     It was objectively reasonable to assume that petitioner's

covenants not to compete were worthless because the ban on

logging, which included the geographical areas covered by the

noncompetition agreements, made it legally impossible for any of

the covenantees to compete.    As a result, Reidhead, Parker, and

Kaibab were unable to reenter the logging industry because no new

logging contracts were being issued.     The functional elimination
                              - 15 -

of Arizona's logging industry rendered worthless most industry

specific intangible assets.

     After the issuance of the injunction, petitioner was unable

to derive any benefit from the covenants not to compete.    No

outside party would have purchased the noncompetition agreements

or assigned any value to the covenants on the purchase of

petitioner's assets.   Any remaining value of the noncompetition

agreements terminated upon the issuance of the prohibitory

injunction.   The injunction served as a death knell to any

individual or company seeking to enter or reenter the Arizona

logging industry.   Furthermore, respondent offered no evidence to

show that the covenants not to compete retained any value.     In

short, the covenants were not worth a hoot.

     Because the injunction issued by the district court was

effective in 1995, petitioner actually sustained losses on its

covenants not to compete in 1995.   See Corra Resources, Ltd. v.

Commissioner, 945 F.2d 224 (7th Cir. 1991) (loss realized in the

year in which mineral lease expired), affg. T.C. Memo 1990-133;

George Freitas Dairy, Inc. v. United States, 582 F.2d 500 (9th

Cir. 1978) (milk processors' acceptance of producers'

cancellation of milk production contract was the identifiable

event).

     The Court is satisfied that the issuance of the injunction

serves as a sufficient identifiable event, in FYE March 31, 1996,
                             - 16 -

to satisfy the objective portion of the worthlessness test.

Thus, the Court finds that sufficient factors objectively support

the worthlessness of petitioner's covenants not to compete.     See

Oak Harbor Freight Lines, Inc. v. Commissioner, supra (An act of

Congress rendered motor carrier authorities worthless because all

rights associated with the authorities were eliminated).     As a

result, the Court finds that all three of petitioner's covenants

not to compete became worthless on the date the prohibitory

injunction was issued.

     Respondent argues that ABCO Oil Corp. v. Commissioner, T.C.

Memo. 1990-40, controls the outcome of this case.     In ABCO Oil

Corp., the taxpayer purchased some of a competitor's assets.

And, in a related but separate agreement, the taxpayer entered

into individual 5-year noncompetition agreements with three of

the competitor's shareholders.   Two of the three covenantees died

before the end of the 5-year noncompetition period.     The taxpayer

deducted the amounts it still owed to the deceased covenantees.

The taxpayer argued that the noncompetition agreements became

worthless and that the deduction should be allowed pursuant to

section 1.167(a)-8(a)(3), Income Tax Regs.    The Court in ABCO Oil

Corp. held that the death of the covenantees did not make the

covenants worthless; rather, the covenantees' "deaths extended

forever the duration of noncompetition."     Id.   Respondent argues

that ABCO Oil Corp. controls the decision in this case because of
                                - 17 -

its factual similarities and because the result in this case

depends on the law as it pertains to section 1.167(a)-8(a)(3),

Income Tax Regs.     Respondent's argument is flawed on both

accounts.

     The facts in ABCO Oil Corp. are distinguishable from those

here.     Respondent's position seems to be that the death of the

covenantees in ABCO Oil Corp. is analogous to the district

court's injunction in this case.     Respondent argues that because

petitioner and the three covenantees were still contractually

bound by the agreements the covenants retained their current

values.     In ABCO Oil Corp., the taxpayer continued to make

payments on the noncompetition agreements to the deceased

covenantees for more than 4 years after their deaths.       Thus, it

was logical for the Court in ABCO Oil Corp. to conclude that the

covenants were not worthless because no subjective determination

of worthlessness was made by the taxpayer during the taxable year

in issue.

