                          T.C. Memo. 1997-193



                        UNITED STATES TAX COURT



                   BEVERLY GORDON, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

                   RONALD GORDON, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket Nos. 9887-95, 9900-95.             Filed April 24, 1997.



      Vincent R. Barrella, for petitioner in docket No. 9887-95.

      Ronald Gordon, pro se in docket No. 9900-95.

      Rajiv Madan and Anthony J. Kim, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION

      CHIECHI, Judge:    Respondent determined the following defi-

ciencies in petitioners' Federal income tax:1

1
    Respondent issued one notice of deficiency (notice) to both
                                                    (continued...)
                                 - 2 -

                         Year     Deficiency
                         1988       $88,979
                         1989        18,979
                         1990         1,330


       The issues remaining for decision are:

       (1)   Are petitioners Ronald Gordon (Mr. Gordon) and Beverly

Gordon (Ms. Gordon) entitled to a net operating loss deduction

for 1988 that is attributable to an alleged net operating loss

carryover from their taxable year 1986?       We hold that they are

not.

       (2)   Is respondent equitably estopped from claiming that

petitioners are not entitled to a net operating loss deduction

for 1988?     We hold that she is not.

       (3)   Is Ms. Gordon entitled to innocent spouse relief under

section 6013(e)(1)2 with respect to the understatement of tax for

1988 that is attributable to the net operating loss deduction

that petitioners claimed for that year?       We hold that she is not.

                           FINDINGS OF FACT

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

       Mr. Gordon and Ms. Gordon resided in New York, New York, at


1
   (...continued)
petitioners, each of whom filed a separate petition with the
Court. The two cases were consolidated for purposes of trial and
opinion, but not for purposes of briefing.
2
   All section references are to the Internal Revenue Code (Code)
in effect for the years at issue. All Rule references are to the
Tax Court Rules of Practice and Procedure.
                               - 3 -

the time their respective petitions in these cases were filed.

(Mr. Gordon and Ms. Gordon are sometimes referred to as the

Gordons.)

     The Gordons were married on April 2, 1959, separated during

March 1991, and divorced on July 14, 1994.   They have two chil-

dren, a daughter Jodi and a son Eric.

Mr. Gordon

     Throughout most of the period 1965 through 1996, Mr. Gordon,

who majored in accounting, held a bachelor's degree in business

administration, and was licensed by the National Association of

Security Dealers (NASD) to sell securities to the public, earned

his livelihood as a trader either for his own account or for the

accounts of the various investment or securities firms (firms)

that employed him.   A trader is a professional investor in

securities, commodities, or options, who is in the trade or

business of buying and selling such products, with the aim of

profiting from increases in the market prices of his or her

positions.

     Mr. Gordon's compensation as a trader for the firms that

employed him was based on a percentage of the profits that his

trading activities generated for those firms, and not on a fixed

salary.   Those firms generally protected themselves against any

losses incurred by traders whom they employed by requiring them

to deposit money as security for any such losses and/or by

retaining for a certain period of time a portion of the compensa-
                               - 4 -

tion to which those traders were entitled.

     At various periods of time during the years 1965 through

1996, Mr. Gordon, acting as either a floor trader (i.e., one who

is, or is employed by, a member of a securities or commodities

exchange and who trades on the floor of such an exchange for his

or her own account or for the account of his or her employer) or

an upstairs trader (i.e., one who executes such trades off the

floor of such an exchange from his or her office) traded options

for his own account or for the accounts of the various firms that

employed him.   An option is a contract under which (1) the buyer

or holder has the right, but not the obligation, for a specified

period of time to buy (i.e., call option) or sell (i.e., put

option) a specified portion of the underlying interest (e.g.,

stocks, bonds, or commodities) at a fixed or determinable price

and (2) the seller or writer is obligated to perform if the buyer

or holder exercises the option.

     A trader on the floor of an exchange who buys and sells

options acts as either a market maker, a specialist, or a floor

broker.   Such a trader who acts as a market maker (options market

maker) buys and sells options on the floor of an exchange either

for his or her own account or for the accounts of others, com-

petes with other options market makers to make a market in

various options that are traded on that exchange, is registered

with that exchange as a market maker in options, and is regis-

tered with the Securities and Exchange Commission (SEC) as a
                               - 5 -

broker/dealer.   A trader on the floor of an exchange who acts as

a specialist in buying and selling options buys and sells options

either for his or her own account or for the accounts of others,

has less competition than an options market maker, is assigned to

a particular option class or classes for which he or she is

obligated to make a market, does not compete with other special-

ists in those option classes to which he or she is assigned, is

the principal dealer responsible for making a market in the

options in which he or she specializes, is registered with that

exchange as a specialist in options, and is registered with the

SEC as a broker/dealer.   A trader on the floor of an exchange who

acts as a floor broker in buying and selling options executes

orders for others on the floor of that exchange, including orders

for options market makers.

     Throughout the period 1965 until sometime in 1969, First

Hanover employed Mr. Gordon as a broker/trader for listed securi-

ties.   As a broker, he sold listed securities to the public.3

     Throughout the period that commenced sometime in 1969 until

sometime in 1976, Mr. Gordon acted as an upstairs trader of

securities listed on the New York Stock Exchange (NYSE) and the

American Stock Exchange (AMEX) for the account of Chartered New

England, a partnership that he and seven other individuals had


3
   The record does not disclose whether Mr. Gordon also acted as
a trader for First Hanover throughout the period 1965 until
sometime in 1969.
                                - 6 -

organized in 1969.

     Throughout the period that commenced sometime in 1976 until

sometime in 1981, Mr. Gordon traded securities, commodities, and

options for his own account.4

     Throughout the period that commenced sometime in 1981 until

sometime in 1982, Bear, Sterns employed Mr. Gordon as a stockbro-

ker of listed securities, and, as such, he sold listed securities

to the public.

     Throughout the period that commenced sometime in 1982 until

sometime in 1983, Mr. Gordon traded futures on the New York

Futures Exchange for his own account.5

     Throughout the period that commenced sometime in 1983 until

sometime in 1984, Mr. Gordon was employed by Rosenkrantz,

Ehrenkrantz, Lyons, and Ross to act for its account as an up-

stairs trader of listed securities.

     Throughout the period that commenced sometime in 1984

through 1985, Moore and Schley, Cameron and Co. Securities

(Moore), a firm that owned a seat on the AMEX, employed Mr.

Gordon to act for its account as an options market maker and paid

him Form W-2 wages (W-2 wages) for those services that were based

on a percentage of the profits that he generated for that firm.


4
   The record does not disclose whether Mr. Gordon acted as an
upstairs trader or as a floor trader during that period.
5
   The record does not disclose whether Mr. Gordon acted as an
upstairs trader or as a floor trader during that period.
                                - 7 -

     On December 31, 1985, Mr. Gordon purchased a seat on and

became a member of the AMEX by purchasing an option-trading

permit from Moore.    Thereafter, during 1986 Mr. Gordon, who was

registered with the SEC as a broker/dealer, registered with and

operated on the AMEX as a market maker in stock options (i.e.,

options in which the underlying interest is stock) and index

options (i.e., options in which the underlying interest is an

index that is the measure of the value of a group of stocks or

other securities).6   All of those options were listed and traded

on the AMEX and subject to the respective rules and regulations

of that exchange and the SEC.

