                          T.C. Memo. 2008-123



                        UNITED STATES TAX COURT



            JACK M. AND AIMEE J. MEZRAH, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



       Docket No. 19742-98.             Filed May 1, 2008.



       Mitchell I. Horowitz, for petitioner.

       Stephen R. Takeuchi, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


       WELLS, Judge:   Respondent determined a deficiency in tax for

petitioners’ 1994 taxable year of $286,300 and a section 6662(a)

penalty of $10,747.    After concessions, the issues we must decide

are:    (1) Whether petitioners properly elected to exclude,

pursuant to section 108(c)(3)(C), $519,413 in cancellation of
                                - 2 -

indebtedness income as a distributive share of the partnership

Capital Concepts Properties 84-A; (2) if not, whether petitioners

should be permitted, pursuant to section 301.9100-3, Proced. &

Admin. Regs., to make a late section 108(c)(3)(C) election for

their taxable year 1994; and (3) whether petitioners are liable

for a section 6662(a) penalty for taxable year 1994.    Unless

otherwise indicated, all section references are to the Internal

Revenue Code, as amended, and all Rule references are to the Tax

Court Rules of Practice and Procedure.

                          FINDINGS OF FACT

     Some of the facts and certain exhibits have been stipulated.

The parties’ stipulations of fact are incorporated in this

opinion by reference and are found as facts in the instant case.

At the time of filing the petition, petitioners resided in

Florida.

     Petitioner husband, Dr. Jack M. Mezrah (Dr. Mezrah), is a

physician specializing in obstetrics and gynecology.    During

taxable year 1994, Dr. Mezrah practiced gynecology.    Dr. Mezrah’s

average workday included surgeries, office work, and hospital

rounds.    Dr. Mezrah’s education did not include any course work

in either accounting or tax.

     During taxable year 1994 petitioner wife, Mrs. Aimee J.

Mezrah (Mrs. Mezrah), was employed as a travel agent.    Mrs.

Mezrah holds a degree in education and taught school for 5 years.
                                - 3 -

Mrs. Mezrah’s education does not include any course work in

either accounting or tax.

     Mrs. Mezrah was not involved in handling the family

finances.   Rather, Mrs. Mezrah left the responsibility of family

investments to Dr. Mezrah.   Dr. Mezrah relied on the investment

and tax advice of his accountant, Elliot Buchman (Mr. Buchman).

Dr. Mezrah referred his financial paperwork to Mr. Buchman.

     During 1984 petitioners purchased for $137,500 a 0.995025-

percent interest in profits, losses and capital of Capital

Concepts Properties 84-A (CapCon 84-A), a Texas limited

partnership.   Petitioners did not make any additional investments

in CapCon 84-A.   CapCon 84-A was a limited partner in Anaheim

Hotel Partnership (AHP), a Texas general partnership.   CapCon 84-

A held a 100-percent profits and loss interest and a 10-percent

capital interest in AHP.    Sun Cal Investments No. 2, Ltd. (SCI2),

a Texas limited partnership, of which May Cal Properties, Inc.

(May Cal), a California corporation was the general partner,

owned the other 90-percent capital interest in AHP.

     During 1984, AHP purchased the Anaheim Hilton & Towers Hotel

and the adjoining parking garage structure (the hotel).    AHP used

the hotel in the trade or business of offering hotel-related

services.   The hotel was subject to several mortgages and to

long-term ground leases on the underlying real estate which was

held by third parties.   During 1989, AHP sold 51.07 percent of
                               - 4 -

its interest in the hotel, leaving it with a 48.93-percent

interest in the hotel.

     In anticipation of a debt restructuring on the debt secured

by the hotel in 1994, AHP converted from a Texas general

partnership to a California limited partnership.   Because of the

hotel debt restructuring, AHP reported on its 1994 Form 1065,

U.S. Partnership Return of Income, as a separately stated item,

cancellation of indebtedness income of $52,200,983.