        In this case, the prohibitory injunction rendered

petitioner's noncompetition agreements worthless.     In FYE March

31, 1996, petitioner was cognizant of its losses and promptly

reported the losses on its corporate tax return.     The facts in

ABCO Oil Corp. bear on a situation different from the one

presented here, and as a result, the Court's holding in ABCO Oil

Corp. is inapposite to the present case.
                              - 18 -

     For the reasons discussed above, the Court holds that

petitioner's recognition of the loss on its covenants not to

compete in FYE March 31, 1996, was proper.

Modification of Form 8594

     Petitioner, at trial and in its trial memorandum, posits

that it incorrectly allocated $200,000 to the covenant not to

compete in the Kaibab Agreement.   Petitioner's position is that

"the amount allocated by the taxpayer to the noncompete agreement

should be allocated to the timber contracts acquired from

Kaibab."   "That is what we should have done, you know."

Petitioner was apparently unaware, when it filed its Form 8594

for the Kaibab agreement, that Kaibab did not allocate any of the

contract price to the noncompete agreement.

     It is unclear whether petitioner now seeks to modify its

position as to its original allocation.   Regardless of whether

petitioner seeks to advance this argument, it is clear that

petitioner did not present this as an argument in the

alternative.

     Assuming it now wishes to allocate $0 to the covenant,

petitioner must satisfy this Court that provisions of the

Internal Revenue Code, the Tax Court Rules of Practice and

Procedure, or case law allow for such a modification.   Respondent

contends that this Court must apply the rule in Commissioner v.
                               - 19 -

Danielson, 378 F.2d 771 (3d Cir. 1967), vacating and remanding 44

T.C. 549 (1965).

     In Danielson, the Court of Appeals for the Third Circuit

held that a party to a contract allocating part of the purchase

price to a covenant not to compete can modify that agreement only

by offering evidence that would be admissible in an action

between the parties to alter the agreement or to show its

unenforceability.   In Throndson v. Commissioner, 457 F.2d 1022,

1025 (9th Cir. 1972), affg. Schmitz v. Commissioner, 51 T.C. 306

(1968), the Court of Appeals for the Ninth Circuit did not decide

whether the Danielson rule applied because there was no binding

contract, which is required to apply the Danielson rule.

Therefore, we do not apply it in cases appealable to the Court of

Appeals for the Ninth Circuit.   See Anderson v. Commissioner, 92

T.C. 138, 171 (1989).   Furthermore, the Danielson rule does not

apply in this case because the parties to the Kaibab agreement

did not specifically allocate any part of the purchase price to

the covenant not to compete.   See Campbell v. United States, 228

Ct. Cl. 661, 661 F.2d 209, 217-218 (1981).

     A taxpayer who files a Form 8594 and follows the proper

procedure for reporting the value of an asset pursuant to a

purchase agreement must follow certain requirements to show an

increase or decrease in the allocated value of the asset.    Sec.

1.1060-1T(h)(2), Temporary Income Tax Regs., 53 Fed. Reg. 27042
                               - 20 -

(July 18, 1988).   The taxpayer is required to file a new Form

8594 in the tax year that such modification is properly taken

into account.   Id.   Petitioner presented no evidence to show that

a new Form 8594, or anything substantially similar, was filed to

reflect the desired changes in the allocation value.

Petitioner's reasons for failure to file a new Form 8594 are

unclear.

     Without a new Form 8594 or any other legal or factual

justification allowing a modification, we see no reason to

allocate $0 to the Kaibab covenant not to compete.      See Hosp.

Corp. of Am. v. Commissioner, T.C. Memo. 1996-559.      Petitioner,

therefore, is not entitled to change the value it allocated to

the Kaibab covenant not to compete.

     As a result, the Court holds that petitioner is entitled to

recognize the losses on its covenants not to compete for FYE

March 31, 1996, and to its deduction for a net operating loss

carryback for FYE March 31, 1993.

     Reviewed and adopted as the report of the Small Tax Case

Division.

                                           Decision will be entered

                                      for petitioner.