     As an options market maker, during 1986 Mr. Gordon (1) was

obligated to comply with the respective rules and regulations

prescribed by the SEC and the AMEX, (2) was required to provide

liquidity for customer orders to be filled on the AMEX, (3) was

obligated to create a market in options by offering simulta-

neously to buy and sell options at a particular price for certain

stock, and (4) was required to make bids and offers in all option

classes consistent with a fair and orderly market.   As an options


6
   In the "Stipulation of Facts as to Ronald Gordon", Mr. Gordon
and respondent interchangeably referred to Mr. Gordon's activi-
ties during 1986 on the AMEX as a market maker in stock options
and index options for his own account as his activities as (1) a
"market maker", (2) an "option market maker", (3) "a dealer in
equity options", and (4) a "listed equity options market maker".
We shall refer to Mr. Gordon's activities during 1986 on the AMEX
as a market maker in stock options and index options for his own
account as his activities as an options market maker.
                               - 8 -

market maker, during 1986 Mr. Gordon had the opportunity to stand

at a post on the AMEX trading floor, where buyers and sellers in

a particular option are concentrated and where trades occur by

open outcry, and to participate in public orders that came into

that post.   For example, as an options market maker, during 1986

Mr. Gordon may have been obligated to provide a bid price for an

option on a particular stock, and traders on the floor of the

AMEX could go to him either to buy or sell options at that bid

price.

     As an options market maker, during 1986 Mr. Gordon purchased

a particular option at a certain bid price, owned that option for

his own account, and expected to sell it at a slightly higher

offered price.   As such, Mr. Gordon took a position, that is,

held an option, with a profit expectation derived from the

fluctuations in the market.   A great deal of Mr. Gordon's trading

activity as an options market maker during 1986 was in options on

the stock index, XMI.   XMI is a stock index gauging the top 20

capitalized stocks on the NYSE.

     During 1986, Mr. Gordon bought and sold over 50,000 option

contracts in the normal course of his trade or business as an

options market maker, and he did not identify any of those trades

in options as a hedging transaction.   All of the options that Mr.

Gordon traded during that year were marked to market contracts.

During 1986, Mr. Gordon was not a specialist on the NYSE who made

a market in the stocks underlying the options that he traded.
                               - 9 -

     During 1986, Mr. Gordon used Wagner Stott Clearing Corpora-

tion (Wagner Stott) as one of his clearing organizations.    A

clearing organization like Wagner Stott provides financing to,

and sets margin requirements for, its clearing members.   All

standardized security options are issued and guaranteed by

clearing organizations like Wagner Stott that are regulated by

the SEC.   During 1986, Wagner Stott provided Mr. Gordon with

financing to trade during that year.

     Wagner Stott issued statements (Wagner Stott statements) to

Mr. Gordon during 1986 that reflected, inter alia, his trading

activity as an options market maker.    The Wagner Stott statements

for the periods March 27, 1986, through May 30, 1986 (April-May

1986 Wagner Stott statements) and October 31, 1986, through

November 28, 1986 (November 1986 Wagner Stott statement)7 showed

Mr. Gordon's trading activities as an options market maker in

various stock options and stock index options.   The April-May

1986 Wagner Stott statements also showed Mr. Gordon's opening and

closing balances with respect to stocks of the following corpora-

tions:   American Can, AMR, Cetus, Digital Equipment, Gould, Home

Shopping Network, J.C. Penney, Merrill Lynch, Motorola, National

Distillers & Chem, and Union Carbide.   The November 1986 Wagner

Stott statement did not show opening or closing balances with

respect to any stocks.

7
   The Wagner Stott statements identified above are the only
Wagner Stott statements that are part of the record.
                                - 10 -

     During 1986, Mr. Gordon sustained a total net loss of

$319,973 (net trading loss) from his activities as an options

market maker.8   Because of that loss, Mr. Gordon owed Wagner

Stott approximately $185,000, which he was unable to repay.     He

instead agreed that Wagner Stott sell his AMEX seat, which it did

for $249,000 on January 19, 1987.    Wagner Stott applied those

sale proceeds to the amount that Mr. Gordon owed it and remitted

the difference to Mr. Gordon.

     Sometime between January and July 1987, Mr. Gordon and

another individual formed a partnership that operated under the

name Ronald Gordon and Company (partnership) and that leased a

seat on the AMEX for a six-month period that commenced on July

24, 1987, and terminated on January 21, 1988.     Mr. Gordon oper-

ated as an options market maker on the AMEX on behalf of that

partnership for a one-month period between July and October 1987

during which losses were sustained.      The partnership terminated

its lease of the AMEX seat prior to the expiration of its lease

term.

     Throughout the period that commenced sometime in October

1987 until sometime in January 1988, Mr. Gordon was employed by

Drexel, Burnham, Lambert as an upstairs trader.

     Throughout the period that commenced sometime in January

1988 until sometime in 1989, Mr. Gordon was employed by MKI

8
   The record does not disclose the gain or loss that resulted
from each option that Mr. Gordon traded during 1986.
                              - 11 -

Securities, Inc. (MKI) as an upstairs trader for listed securi-

ties and received W-2 wages that were based on a percentage of

the profits that he generated for that firm.   Mr. Gordon depos-

ited $25,000 with MKI as security, $11,000 of which was retained

by MKI to cover the losses that Mr. Gordon incurred when he

traded for that firm.

     During 1989, Mr. Gordon was employed by First New York

Securities as an upstairs trader.

     Throughout the period that commenced sometime in 1990 until

sometime in early 1991, Mr. Gordon was employed by Schoenfeld

Securities (Schoenfeld) as an upstairs trader and received W-2

wages that were based on a percentage of the profits that he

generated for that firm.   Mr. Gordon deposited an undisclosed

amount with Schoenfeld as security, $47,000 of which was retained

by that firm to cover the losses that Mr. Gordon incurred when he

traded for that firm.

     During 1992, Mr. Gordon was employed as an account executive

by Merrill Lynch in Palm Beach, Florida.

     Throughout the period that commenced sometime in 1993 until

at least the date of the trial herein, Mr. Gordon was again

employed by Schoenfeld as an upstairs trader and was compensated

in the same manner as he had been when he worked there during

1990 and 1991.
                              - 12 -

Ms. Gordon

     Ms. Gordon received a bachelor's degree in education and in

English in 1955 and a master's degree in psychology and in

remedial reading in 1959.   She also has taken courses in various

other subjects, including teaching methods and humanities.

     Throughout the period that commenced sometime in 1955 until

sometime in 1965 and throughout 1971 and 1972, Ms. Gordon was

employed as a school teacher.9

     Throughout 1976 and 1977, Ms. Gordon was employed as an ice-

skating instructor.

     Throughout the period that commenced on January 5, 1979,

until August 31, 1982, Ms. Gordon worked part-time as a regis-

tered representative with First Investors Corporation (FIC), a

mutual fund broker/dealer, and, as such, she sold certain mutual

funds for FIC and received commissions from FIC for selling such

funds.   As a registered representative with FIC, Ms. Gordon

(1) was required and trained by FIC to pass, and did pass, the

NASD Series-Six licensing examination, (2) attended training

programs that were provided by FIC on, inter alia, the mutual

funds that FIC offered to the public, the sales practices that

its employees were to use in selling such funds, and the suit-

ability of such funds for each potential client of FIC in light


9
   With one exception that is noted below, the record does not
disclose whether Ms. Gordon was employed on a full-time or a
part-time basis during the periods that are specified herein.
                              - 13 -

of that potential client's investment goals, and (3) was respon-

sible for explaining to each potential client of FIC the differ-

ences among the various financial investments that were available

through FIC and for assessing the suitability of such investments

for each such potential client.

     Throughout the period that commenced sometime in 1979 until

sometime in 1981, Ms. Gordon was also employed as a salesperson

by a retail store.

     Throughout the period that commenced sometime in 1982 until

at least the date of the trial herein, Ms. Gordon was employed as

a school teacher.