Additionally, 100 percent of that $52,200,983 was reported on

the Schedule K-1, Partner’s Share of Income, Deductions, Credits,

etc., issued to CapCon 84-A.   On its 1994 Form 1065, CapCon 84-A

included that cancellation of indebtedness income as a separately

stated item.   CapCon 84-A allocated that income among its

partners, including petitioners.   Cancellation of indebtedness

income of $519,413 flowed through to petitioners as partners in a

double-tiered partnership.

     On September 16, 1994, Richard A. Callaghan, general partner

of CapCon 84-A, corresponded with all CapCon 84-A partners to

inform them of the immediate need for additional capital

investments of $1.5 million.   In addition to other tax

implications, the correspondence indicated that petitioners would

be forced to recapture their entire negative capital account of

$1,419,000 in 1994.
                               - 5 -

      On their joint 1994 income tax return, petitioners excluded

$519,413 from their income and failed to file with the return the

required Form 982, Reduction of Tax Attributes Due to Discharge

of Indebtedness.   Instead, petitioners filed with their joint

1994 return Form 8082, Notice of Inconsistent Treatment or

Amended Return (Administrative Adjustment Requirement (AAR)), in

which they excluded the $519,413 from income and reported “0”

income.   On Form 8082, petitioners stated:

     The K-1 of the partnership above reflected forgiveness
     of debt. According to the records of the taxpayer,
     this debt was the debt of the seller, and should have
     reduced the carrying value of the asset, under section
     108(e)(5) and not have been reflected as income.
     In addition, it is believed that this debt was never
     included as part of the qualified debt, nad (sic)
     therefore would have no effect on this taxpayer’s
     return.

Because petitioners were unsure of their basis in CapCon 84-A,

they did not reduce their basis in any property.

     Petitioners timely filed their 1994 joint income tax return.

During early 1997 Internal Revenue Service (IRS) Agent Ellen Loeb

(Agent Loeb) commenced an audit of petitioners’ 1994 income tax

return.   Mr. Buchman sent Agent Loeb a power of attorney form and

represented petitioners during an audit for petitioners’ taxable

year 1994.   Agent Loeb conducted research and concluded that the

section 108(a)(1)(D) exclusion from gross income for qualified

property business indebtedness applied under such circumstances.

However, Agent Loeb also concluded, in error, that the
                              - 6 -

partnership, CapCon 84-A, as opposed to the partner, i.e.,

petitioners, should have made the section 108(c)(3)(C) election.

On December 9, 1997, Agent Loeb prepared and issued her Revenue

Agent’s Report (RAR) in which she stated that “The partners of

CapCon 84-A do not make the election to exclude the income.”

     On September 16, 1998, respondent issued to petitioners a

notice of deficiency determining a deficiency for petitioners’

taxable year 1994 of $286,030 and a section 6662(a) penalty of

$10,747.

     The parties have stipulated that, on the basis of

information supplied to respondent between July and October,

2001, if petitioners had reduced their CapCon 84-A partnership

basis to the extent of any flowthrough interest in qualified real

property, or their basis in other qualified real property

interests, petitioners would have been entitled to make a timely

section 108(c)(3)(C) election and a section 1017 reduction in

basis of the partner’s proportionate interest in depreciable

property held by that partnership.    Sec. 1017(b)(3)(C).

Additionally, the parties have stipulated that if petitioners had

timely made the election, they could have excluded $519,413 in

cancellation of indebtedness income from their income for taxable

year 1994.

     During 2002, petitioners requested a private letter ruling

seeking relief under section 301.9100-3, Proced. & Admin. Regs.
                               - 7 -

(section 9100 relief).   On July 25, 2005, respondent issued Priv.

Ltr. Rul. 137467-03 in which respondent denied petitioners’

section 9100 relief request on the grounds that the IRS was

prejudiced because petitioners took depreciation deductions

beyond their exhaustible partnership basis for taxable years

closed by expiration of the limitations periods for assessments.

