                        T.C. Memo. 1997-118



                      UNITED STATES TAX COURT



          ROBERT J. AND ANNE L. WILSON, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent*



     Docket Nos. 18481-93, 17723-94.            Filed March 6, 1997.



     Rex L. Sturm, for petitioners.

     Michal Cline, for respondent.



      SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION

     PARR, Judge:   These proceedings arise out of a dispute

between the parties over their differing computations under Rule




* This opinion is supplementing Wilson v. Commissioner, T.C.
Memo. 1996-418.
                                 - 2 -

155.1    On September 17, 1996, we filed our findings of fact and

opinion in these cases, T.C. Memo. 1996-418 (Wilson I), and

directed that decisions be entered under Rule 155.

        Petitioners have objected to respondent's computation under

Rule 155.     For the taxable year 1990, we find petitioners'

argument to be correct and therefore sustain their objection.

However, for the taxable year 1989, we find that both

respondent's and petitioners' computations are incorrect.

Accordingly, based on the conclusions reached in Wilson I, we

make the necessary adjustments to respondent's Rule 155

computation for 1989 as set out below.

        In Wilson I, we made findings of fact which we adopt for

purposes of this supplemental opinion.     However, for clarity, we

begin with a brief summary of some of the facts found therein and

also report additional findings of fact pertinent to this

supplemental opinion.

                           FINDINGS OF FACT

        In 1989, petitioners received $62,937 from the State of

Maryland (the State), representing the balance of a $104,000

settlement award paid as compensation for rental property that

the State acquired through a "quick take" condemnation


1
     All Rule references are to the Tax Court Rules of Practice
and Procedure, and all section references are to the Internal
Revenue Code in effect for the years in issue, unless otherwise
indicated. All dollar amounts are rounded to the nearest dollar,
unless otherwise indicated.
                                 - 3 -

proceeding.   The property was needed to widen and improve Route

355 in Gaithersburg, Maryland.    In Wilson I, we held that of the

$62,937 condemnation award received by petitioners, $34,618 is

allocable to prejudgment interest.       Furthermore, petitioners

conceded that $1,333 of the $62,937 is taxable as postjudgment

interest income.

     In 1989, petitioners paid $26,341 for attorney's fees

incurred in connection with the condemnation proceedings.

Petitioners did not claim the expenses on their 1989 return,

since they believed the fees were not deductible because they

were attributable to a condemnation award eligible for

nonrecognition of gain pursuant to section 1033.

     Respondent determined in the notice of deficiency for 1989

that petitioners had unreported dividend income of $1,677.

However, on brief, respondent conceded that for 1989 petitioners

had unreported dividend income of only $573.       In Wilson I, we

found that for 1989, petitioners received a $2,105 dividend

distribution from the T. Rowe Price stock fund (stock fund),

which they failed to report on their 1989 income tax return.

     In 1989, petitioners received $27,206 on the sale of the

stock fund.   Petitioners did not report the sale on their 1989

tax return.   Respondent determined in the notice of deficiency

for 1989 that petitioners had a $29,904 unreported capital gain.

However, the notice of deficiency failed to give petitioners

credit for their basis in the stock fund.       On brief, respondent
                               - 4 -

conceded that petitioners had a $29,214 basis in the stock and

therefore are entitled to a $2,0092 loss in 1989 on the sale of

the stock fund.

                              OPINION

I. Allocation of Condemnation Award Between Gain From the Sale of
Property and Interest Income

     In their Rule 155 computations for 1989, neither respondent

nor petitioner made a correct allocation of the condemnation

award between gain from the sale of property and ordinary

interest income.   To comply with our holding in Wilson I, for

1989 petitioners' $62,937 condemnation award must be decreased,

not only by the $1,333 attributable to postjudgment interest, but

also by the $34,618, representing prejudgment interest.

Simultaneously, petitioners' interest income must be increased by

that amount.   Accordingly, we find that in 1989, petitioners

received a condemnation award of $26,986, which is characterized

as capital gain, and interest income of $35,951, representing

$34,618 in prejudgment interest and $1,333 in postjudgment

interest, which is characterized as ordinary income.