     During 1982, Ms. Gordon inherited from her mother assets

valued at about $200,000 that consisted of stocks, mutual funds,

and cash.   Ms. Gordon invested the cash that she inherited in

various interest-bearing accounts, including money market funds,

certificates of deposit, and savings accounts.

     During 1988, 1989, and 1990, respectively, Ms. Gordon

maintained 16, 21, and 18 separate financial accounts that

consisted of money market funds, certificates of deposit, savings

accounts, and checking accounts.

     During 1979, after Ms. Gordon began working for FIC, she

purchased stock of certain of the mutual funds offered by that

company and continued to own that stock through 1989.

     On February 26, 1987, Ms. Gordon opened a brokerage account

with Charles Schwab & Co., Inc. (Charles Schwab) that she main-
                                - 14 -

tained at least through 1993.    Sometime after February 26, 1987,

but prior to December 31, 1987, she submitted an application to

Charles Schwab to add options trading to her Charles Schwab

brokerage account.   In that application, Ms. Gordon indicated,

inter alia, (1) that she had 10 years of investment experience

that consisted of engaging during each such year in 10 stock

transactions ranging from $5,000 to $15,000 and (2) that she had

"Good", rather than "Limited" or "Extensive", investment knowl-

edge.   Charles Schwab approved that application and provided to

Ms. Gordon two form disclosure documents entitled "What You

Should Know About Option Trading at Schwab" and "Characteristics

and Risks of Standardized Options".      During all relevant periods,

Charles Schwab issued monthly statements to Ms. Gordon reflecting

her account activity.

     During all relevant periods, Ms. Gordon occasionally pur-

chased and sold stocks of various corporations (e.g., Compaq

Computer, Mylex, and General Electric).     During the latter part

of 1987, based on Mr. Gordon's advice, Ms. Gordon, who at that

time owned the stock of Compaq Computer Corporation, sold for $55

each two Compaq Computer call options with expiration dates of

February 20, 1988, that were not exercised.

     During all relevant periods, Ms. Gordon, who had an under-

standing of some of the financial products bought and sold in

financial markets by investors, managed her own investments and

reviewed the account statements issued to her in order to keep
                              - 15 -

track of her investments (e.g., determine the value of her

stocks).

     At least for all relevant periods since 1982, Ms. Gordon

generally held any asset that she acquired, including the assets

that she inherited from her mother during 1982 and any income

produced therefrom, exclusively in her own name, and not in joint

names with Mr. Gordon.   She did so in order to protect those

assets against the risks that were associated with the volatility

of Mr. Gordon's business activities.

The Gordons' Sale of the Roslyn
Residence and the Purchase of
the Lincoln Plaza Residence

     On November 21, 1986, the Gordons sold for $514,000 their

principal residence in Roslyn, New York (Roslyn residence) and

realized a gain from that sale.   The Gordons used those sale

proceeds in the following manner:    (1) An undisclosed amount was

used to pay certain unidentified debts and certain costs and

expenses that were associated with the sale of the Roslyn resi-

dence; (2) $100,000 was used to pay off a mortgage loan ($100,000

mortgage loan) on the Roslyn residence that the Gordons had

obtained during 1986 for Mr. Gordon to use in his business

activities; and (3) the remaining amount was divided equally

between Mr. Gordon and Ms. Gordon.

     Throughout the period November 1986 until November 9, 1988,

the Gordons rented for $2,350 a month a condominium located at

One Lincoln Plaza Condominiums in New York City.   Ms. Gordon was
                                - 16 -

aware of that monthly rent.

     The accounting firm of Braunstein & Stern (B&S) advised the

Gordons to purchase another principal residence after the sale of

the Roslyn residence in order to defer the recognition of the

gain from the sale of the Roslyn residence by satisfying the

requirements of section 1034.

     On November 9, 1988, the Gordons purchased for $420,000 and

titled in both their names another condominium located at One

Lincoln Plaza Condominiums (Lincoln Plaza residence).      The

Gordons financed that purchase with (1) cash of $100,000 which

Ms. Gordon provided and for which Mr. Gordon reimbursed her

shortly thereafter and (2) a mortgage loan of $320,000 on which

the Gordons were jointly liable and which required payments of

that amount on or before November 9, 1993, and monthly interest

calculated at 10 percent annually.       The $100,000 in cash that Mr.

Gordon paid when the Gordons purchased the Lincoln Plaza resi-

dence made Ms. Gordon whole with respect to the Gordons' using

$100,000 of the proceeds from the sale of the Roslyn residence to

pay off the $100,000 mortgage loan on that residence that Mr.

Gordon utilized in his business activities.      The Gordons' total

monthly payment for the Lincoln Plaza residence was, and Ms.

Gordon was aware that it was, approximately $3,000.

The Gordons' Marriage, Lifestyle,
and Household Expenses

     Throughout their marriage until some point prior to their
                              - 17 -

separation, (1) Mr. Gordon and Ms. Gordon had a trusting rela-

tionship; (2) they communicated openly with each other concerning

personal and certain professional matters; (3) they did not

conceal assets or losses from each other; (4) Ms. Gordon was

aware that Mr. Gordon's business involved trading options and

securities and was extremely volatile; (5) Ms. Gordon generally

knew whether Mr. Gordon had a successful or an unsuccessful

trading day; and (6) Ms. Gordon knew about Mr. Gordon's job

changes and was at times consulted by him as a sounding board for

his career moves.

     Ms. Gordon was aware that Mr. Gordon suffered a major

trading loss for 1986.

     During 1986 through 1990, the Gordons had a comfortable,

upper-middle class lifestyle that was fully consistent with their

lifestyle prior to 1986.   By way of illustration of their life-

style during their marriage, (1) the Gordons (a) were charter

members of the Old Westbury Golf & Country Club located in Long

Island, New York, for which they paid annual dues of approxi-

mately $10,000, (b) took at least one annual family vacation that

cost approximately $4,000, and (c) owned various automobiles,

including a Porsche, a Mercedes Benz 500 SEL, a Chrysler, a

Cadillac, and a Ford Taurus; and (2) Ms. Gordon (a) regularly

took spa vacations that cost between $1,700 to $2,500 per trip

and (b) owned five fur coats, one of which, a mink coat, she

purchased during 1988 for approximately $8,000 and for which Mr.
                              - 18 -

Gordon reimbursed her.

     During their marriage, the Gordons had the understanding by

which they generally abided that Mr. Gordon was solely responsi-

ble for paying all major household expenses that they incurred,

including their Federal and State income tax liabilities (house-

hold expenses).   Starting in 1986, as circumstances forced Mr.

Gordon to rely on Ms. Gordon's assets to maintain the lifestyle

to which they had become accustomed, Ms. Gordon became more

active in household finances and advanced the funds necessary to

pay certain household expenses in order to maintain that life-

style.   That situation continued through 1990, by which time Ms.

Gordon was using her own assets to pay both major and minor

household expenses.   The Gordons agreed that the funds that Ms.

Gordon advanced for the payment of household expenses were loans

to Mr. Gordon by her (household expense loans) that he would

repay.

     During 1987, 1988, 1989, and 1990, Ms. Gordon paid household

expenses of at least $44,240, $6,600, $51,000, and $51,236,

respectively.   By way of illustration of the household expenses

that Ms. Gordon paid, (1) during 1989 Ms. Gordon paid $20,000 and

$5,000 to the Internal Revenue Service (IRS) and the State of New

York, respectively, with respect to the Gordons' joint Federal

and State income tax liabilities for 1988; and (2) during 1990

Ms. Gordon paid $5,816 for real estate taxes and an undisclosed

amount for country club membership dues and credit card charges
                                - 19 -

as well as monthly expenses of (a) $3,000 for the mortgage loan

and maintenance on the Lincoln Plaza residence, (b) $325 for

garage space, and (c) $460 for the lease of a car.