                              OPINION

     Petitioners do not dispute that they did not timely elect to

exclude the relief of indebtedness income in issue pursuant to

section 108(c)(3)(C).1   Petitioners did not properly file Form


     1
      SEC. 108 INCOME FROM DISCHARGE OF INDEBTEDNESS.

          (a) Exclusion from Gross Income.--

               (1) In general.–Gross income does not include any
          amount which (but for this subsection) would be
          includable in gross income by reason of the discharge
          (in whole or in part) of indebtedness of the taxpayer
          if--

                    (A) the discharge occurs in a title 11
               case, or

                    (B) the discharge occurs when the taxpayer
               is insolvent,

                    (C) the indebtedness discharged is qualified
               farm indebtedness, or

                    (D) in the case of a taxpayer other than a
               C corporation, the indebtedness discharged is
               qualified real property business
               indebtedness.

          *         *          *         *         *           *


                                                    (continued...)
                               - 8 -

982 with their 1994 return.   Instead, petitioners incorrectly

filed Form 8082 disclosing inconsistent treatment of the

cancellation of indebtedness income.    Petitioners do not now




     1
      (...continued)
          (c) Treatment of Discharge of Qualified Real
     Property Business Indebtedness. --

               (1) Basis reduction.--

                    (A) In general.–-The amount excluded from
               gross income under subparagraph (D) of subsection
               (a)(1) shall be applied to reduce the basis of the
               depreciable real property of the taxpayer.

                    (B) Cross reference.–For provisions making
               the reduction described in subparagraph (A), see
               section 1017.

          *         *          *          *         *            *


               (3) Qualified real property business
          indebtedness.–-The term “qualified real property
          business indebtedness” means indebtedness which--

                    (A) was incurred or assumed by the taxpayer
               in connection with real property used in a trade
               or business and is secured by such real property,

                    (B) was incurred or assumed before January 1,
               1993, or if incurred or assumed on or after such
               date, is qualified acquisition indebtedness, and

                    (C) with respect to which such taxpayer makes
               an election to have this paragraph apply.


          * * * Indebtedness under subparagraph (B)
          shall include indebtedness resulting from the
          refinancing of indebtedness under subparagraph (B) (or
          this sentence), but only to the extent it does not
          exceed the amount of the indebtedness being refinanced.
                               - 9 -

argue that they properly followed the procedure under section

1.108(c)-1T, Temporary Income Tax Regs., 58 Fed. Reg. 68300

(Dec. 27, 1993),2 for excluding income.3   Rather, petitioners

contend that they should be granted section 9100 relief in order

to file a late section 108(c)(3)(C) election for their taxable

year 1994.   They note that they are willing to refund any benefit

they received during the closed years from depreciation

deductions taken beyond their partnership basis as it should have

been reduced under section 1017.




     2
      In order to exclude cancellation of indebtedness income and
make a sec. 108(c)(3)(C) election and an accompanying sec. 1017
basis reduction, sec. 1.108(c)-1T, Temporary Income Tax Regs., 58
Fed. Reg. 68300 (Dec. 27, 1993), requires taxpayers to file Form
982, Reduction of Tax Attributes Due to Discharge of
Indebtedness, with their tax return or amended tax return for the
relevant taxable year.
     3
      At the time that petitioners filed their return for 1994,
sec. 1.108(c)-1T, Temporary Income Tax Regs., supra, was in
effect. If the taxpayer establishes reasonable cause for failure
to make the election on the original return, sec. 1.108(c)-1T,
Temporary Income Tax Regs., supra, promulgated in 1996,
explicitly permits an election to be made on an amended return by
means of a claim for credit or refund. The final regulation,
sec. 1.108(c)-1, Income Tax Regs., was made retroactively
effective as of Dec. 27, 1993, and does not include a reasonable
cause exception for amended returns by means of a claim for
credit or refund. Instead, the taxpayer must request under sec.
301.9100-3T, Temporary Proced. & Admin. Regs., 58 Fed. Reg. 68300
(Dec. 27, 1993), the Commissioner’s consent to file a late
election on a timely-filed return for the year in which
cancellation of indebtedness income is realized. T.D. 8688,
1997-1 C.B. 12. In the instant case, the final regulation
controls. However, petitioners concede that they failed to
comply with the temporary regulation, the more lenient of the two
regulations. We consider below whether petitioners are entitled
to relief under sec. 301.9100-3(a), Proced. & Admin. Regs.
                              - 10 -

     Section 108(a)(1)(D) and (c) generally allows a taxpayer to

avoid reporting income generated from discharge of qualified real

property business indebtedness and, instead, pursuant to section

1017, reduce their basis of the partner’s proportionate interest

in depreciable property held by the partnership.   Sec.