       Mr. Gordon repaid Ms. Gordon at least $14,240 of the house-

hold expense loans by allowing her to retain a Federal income tax

refund in that amount received around July 1990 that the Gordons

claimed in their joint Federal income tax return (return) for

1989.     Mr. Gordon did not repay all the household expense loans.

The Gordons' 1983 Through 1990
Returns and the IRS Examination
of Their 1986 and 1988 Returns

        Mr. Gordon, who had some knowledge of the Federal income tax

laws based on conversations that he had with his colleagues and

other professionals, and Ms. Gordon, who did not have much

knowledge of those laws, filed a joint return for each of the

years 1983 through 1990 and amended returns for 1986 and 1988.

With the exception of the 1990 return which was prepared by

Bonnie Wolpe (Ms. Wolpe), all of those returns were prepared by

B&S.     The date April 15, 1987, appeared next to the signature

line in the Gordons’ 1986 return.     The original return that the

Gordons filed for 1988 was destroyed by the IRS as part of its

record retention policy.

        Ms. Gordon knew that she was obligated to file returns and

that B&S and Ms. Wolpe, respectively, prepared the Gordons' 1983

through 1989 returns and the 1990 return.     Ms. Gordon partici-

pated in the preparation of those returns by providing Mr. Gordon
                              - 20 -

with information relating to the income that she received during

1983 through 1990 (e.g., Forms W-2 and 1099) and the expenses

that she paid during those years (e.g., canceled checks for

charitable contributions).   Ms. Gordon relied on B&S and Mr.

Gordon for the preparation of the 1983 through 1989 returns.

Although Ms. Gordon had the opportunity to review those returns,

she did not.   Except for discussions with Mr. Gordon about

certain important items reported in the Gordons' 1986 through

1989 returns, such as the gain from the sale of the Roslyn

residence, Ms. Gordon did not discuss those returns with Mr.

Gordon or B&S.   Because she was not available at the time the

1986, 1987, and 1989 returns and the 1986 amended return were

filed, Ms. Gordon did not sign them; instead, Mr. Gordon signed

Ms. Gordon's name to those returns.

     The Gordons’ 1983 through 1990 returns listed the respective

occupations of Mr. Gordon and Ms. Gordon as securities trader and

teacher.   The Gordons reported the results of Mr. Gordon’s

activities as a securities trader in Schedules C of their returns

for 1983 through 1986, 1989, and 1990, regardless whether those

results related to his activities as a securities trader for his

own account or to his activities as a securities trader for the

accounts of the firms that employed and paid him W-2 wages.     In

their 1987 and 1988 returns, the Gordons reported the results of

Mr. Gordon's activities as a securities trader for the accounts

of the firms that employed and paid him W-2 wages as “Wages,
                              - 21 -

salaries, tips, etc.”   The results of Mr. Gordon's activities as

a securities trader for 1983 through 1990 that were reported in

the returns for those years ranged from income of $345,714 for

1988 to a loss of $324,723 for 1986.   Ms. Gordon’s income from

her activities as a teacher for 1983 through 1990 that was

reported as “Wages, salaries, tips, etc.” in the Gordons' returns

for those years ranged from $19,822 for 1983 to $37,056 for 1989.

     In Schedule C of their 1986 return, the Gordons reported a

loss of $324,723 (1986 claimed Schedule C loss) that consisted of

the net loss of $319,973 that Mr. Gordon sustained from trading

options on the AMEX as an options market maker and expenses of

$4,750 that he incurred in connection with that trading activity.

Based upon discussions with B&S, it was Mr. Gordon's understand-

ing that his 1986 net trading loss of $319,973 should be treated

as an ordinary loss in the Gordons' 1986 return.   The Gordons

treated the 1986 Schedule C loss of $324,723 as an ordinary loss

in their 1986 return, used it to reduce $47,724 of income re-

ported in that return, and showed the balance of $276,999 of that

loss on page 1 of that return as "total income".

     In a statement that was attached to their 1986 return, the

Gordons indicated that they had incurred a net operating loss for

1986 in an undisclosed amount and that, pursuant to section

172(b)(3)(C), they were making an election to relinquish the

carryback of that loss.

     The Gordons reported in Form 2119 (Sale or Exchange of
                               - 22 -

Principal Residence) (Form 2119) that was included as part of

their 1986 return that they sold the Roslyn residence for

$500,000, had a basis in it of $155,500, realized a gain of

$344,500 from its sale, and planned to replace it within the

"replacement period".   Consequently, the Gordons did not include

any portion of that gain in the income that they reported in

their 1986 return.

     In a statement that was attached to their 1987 return, the

Gordons indicated that they had incurred a net operating loss for

1987 in an undisclosed amount and that, pursuant to section

172(b)(3)(C), they were making an election to relinquish the

carryback of that loss.

     During August 1987, the IRS initiated an examination of the

Gordons' 1986 return.   Around 1988, a revenue agent met with B&S

and examined the Gordons' 1986 return and certain documents

relating to that return that B&S had maintained.    He also re-

quested a meeting with Mr. Gordon in order to discuss his 1986

net trading loss.    Based on her conversations with Mr. Gordon,

Ms. Gordon was aware that the 1986 return was being examined by

the IRS.   On October 14, 1988, Mr. Gordon met with the IRS

revenue agent who was examining the Gordons' 1986 return and

described to him the nature of his activities as an options

market maker on the AMEX.    At the conclusion of that meeting,

that agent told Mr. Gordon that his 1986 net trading loss was

properly treated as an ordinary loss in the Gordons' 1986 return
                              - 23 -

and that he was allowing the claimed deduction in that return

with respect to that loss.   Mr. Gordon related that information

to Ms. Gordon.   On May 1, 1989, the IRS issued a letter (no-

change letter) to the Gordons formally notifying them that the

examination of their 1986 return showed that "no change" was

necessary in the tax reported in that return.

     On December 7, 1988, the IRS received the Gordons' 1986

amended return that included an amended Form 2119.   In their 1986

amended return, the Gordons included in their income a capital

gain of $29,391 from the sale of the Roslyn residence, claimed a

net operating loss deduction of $35,065 that was attributable to

an alleged net operating loss carryover from their taxable year

1985, and reported that the loss reported in their 1986 return

was increased by $5,674 from $276,999 to $282,673.   In calculat-

ing the capital gain from the sale of the Roslyn residence that

was reported in the Gordons' 1986 amended return, the Gordons

(1) indicated in that amended return and/or the amended Form 2119

that was included as part of that return that they (a) sold the

Roslyn residence for $500,000, (b) had a basis in that residence,

as adjusted by the IRS on audit, of $120,500, rather than

$155,500, (c) consequently realized a gain of $379,500, rather

than $344,500, from the sale of that residence, and (d) replaced

that residence with the Lincoln Plaza residence; and (2) took

account of, inter alia, the purchase price of the Lincoln Plaza

residence in arriving at the portion of the capital gain from the
                              - 24 -

sale of the Roslyn residence that should be included in their

income for 1986.

     In their 1988 return, the Gordons reported as ordinary

income the wages of $379,071 that MKI had paid to Mr. Gordon

during that year and claimed a net operating loss deduction of

$268,318 (claimed 1988 NOL deduction) that was attributable to

Mr. Gordon's 1986 net trading loss that they claimed in their

1986 return.

     In their 1989 and 1990 returns, the Gordons did not claim

any net operating loss deductions.

     During 1992, the IRS initiated an examination of the

Gordons' 1988 return.   The IRS revenue agent examining that

return examined, inter alia, the claimed 1988 NOL deduction.

Because that claimed deduction was attributable to Mr. Gordon's

1986 net trading loss, that agent reexamined that loss after

having notified the Gordons in writing of his intention to do so.

Based on that reexamination, the revenue agent concluded that Mr.

Gordon's 1986 net trading loss constituted a capital, and not an

ordinary, loss and that, consequently, that loss did not result

in a net operating loss for 1986, and the Gordons were not

entitled to the claimed 1988 NOL deduction.

The Gordons' Separation and
Their Separation Agreement

     The Gordons separated in March 1991.   Thereafter, Mr. Gordon

moved out of the Lincoln Plaza residence.
                                 - 25 -

     Around 1992, after the Gordons had separated, Chemical Bank

seized a bank account and sealed a safe deposit box, both of

which were held in the joint names of Mr. Gordon and Ms. Gordon,

and refused to release them until satisfaction of a judgment that

it had against Mr. Gordon with respect to the unpaid portion of a

$25,000 business loan that he had obtained.     In order to obtain

the release of those assets, Ms. Gordon made a payment to Chemi-

cal Bank around 1992 in satisfaction of that outstanding judg-

ment.

     In September 1992, the Gordons entered into a separation

agreement (separation agreement) that provided, inter alia:

             3. Distribution of Certain Property. The condo-
        minium apartment which was the marital residence of the
        parties was transferred to the sole ownership of
        Beverly Gordon on July 2, 1992. In settlement of their
        mutual claims to marital and separate property, the
        parties agree that all right, title and interest there-
        on and any and all equity therein shall belong to
        Beverly and any and all responsibility for the mortgage
        thereon shall belong to Beverly.

             4.   Distribution of Certain Personal Property.

             A. * * * The parties agree that [certain] * * *
        articles of personal property currently in the posses-
        sion of each of them * * * shall * * * be owned exclu-
        sively by the party presently in possession * * *

             B. Each of the parties has an interest in certain
        retirement and/or deferred benefit plans. Each of the
        parties hereby waives any right or interest in such
        plans or with respect to the receipt of benefits in
        such plans owned by the other party and confirms that
        such plans and the benefits therefrom shall be the sole
        and exclusive property of the current title owner
        thereof. * * *
                              - 26 -

         C. In the course of the marriage, Beverly ac-
    quired by gift or inheritance certain personal property
    including but not limited [to] cash or cash equivalents
    and securities. Ronald acknowledges and agrees that
    said property has been and will continue to be the sole
    and absolute property of Beverly.

              *     *     *     *      *    *     *

          6. Mutual Release and Discharge of General
     Claims. Except as otherwise expressly set forth here-
     in, each party hereby remises, releases, and forever
     discharges the other from all causes of action, claims,
     rights, and demands whatsoever, in law or in equity,
     known or unknown, past, present, or future, which
     either of the parties hereto ever had, or now, or
     hereafter may have, against the other, * * *

          7. Responsibility for Debts. * * * Ronald hereby
     acknowledges and agrees that Beverly paid the sum of
     $5,000.00 on June 30, 1992 to Chemical Bank as and for
     a partial payment on a debt of approximately $24,000.00
     which is the sole and absolute responsibility of Ron-
     ald. In consideration thereof, Ronald agrees to indem-
     nify and repay Beverly the $5,000.00 debt payment plus
     $500.00 for her expenses in settling the litigation
     thereon. Said payment of $5,500.00 shall be made in
     eighteen installments of $300.00 per month and a final
     payment of $100.00 commencing Oct. 15, 1992 and lasting
     through March 15, 1994. Said payments shall be by
     check or money order and mailed to Beverly by the 15th
     day of each month.

A handwritten addition by Mr. Gordon to paragraph 7 of the

separation agreement that was initialed by Ms. Gordon stated:

"This paragraph is based on the premise that I remain gainfully

employed."   Mr. Gordon paid a total of only $1,800 to Ms. Gordon

sometime around 1992 pursuant to paragraph 7 of the separation

agreement.

     The separation agreement did not provide for any spousal

support payments to be made by Mr. Gordon to Ms. Gordon because
                              - 27 -

Mr. Gordon was not financially capable of making any such pay-

ments.

     In July 1993, the Gordons executed an amendment to the

separation agreement under which they agreed, inter alia, that

any "tax liabilities that may be assessed" against them in

connection with their joint tax liabilities shall be "the sole

and absolute responsibility" of Mr. Gordon.

     After the Gordons separated, Ms. Gordon was responsible for

and paid the mortgage loan on the Lincoln Plaza residence and all

her own living expenses.   The sources of those payments were Ms.

Gordon's salary, the dividends on stocks that she owned, and the

proceeds from the sale of some of her assets.

                              OPINION

     Petitioners bear the burden of proving that respondent's

determinations in the notice are erroneous.   Rule 142(a); Welch

v. Helvering, 290 U.S. 111, 115 (1933).

The Claimed 1988 NOL Deduction

     Section 1256

     During 1986, Mr. Gordon sustained a net loss of $319,973

from trading options on the AMEX as an options market maker.10



10
   The parties agree that the amount of Mr. Gordon's 1986 net
trading loss that is in question is $319,973 and that that
trading loss does not include the expenses of $4,750 that the
Gordons reported in Schedule C of their 1986 return as having
been incurred in connection with Mr. Gordon's trading activity
during that year.
                              - 28 -

The Gordons claimed that net trading loss as an ordinary loss in

their 1986 return and claimed a net operating loss deduction of

$268,318 in their 1988 return that is attributable to the carry-

over of that loss.

     Mr. Gordon contends, and respondent disputes, that the

Gordons are entitled to the claimed 1988 NOL deduction because

the net trading loss that Mr. Gordon sustained during 1986 is an

ordinary, and not a capital, loss.11

     To support his contention that his 1986 net trading loss is

an ordinary loss, Mr. Gordon asserts:

     [As a market maker, I was] trading for profitable
     opportunities. * * * But at the same times [sic], * * *
     [I had] a dual purpose and dual function.

             *       *   *     *        *   *    *

          * * * As a dealer, in providing a service to the
     public, in making a two-sided market and being obli-
     gated to participate on both side [sic] of every public
     order, taking on this inventory so that I would be able
     to resell it to the public and provide liquidity in the
     derivative product, * * * I provided a service to the
     public * * *

             *       *   *     *        *   *    *

          * * * As a market-make [sic], [I was] providing a


11
   In presenting their respective arguments on whether the
Gordons are entitled to the claimed 1988 NOL deduction, Mr.
Gordon and respondent focus on Mr. Gordon's 1986 net trading
loss, and not on the individual components of that loss. Al-
though the applicable sections of the Code address those individ-
ual components, for convenience, we, like the parties, shall
focus on Mr. Gordon's 1986 net trading loss since it is immate-
rial to our resolution of the issue presented whether we address
that loss or its individual components.
                             - 29 -

     service to the public, being placed in a position of
     taking on massive positions, responding to public
     orders, [and] * * * my motivation was not wholly for
     self-profit * * *

             *     *     *     *      *       *       *

          * * * I was a dealer. * * * I hedged more than
     80% of my transactions and all of my inventory was
     taken on so that the public interest could be served.
     All of this inventory was for resale and allows [sic]
     me under Public Law 98-369 [the Deficit Reduction Act
     of 1984] to report gains and losses as ordinary.