1017(b)(3)(C).4   As noted above, the parties have stipulated

that, if petitioners had duly and timely made a section 108(c)

election, and actually reduced their basis according to section

1017, they would have qualified to exclude the $519,413 in

cancellation of indebtedness income for their 1994 taxable year.

Petitioners do not now contend that they properly elected to

exclude such income under section 108(c).   Accordingly, we decide

whether petitioners should be allowed the benefit of section 9100

relief to extend the time to make the section 108(c) election.

     We have previously ruled on the availability of section 9100

relief as it pertained to the mark-to-market method of accounting

under section 475(f).5   See Vines v. Commissioner, 126 T.C. 279

(2006).   Section 301.9100-3(a), Proced. & Admin. Regs., provides



     4
      If petitioners were allowed to make a sec. 108(c)(3)(C)
election and a concomitant sec. 1017 reduction in basis of the
partner’s proportionate interest in depreciable property held by
that partnership, the partnership correspondingly must reduce the
partnership’s basis in depreciable property with respect to such
partner. Sec. 108(c)(3)(C).
     5
      Subsequently, in Knish v. Commissioner, T.C. Memo. 2006-
268, we found that sec. 9100 relief was unavailable under the
facts of the case because the taxpayers used hindsight to make
the mark-to-market election when it was most advantageous.
                              - 11 -

that the Commissioner must grant relief if the taxpayer provides

evidence establishing to the Commissioner’s satisfaction that two

conditions are satisfied:   (1) The taxpayer acted reasonably and

in good faith, and (2) the interests of the Government will not

be prejudiced by granting relief.

     In Priv. Ltr. Rul. 137467-03, issued to petitioners with

respect to the instant case, respondent ruled that petitioners

must be denied section 9100 relief because the interests of the

Government are deemed prejudiced pursuant to section 301.9100-

3(c)(1), Proced. & Admin. Regs., which provides in pertinent part

as follows:

     (c) Prejudice to the interests of the Government–-(1)
     In general. The Commissioner will grant a reasonable
     extension of time to make a regulatory election only
     when the interests of the Government will not be
     prejudiced by the granting of relief. This paragraph
     (c) provides the standards the Commissioner will use to
     determine when the interests of the Government will be
     prejudiced.

          (i) Lower tax liability. The interests of the
          Government are prejudiced if granting relief would
          result in a taxpayer having a lower tax liability
          in the aggregate for all taxable years affected by
          the election than the taxpayer would have had if
          the election had been timely made (taking into
          account the time value of money). Similarly, if
          the tax consequences of more than one taxpayer are
          affected by the election, the Government’s
          interests are prejudiced if extending the time for
          making the election may result in the affected
          taxpayers, in the aggregate, having a lower tax
          liability than if the election had been timely
          made.
                           - 12 -


          (ii) Closed years. The interests of the
          Government are ordinarily prejudiced if the
          taxable year in which the regulatory elections
          should have been made or any taxable years that
          would have been affected by the election had it
          been made are closed by the period of limitations
          on assessment under section 6501(a) before the
          taxpayer’s receipt of a ruling granting relief
          under this section. The IRS may condition a grant
          of relief on the taxpayer providing the IRS with a
          statement from an independent auditor (other than
          an auditor providing an affidavit pursuant to
          paragraph (e)(3) of this section) certifying that
          the interests of the Government are not prejudiced
          under the standards set forth in paragraph
          (c)(1)(i) of this section.