     To support her contention that Mr. Gordon's 1986 net trading

loss is a capital loss, respondent asserts:       (1) Pursuant to

section 1256(f)(3)(A), that loss, which Mr. Gordon realized from

trading options as an options market maker, constitutes a loss

from the sale or exchange of a capital asset; (2) the exception

in section 1256(f)(3)(B) to the treatment required by section

1256(f)(3)(A) for certain hedging transactions does not apply to

that loss; and (3) therefore, pursuant to section 1256(a)(3), 40

percent of that loss is treated as a short-term capital loss and

the remaining 60 percent is treated as a long-term capital

loss.12

     Section 1256(f)(3), which is headed "Capital Gain Treatment

For Traders in Section 1256 Contracts", provides in pertinent



12
   Respondent also contends, in the alternative, that Mr.
Gordon’s 1986 net trading loss is a capital loss because it
resulted from the sale of options that are capital assets within
the meaning of sec. 1221. In light of our holding that that loss
constitutes a capital loss pursuant to sec. 1256(f)(3)(A), we
shall not address respondent's contention under sec. 1221.
                                 - 30 -

part:

          (A) In general.--For purposes of this title, gain
     or loss from trading of section 1256 contracts shall be
     treated as gain or loss from the sale or exchange of a
     capital asset.

          (B) Exception for certain hedging transactions.--
     Subparagraph (A) shall not apply to any section 1256
     contract to the extent such contract is held for pur-
     poses of hedging property if any loss with respect to
     such property in the hands of the taxpayer would be
     ordinary loss.

     The following legislative history is instructive in constru-

ing section 1256(f)(3)(A):

          Historically, options market makers on securities
     exchanges have reported ordinary income or loss from
     their options transactions as well as from transactions
     in the property subject to the option. Commodity
     traders derive capital gain or loss from their * * *
     [regulated futures contracts] transactions and are
     subject to mark-to-market and 60/40 treatment.

                 *     *     *     *      *    *     *

             The House bill changes the claimed present-law
        treatment of options market makers and codifies present
        law with respect to professional commodity traders by
        providing that both categories of traders are treated
        as buying and selling capital assets, except to the
        extent that an option or future is acquired to hedge
        property that would generate ordinary income or loss.
        An options dealer is defined as any person who is
        registered with the SEC and an appropriate national
        securities exchange as a market maker or specialist in
        listed options. Under the bill, an options dealer
        would not recognize ordinary income or loss with re-
        spect to his stock and securities transactions, unless
        the taxpayer is a dealer in stock and securities under
        general Federal income tax rules (determined without
        regard to whether options in such property produce
        ordinary income or loss).

             In addition to nonequity options, which are
        marked-to-market in the hands of all holders, equity
                               - 31 -

     options held by options dealers are also subject to the
     mark-to-market rule and 60/40 treatment.

               *     *     *     *        *     *     *

          The conference agreement eliminates the reference
     to registration with the SEC in the definition of
     "options dealer" * * *. Further, the conferees intend
     that the capital gain or loss status of options traded
     in the normal course of an options dealer's activity in
     trading options is to be determined without regard to
     the identification requirement of sec. 1236. [H. Conf.
     Rept. 98-861, at 899, 903, 909, 1984-3 C.B. (Vol. 2)
     153, 157, 163; emphasis added.]

See also S. Prt. 98-169 (Vol. 4), at 285, 289 (1984).

     Respondent contends, and Mr. Gordon does not dispute, that

each of the options that Mr. Gordon traded during 1986 as an

options market maker is a "section 1256 contract" within the

meaning of section 1256(b)(3) or (4) because each of those

options constitutes either a "nonequity option" within the

meaning of section 1256(g)(3) or a "dealer equity option" within

the meaning of section 1256(g)(4).      Respondent and Mr. Gordon

have stipulated that during 1986 Mr. Gordon was registered and

operated on the AMEX as a market maker in stock options and index

options, all of which were listed and traded on the AMEX and

subject to the respective rules and regulations of that exchange

and the SEC.   They thus agree that during 1986 Mr. Gordon was an

"options dealer" within the meaning of section 1256(g)(8)(A),

i.e., a "person registered with an appropriate national securi-

ties exchange as a market maker or specialist in listed options."

Respondent and Mr. Gordon have further stipulated that (1) a
                             - 32 -

trader on the floor of an exchange who buys and sells options

acts as either a market maker, a specialist, or a floor broker;

(2) an options market maker is a trader on the floor of the

exchange who buys and sells options either for his or her own

account or for the accounts of others and who competes with other

options market makers to make a market in various options that

are traded on that exchange; (3) as an options market maker,

during 1986 Mr. Gordon purchased a particular option at a certain

bid price, owned that option for his own account, expected to

sell it at a slightly higher offered price, and took a position,

that is, held an option, with a profit expectation derived from

the fluctuations in the market; (4) Mr. Gordon bought and sold

over 50,000 option contracts during 1986 in the normal course of

his trade or business as an options market maker; and (5) Mr.

Gordon sustained a net trading loss of $319,973 during that year

from his activities as an options market maker.

     Based on our review of the entire record before us, we find

that, pursuant to section 1256(f)(3)(A), the 1986 net trading

loss that Mr. Gordon realized from selling options as an options

market maker is a loss from the trading of section 1256 contracts

that is treated as a loss from the sale or exchange of a capital

asset.

     As we understand Mr. Gordon's position, he appears to

contend that, even if the Court were to find that, pursuant to
                               - 33 -

section 1256(f)(3)(A), his 1986 net trading loss is a loss from

the sale or exchange of a capital asset, that loss nonetheless is

an ordinary loss pursuant to section 1256(f)(3)(B)13 because he

"hedged more than 80% of * * * [his] transactions".   To support

that contention, Mr. Gordon relies on his general, vague, and

conclusory testimony that he used certain options to hedge the

risks that were associated with certain other options and that he

used common stock to hedge the risks that were associated with

certain options.14   We are unable to find from that testimony

that Mr. Gordon held the options that generated his 1986 net

trading loss for the purposes specified in section 1256(f)(3)(B)

or that he otherwise fits within that statutory exception to the

rule mandated by section 1256(f)(3)(A).   Mr. Gordon has not

presented any evidence showing (1) what specific options were

held by him during 1986 for hedging purposes and what specific

properties were being hedged by those options; (2) the nature of

his hedging transactions (e.g., what specific risks were associ-

ated with the properties that he claims were being hedged and how



13
   As noted above, sec. 1256(f)(3)(B) provides an exception to
the capital gain or loss treatment required by sec. 1256(f)(3)(A)
in the case of "any section 1256 contract to the extent such
contract is held for purposes of hedging property if any loss
with respect to such property in the hands of the taxpayer would
be ordinary loss."
14
   Mr. Gordon does not contend and did not testify that he used
any of the options in question to hedge the risks that were
associated with any of the common stock that he may have owned.
                             - 34 -

such risks were offset by the options that he claims were being

held for hedging purposes); (3) that he held any of the options

in question for purposes of hedging property, any loss with

respect to which would be an ordinary loss in his hands;15 or (4)

what portion, if any, of his 1986 net trading loss was attribut-

able to such hedging transactions.    On the record before us, we

find that Mr. Gordon has failed to establish that the hedging

exception in section 1256(f)(3)(B) applies to any portion of his

1986 net trading loss.

     Having found that, pursuant to section 1256(f)(3)(A), Mr.

Gordon’s 1986 net trading loss is treated as a loss from the sale

or exchange of a capital asset and that Mr. Gordon has failed to

establish that he held the options that generated that loss for

the purposes specified in section 1256(f)(3)(B), we sustain

respondent's determinations (1) that, pursuant to section

1256(a)(3), 40 percent of that loss is treated as a short-term

capital loss and the remaining 60 percent is treated as a long-

term capital loss and (2) that petitioners are not entitled to

the claimed 1988 NOL deduction.




15
   We note that, to the extent that Mr. Gordon may have used
certain of the options in question to hedge certain other options
that are also in question, he would not be entitled under sec.
1256(f)(3)(B) to ordinary loss treatment for any loss from the
options that he may have used in such hedging. That is because
any loss with respect to the options that were being hedged would
not constitute ordinary loss. See sec. 1256(f)(3)(A).
                              - 35 -

     Equitable Estoppel

     Mr. Gordon argues that respondent is equitably estopped from

claiming that petitioners are not entitled to the claimed 1988

NOL deduction because his 1986 net trading loss constitutes a

capital, and not an ordinary, loss.    To support his argument, Mr.

Gordon contends that (1) the IRS initiated an examination of the

Gordons’ 1986 return in August 1987; (2) the revenue agent

conducting that examination orally informed Mr. Gordon in October

1988 that that loss was properly characterized as an ordinary

loss; (3) the IRS issued a no-change letter to the Gordons in May

1989 that formally notified them that the examination of their

1986 return showed that "no change" was necessary in the tax

reported in that return; and (4) he arranged his affairs to his

detriment in reliance on that oral statement and that no-change

letter.   Respondent contends that Mr. Gordon has not established

the elements necessary to warrant application of the doctrine of

equitable estoppel.   We agree with respondent.

     "Equitable estoppel is a judicial doctrine that 'precludes a

party from denying his own acts or representations which induced

another to act to his detriment.'"     Hofstetter v. Commissioner,

98 T.C. 695, 700 (1992) (quoting Graff v. Commissioner, 74 T.C.

743, 761 (1980), affd. 673 F.2d 784 (5th Cir. 1982)).    That

doctrine is applied against respondent "'with the utmost caution

and restraint.'"   Boulez v. Commissioner, 76 T.C. 209, 214-215
                              - 36 -

(1981) (quoting Estate of Emerson v. Commissioner, 67 T.C. 612,

617-618 (1977)), affd. 810 F.2d 209 (D.C. Cir. 1987).    A no-

change letter does not necessarily provide the necessary founda-

tion for applying that doctrine against respondent.    See Opine

Timber Co. v. Commissioner, 64 T.C. 700, 712 (1975), affd.

without published opinion 552 F.2d 368 (5th Cir. 1977); Lawton v.

Commissioner, 16 T.C. 725, 726-727 (1951).

      The following factors must be established in order to apply

the doctrine of equitable estoppel:    (1) There must be a false

representation or wrongful misleading silence; (2) the error must

be in a statement of fact, and not in an opinion or a statement

of law; (3) the person claiming estoppel must be ignorant of the

true facts; and (4) that person must be adversely affected by the

acts or statements of the person against whom estoppel is claim-

ed.   Estate of Emerson v. Commissioner, supra at 617-618.

      Mr. Gordon has failed to show that the IRS revenue agent's

oral statement to him in October 1988 that his 1986 net trading

loss was properly reported in the 1986 return as an ordinary loss

and the IRS' issuance of the no-change letter in May 1989 were

misrepresentations of fact, and not mistakes of law resulting

from a failure to take into account the change in the law in 1984

that Congress believed it was making with respect to the charac-

terization of gains and losses from the option transactions of

options market makers when it enacted section 1256(f)(3)(A) into
                              - 37 -

the Code.   See Automobile Club of Mich. v. Commissioner, 353 U.S.

180, 183 (1957).

     Nor has Mr. Gordon established that he relied to his detri-

ment on the IRS revenue agent's oral statement to him in October

1988 and the IRS' issuance of the no-change letter in May 1989 by

arranging his business affairs so that any income that he re-

ceived during 1988 and subsequent years would constitute ordinary

income that could be offset by a net operating loss deduction

attributable to his 1986 net trading loss.   In this connection,

we find it significant that (1) although Mr. Gordon's employment

with MKI from which he received ordinary income during 1988

commenced sometime in January 1988, it was not until October 1988

that the IRS revenue agent told him that his 1986 net trading

loss was properly reported as an ordinary loss in the Gordons'

1986 return, and it was not until May 1989 that the IRS issued

the no-change letter to the Gordons; and (2) the Gordons did not

claim any net operating loss deductions in their 1989 and 1990

returns.

     We also reject Mr. Gordon's claim that he relied to his det-

riment on the IRS revenue agent's oral statement to him in

October 1988 and the IRS' issuance of the no-change letter in May

1989 when he and Ms. Gordon did not use his 1986 net trading loss

to offset the long-term capital gain that they realized from the

sale of their Roslyn residence.   The Gordons realized a gain from
                              - 38 -

the sale of the Roslyn residence on November 21, 1986, and they

purchased the Lincoln Plaza residence on November 9, 1988.    We

note initially that the Gordons could have used Mr. Gordon's 1986

net trading loss to offset the long-term capital gain that they

realized from the sale of their Roslyn residence, regardless

whether that loss was characterized as a capital, or an ordinary,

loss.   Moreover, although the Gordons did not offset the gain

from the sale of the Roslyn residence by Mr. Gordon's 1986 net

trading loss, they did not have any additional tax liability for

1986 resulting from that gain.   Indeed, the Gordons indicated in

the Form 2119 included as part of their 1986 return that they

planned to replace the Roslyn residence within the "replacement

period".   Consequently, they did not include any portion of that

gain in the income reported in that return.   In addition, the

Gordons indicated in the amended Form 2119 included as part of

their amended 1986 return that they had replaced the Roslyn

residence, included in the income that they reported in that

return a capital gain of $29,391 from the sale of that residence,

and claimed a net operating loss deduction of $35,065 that was

attributable to an alleged net operating loss carryover from

1985.

     Moreover, we do not believe that Mr. Gordon relied on the

IRS revenue agent's oral statement to him in October 1988 and the

IRS' issuance of the no-change letter in May 1989 in choosing to
                                - 39 -

defer the recognition of the gain from the sale of the Roslyn

residence, rather than choosing to offset that gain by his 1986

net trading loss.     About 18 months before the IRS revenue agent

orally informed Mr. Gordon in October 1988 that his 1986 net

trading loss was properly reported as an ordinary loss in the

1986 return, the Gordons indicated in the Form 2119 included as

part of their 1986 return that they planned to replace the Roslyn

residence within the "replacement period".     Furthermore, only a

few weeks after that agent so informed Mr. Gordon, the Gordons

consummated the purchase of the Lincoln Plaza residence.

     On the record before us, we find that Mr. Gordon has failed

to show that, under the facts and circumstances presented here,

the doctrine of equitable estoppel should be applied against

respondent.     Accordingly, on that record, we find that respondent

is not equitably estopped from claiming that petitioners are not

entitled to the claimed 1988 NOL deduction because Mr. Gordon's

1986 net trading loss constitutes a capital, and not an ordinary,

loss.

Innocent Spouse

        Ms. Gordon claims that she qualifies for innocent spouse

relief under section 6013(e)(1) with respect to the portion of

the understatement of tax for 1988 that is attributable to the
                                - 40 -

claimed 1988 NOL deduction.16

     Section 6013(e) provides in pertinent part:

     (e) Spouse Relieved of Liability in Certain Cases.--

          (1) In general.--Under regulations prescribed by
     the Secretary, if--

              (A) a joint return has been made under this
          section for a taxable year,

              (B) on such return there is a substantial
          understatement of tax attributable to grossly
          erroneous items of one spouse,

              (C) the other spouse establishes that in
          signing the return he or she did not know, and had
          no reason to know, that there was such substantial
          understatement, and

              (D) taking into account all the facts and
          circumstances, it is inequitable to hold the other
          spouse liable for the deficiency in tax for such
          taxable year attributable to such substantial
          understatement,

     then the other spouse shall be relieved of liability
     for tax (including interest, penalties, and other
     amounts) for such taxable year to the extent such
     liability is attributable to such substantial under-
     statement.