     In denying petitioners’ request for section 9100 relief,

respondent ruled in Priv. Ltr. Rul. 137467-03 as follows:

     In this case, the government would be prejudiced under
     Section 301.9100-3(c)(1)(i) if we were to grant relief
     to file a late election because you would have a lower
     tax liability in the aggregate for all years affected
     by the election than you would have had if the election
     had been made timely. You filed returns for taxable
     year 1995 and all subsequent years taking depreciation
     deductions on property, the basis of which should have
     been exhausted had you timely made a Section
     108(c)(3)(C) election. Taxable years 1995-2000 are now
     closed. Granting relief would permit you to exclude
     cancellation of indebtedness income in 1994. However,
     due to the expiration of the period of limitations the
     IRS cannot reduce or eliminate the depreciation
     deductions taken in Years 1995-2000. Thus, you would
     have a lower tax liability in the aggregate for all
     taxable years affected by the election than if you had
     made a timely election.

     Section 301.9100-3(c)(1)(ii) contemplates that the
     interests of the Government might not be prejudiced
     where closed years are involved. However, those
     situations would appear to be where the amount of the
     tax the taxpayers would pay if relief were granted to
     make a late election would be the same as if the
     election were made timely. That is not the case here.
     The interests of the government would be prejudiced
                             - 13 -

     because your depreciation deductions for the closed
     years (taxable years 1995-2000) are higher than they
     would have been if you had made a timely election and
     reduced your basis as required by Section 108(c)(1).
     Thus, you do not qualify for relief under Section
     301.9100-3(c)(1)(ii). Based on the above analysis, it
     is not necessary to address whether you would fail or
     meet the other tests to qualify for relief under
     Section 301.9100-3.

     As noted above, petitioners counter respondent’s prejudice

argument by offering to refund any benefit they may have received

during the closed years from depreciation deductions beyond

exhaustible basis.    While petitioners’ offer may be a possible

avenue of settling the instant case with respondent, we are

without jurisdiction over petitioners’ closed taxable years.       The

only taxable year over which we have jurisdiction is the year to

which the Notice of Deficiency pertains; i.e., 1994.      Petitioners

have failed to show that they did not receive the benefit of

depreciation deductions in excess of the deductions that they

would have had if they had properly elected to exclude the income

under section 108(c)(3)(C) and concomitantly reduced their basis

under section 1017.    Allowing petitioners to make a late section

108(c)(3)(C) election now would lead to a lower tax liability for

all tax years affected by the election and result in prejudice to

the interests of the Government.      Consequently, we hold that

respondent would be prejudiced under section 301.9100-3(c)(1)(i),

Proced. & Admin. Regs., if we were to allow petitioners to elect
                                - 14 -

to exclude the cancellation of indebtedness income for taxable

year 1994.

     Because petitioners fail to satisfy the second of the two

conditions of section 301.9100-3(a), Proced. & Admin. Regs., we

do not need to address the first condition of that provision;

i.e., whether petitioners acted reasonably and in good faith.       We

conclude that petitioners are not entitled to section 9100 relief

to make a late section 108(c)(3)(C) election.

     We next consider whether petitioners are liable for the

accuracy-related penalty under section 6662(a).       Respondent

determined that petitioners were liable for an accuracy-related

penalty for 2004 of $10,747.

     Pursuant to Rule 142(a)(1), the taxpayer generally bears the

burden of proof.   Section 7491(c) provides an exception to Rule

142(a)(1) and places the burden of production on the Commissioner

to show that penalties are appropriate.       Higbee v. Commissioner,

116 T.C. 438, 440-441 (2001).    However, as the examination of the

instant case began before the effective date of section 7491,

July 22, 1998, section 7491(c) does not apply.       See Internal

Revenue Service Restructuring and Reform Act of 1998, Pub. L.

105-206, sec. 3001, 112 Stat. 726.       Respondent asserts that

petitioners bear the burden of production and the burden of

persuasion on the penalty issues, and petitioners do not assert

otherwise.
                                - 15 -

     Respondent determined that petitioners are liable for the

accuracy-related penalty for negligence or disregard of rules or

regulations and/or a substantial understatement of income tax

under section 6662 for 1994.

     Pursuant to section 6662(a), a taxpayer may be liable for

a penalty of 20 percent of the portion of an underpayment of

tax attributable to negligence or disregard of rules or

regulations.    Sec. 6662(b).   The term “negligence” in section

6662(b)(1) includes any failure to make a reasonable attempt to

comply with the Internal Revenue Code and any failure to keep

adequate books and records or to substantiate items properly.

Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.     Negligence

has also been defined as the failure to exercise due care or the

failure to do what a reasonable person would do under the

circumstances.   See Allen v. Commissioner, 92 T.C. 1, 12 (1989),

affd. 925 F.2d 348, 353 (9th Cir. 1991); Neely v. Commissioner,

85 T.C. 934, 947 (1985).    The term “disregard” includes any

careless, reckless, or intentional disregard.     Sec. 6662(c).

     Section 6664(c)(1) provides that a penalty shall not apply

to any portion of an underpayment if it is shown that there was

reasonable cause for the taxpayer’s position with respect to that

portion and that the taxpayer acted in good faith with respect to

that portion.    The determination of whether a taxpayer acted with

reasonable cause and in good faith within the meaning of section
                               - 16 -

6664(c)(1) is made on a case-by-case basis, taking into account

all of the pertinent facts and circumstances.    Sec. 1.6664-

4(b)(1), Income Tax. Regs.

     The first ground for the section 6662(a) penalty relates to

petitioners’ partnership interest in Capital Concepts 82-I

(CapCon 82-I).6   For petitioners’ 1994 taxable year, the parties

stipulated the inclusion of $202,459 as additional passive income

from CapCon 82-I, less reductions for suspended losses of $14,398

from 1992 and $16,449 from 1993.

     Petitioners argue that during 1991, Dr. Mezrah made a gift

of the entire CapCon 82-I partnership interest to Mr. Buchman’s

son, Todd Buchman.   However, petitioners stipulated the inclusion

of the aforementioned passive income from CapCon 82-I

for the taxable year 1994, which stands in contrast to Dr.

Mezrah’s and Mr. Buchman’s testimony at trial that petitioners

intended to transfer ownership of their CapCon 82-I partnership

interest to Todd Buchman in 1991.    Petitioners have failed to

explain this discrepancy.    Consequently, we conclude that

petitioners have failed to carry their burden of showing that

they acted reasonably and in good faith in their failure to

include the passive income from their CapCon 82-I partnership




     6
      CapCon 82-I is distinct from CapCon 84-A, the partnership
discussed above in relation to petitioners’ claim for sec. 9100
relief.
                               - 17 -

interest on their return for taxable year 1994.    Accordingly, we

hold that petitioners are liable for the penalty pursuant to

section 6662 for negligence.

     The second ground for the section 6662(a) penalty relates to

petitioners’ misclassification of passive activity losses as

ordinary losses that allegedly pertain to nonpassive activities.

Respondent contends that petitioners misclassified three separate

passive activities as ordinary losses.

     Petitioners contend that they should not be liable for such

penalties because they relied on professional advice.     In order

for a taxpayer’s reliance on professional advice to constitute

reasonable cause to negate a section 6662(a) accuracy-related

penalty, the taxpayer must show that:    (1) The adviser was a

competent professional who had sufficient expertise to justify

reliance, (2) the taxpayer provided necessary and accurate

information to the adviser, and (3) the taxpayer actually relied

in good faith on the adviser’s judgment.    Thrane v. Commissioner,

T.C. Memo. 2006-269.   Mr. Buchman has served as petitioners’

certified public accountant since 1970 or 1971.   Petitioners

argue that they lack accounting backgrounds and that the

classification of losses was a highly technical matter.

Petitioners have persuaded us, on the basis of the record, that

they relied in good faith on their accountant to accurately

report the losses.   See Schwalbach v. Commissioner, 111 T.C. 215,
                              - 18 -

230-231 (1998).   Accordingly, we hold that petitioners have

carried their burden regarding their good faith reliance on their

accountant and are not liable for the accuracy-related penalties

stemming from the mischaracterization of their passive activity

losses.

     We have considered the parties’ remaining arguments and

conclude that the arguments are either without merit or

unnecessary to reach.

     To reflect the foregoing,


                                         Decision will be entered

                                    under Rule 155.