          (2) Grossly Erroneous Items.--For purposes of this
     subsection, the term "grossly erroneous items" means,
     with respect to any spouse--

              (A) any item of gross income attributable to
          such spouse which is omitted from gross income,
          and

              (B) any claim of a deduction, credit, or
          basis by such spouse in an amount for which there
          is no basis in fact or law.


16
   Ms. Gordon does not contend that the Gordons are entitled to
the claimed 1988 NOL deduction.
                               - 41 -


     The spouse claiming innocent spouse relief must prove that

all four requirements prescribed by section 6013(e)(1) are

satisfied in order to be entitled to such relief.   Bliss v.

Commissioner, 59 F.3d 374, 378 (2d Cir. 1995), affg. T.C. Memo.

1993-390.

     Respondent concedes that (1) the Gordons filed a joint

return for 1988, (2) there was a substantial understatement of

tax in that return with respect to the claimed 1988 NOL deduction

that was attributable to Mr. Gordon, and (3) Ms. Gordon did not

know, and had no reason to know, of the substantial understate-

ment of tax for 1988 that was attributable to that claimed

deduction.17   Respondent argues, however, that the claimed 1988

NOL deduction does not constitute a grossly erroneous item under

section 6013(e)(1)(B) because (1) respondent did not disallow

that deduction, but merely recharacterized it as a deduction for

a capital, rather than an ordinary, loss, and (2) even if respon-

dent were considered to have disallowed that deduction, Ms.

Gordon has not established that there was no basis in fact or in

law for that deduction.   Respondent further argues that, under

the facts and circumstances presented here, it is not inequitable

under section 6013(e)(1)(D) to hold Ms. Gordon liable for the

portion of the understatement of tax for 1988 that is attribut-


17
   Respondent also concedes that the understatement attributable
to the claimed 1988 NOL deduction satisfies sec. 6013(e)(4).
                              - 42 -

able to the claimed 1988 NOL deduction.

     We reject respondent's contention that the claimed 1988 NOL

deduction does not constitute a grossly erroneous item under

section 6013(e)(1)(B) because that deduction was not disallowed,

but was merely recharacterized.   That respondent’s basis for

disallowing the claimed 1988 NOL deduction is the recharacter-

ization of Mr. Gordon's 1986 net trading loss from an ordinary,

to a capital, loss does not mean that she is not disallowing that

deduction.   See Bokum v. Commissioner, 94 T.C. 126, 141-142

(1990), affd. 992 F.2d 1132 (11th Cir. 1993).   Indeed, respondent

determined in the notice (1) that the Gordons are not entitled to

the claimed 1988 NOL deduction of $268,318 and (2) that they are

entitled for 1988 to a deduction for a capital loss carryover of

$7,612 that is attributable to Mr. Gordon's 1986 net trading

loss.   Accordingly, we conclude that the claimed 1988 NOL deduc-

tion will constitute a grossly erroneous item within the meaning

of section 6013(e)(1)(B) if Ms. Gordon establishes that that

claimed deduction has "no basis in fact or law" within the

meaning of section 6013(e)(2)(B).   See Bokum v. Commissioner,

supra at 141-142; Flynn v. Commissioner, 93 T.C. 355, 364 (1989).

     In Douglas v. Commissioner, 86 T.C. 758, 762-763 (1986), we

construed the phrase "no basis in fact or law" as follows:

     As we read the statute as a whole and its legislative
     history, a deduction has no basis in fact when the
     expense for which the deduction is claimed was never,
     in fact, made. A deduction has no basis in law when
                              - 43 -

     the expense, even if made, does not qualify as a de-
     ductible expense under well-settled legal principles or
     when no substantial legal argument can be made to
     support its deductibility. Ordinarily, a deduction
     having no basis in fact or in law can be described as
     frivolous, fraudulent, or, to use the word of the
     committee report, phony. [Fn. ref. omitted.]

That a deduction is disallowed does not necessarily mean that it

has no basis in fact or in law within the meaning of section

6013(e)(2)(B).   See id. at 763.

     Ms. Gordon concedes that Mr. Gordon's 1986 net trading loss

to which the claimed 1988 NOL deduction is attributable was, in

fact, sustained by Mr. Gordon during 1986.    She argues, however,

that the claimed 1988 NOL deduction is grossly erroneous because,

pursuant to section 1256(a)(3), Mr. Gordon's 1986 net trading

loss to which that deduction is attributable is a capital loss,

and, consequently, that loss is not a net operating loss that the

Gordons are entitled to carry over to years after 1986.   Respon-

dent counters that the claimed 1988 NOL deduction is not grossly

erroneous because it is not frivolous, fraudulent, or phony.

     We note initially that Ms. Gordon is wrong in claiming that

section 1256(a)(3) mandates capital loss treatment for Mr.

Gordon's 1986 net trading loss.    It is section 1256(f)(3)(A), and

not section 1256(a)(3), that requires that any gain or loss from

trading of section 1256 contracts be treated as gain or loss from

the sale or exchange of a capital asset, unless the hedging

exception in section 1256(f)(3)(B) applies.   Section 1256(a)(3)
                              - 44 -

requires only that any gain or loss with respect to a section

1256 contract is to be treated as short-term capital gain or loss

to the extent of 40 percent of such gain or loss and as long-term

capital gain or loss to the extent of 60 percent of such gain or

loss.   Indeed, section 1256(f)(2) provides that section

1256(a)(3) is not to apply to any gain or loss which, but for

such paragraph, would be ordinary income or loss.

     We have found on the instant record that, pursuant to

section 1256(f)(3)(A), Mr. Gordon's 1986 trading loss is treated

as a loss from the sale or exchange of a capital asset and that

Mr. Gordon failed to establish that the hedging exception in

section 1256(f)(3)(B) applies to any portion of that loss.   Our

latter finding does not necessarily mean that Mr. Gordon did not

hold any of the options that generated his 1986 net trading loss

for the purposes specified in section 1256(f)(3)(B).   It means

only that although Mr. Gordon claims that he so held most of

those options, the evidence that he presented did not persuade us

that he did.   In contrast, Ms. Gordon does not even claim that

Mr. Gordon did not hold the options in question for the purposes

specified in section 1256(f)(3)(B), let alone that there was no

substantial argument that can be made that he so held any of

those options.   Ms. Gordon could have developed the record in

order to attempt to establish that Mr. Gordon did not hold the

options that generated his 1986 net trading loss for the purposes
                              - 45 -

specified in section 1256(f)(3)(B).     However, she failed to do

so.

      On the record before us, we find that Ms. Gordon has failed

to show that there is no basis in fact or in law within the

meaning of section 6013(e)(2)(B) for the claimed 1988 NOL deduc-

tion and that that item constitutes a grossly erroneous item

within the meaning of that section.18

      Based on our review of the entire record before us, we find

that Ms. Gordon is not entitled to innocent spouse relief under

section 6013(e)(1) with respect to the portion of the understate-

ment of tax for 1988 that is attributable to the claimed 1988 NOL

deduction.

      To reflect the foregoing and the concessions of the parties,



                                           Decisions will be entered

                                      under Rule 155.




18
   Consequently, we shall not address whether Ms. Gordon satis-
fies sec. 6013(e)(1)(D) with respect to the portion of the
understatement of tax for 1988 that is attributable to the
claimed 1988 NOL deduction.