II. Itemized Deduction for Attorney Fees

     Respondent's Rule 155 computation fails to take into account

the fact that petitioners incurred $26,341 in attorney's fees for

1989 in connection with the condemnation proceedings on their


2
     On brief, respondent concedes a $2,008.81 actual loss on the
sale of the stock, which we rounded up to $2,009.
                               - 5 -

rental property in Gaithersburg, Maryland.    At trial and on

brief, petitioners argued that they should be allowed to deduct

those expenses if the Court should find, as we indeed did in

Wilson I, that the condemnation proceeds do not qualify for tax-

free treatment under section 1033.3    We agree with petitioners.

     Ordinary and necessary attorney fees are generally

deductible subject to certain restrictions under section 67(a),

provided such expenses are paid or incurred during the taxable

year with respect to an issue involving income-producing

property.   Sec. 212(1); sec. 1.212-1(l), Income Tax Regs.   In

addition, a deduction is allowed for attorney's fees paid or

incurred during the taxable year in connection with the

determination, collection, or refund of any tax with respect to



3
     Although this issue was not raised by petitioners in their
petition herein, it was argued by them at trial and on brief, and
the evidence is uncontested that they indeed incurred attorney
fees of $26,341 in 1989. Leahy v. Commissioner, 87 T.C. 56, 65
(1986); Estate of Horvath v. Commissioner, 59 T.C. 551, 555
(1973); Wynn v. Commissioner, T.C. Memo. 1996-415. Moreover, at
trial, respondent did not object to petitioners' assertion that
the attorneys' fees are at issue if "the Court should find that
[petitioners] didn't reinvest" the condemnation award pursuant to
sec. 1033.
     Normally we will not consider an issue that was not pleaded,
but raised for the first time on brief. Rule 34(b)(4). However,
respondent did not object to petitioners' arguments, and we find
that based on the entire record, respondent was not surprised or
prejudiced by petitioners' position. Accordingly, we deem the
issue raised and tried by consent of the parties under Rule
41(b). Mills v. Commissioner, 399 F.2d 744, 748 (4th Cir. 1968)
affg. T.C. Memo. 1967-67; Leahy v. Commissioner, supra; Estate of
Horvath v. Commissioner, supra; Christensen v. Commissioner, T.C.
Memo. 1996-254.
                                - 6 -

income-producing property.    Sec. 212(3); Page v. Commissioner,

T.C. Memo. 1993-398, affd. 58 F.3d 1342 (8th Cir. 1995).

     In 1989, petitioners received a condemnation award and paid

attorney fees of $26,341 in connection with the condemnation

proceedings.   Petitioners treated the condemnation award as tax

free under section 1033.   Accordingly, petitioners did not deduct

the attorney's fees because they thought they were precluded from

doing so, as the fees were allocable to what they believed to be

tax-free income.   Sec. 1.212-1(e), Income Tax Regs.

     In Wilson I, we held that the condemnation award received by

petitioners in 1989 did not qualify for nonrecognition treatment

under section 1033.   Therefore, the condemnation award was

includable in petitioners' income for 1989.   As petitioners are

required to include the condemnation award in their taxable

income for 1989, they are also entitled to claim a deduction for

the legal expenses incurred in litigating the condemnation

dispute.   Accordingly, we find that in 1989 petitioners paid and

therefore may claim a miscellaneous itemized deduction for

attorney's fees of $26,341.   Sec. 67(a) and (b).

III. Unreported Dividend Income

      In the notice of deficiency for 1989, respondent determined

that petitioners had unreported dividend income of $1,677.    On

brief, respondent conceded that petitioners had only $573 in

unreported dividend income.   To reflect this concession,

respondent's Rule 155 computation should have subtracted $1,104
                                 - 7 -

from the $1,677 amount.    Instead, respondent subtracted only

$1,084 from the $1,677 amount.

     Moreover, respondent's computation is flawed with respect to

an additional item of dividend income.      In Wilson I, we found

that petitioners received a $2,105 dividend distribution from a

stock fund, which they failed to report on their 1989 income tax

return.   Accordingly, respondent's Rule 155 computation should

have made an adjustment to increase petitioners' dividend income

by this amount.    Thus, petitioners' unreported dividend income

for 1989 is $1,001 ($2,105 minus $1,104).      However, rather than

increasing petitioners' dividend income by $2,105, respondent's

Rule 155 computation decreases petitioners' determined capital

gain income of $29,904 by $27,800, thus leaving petitioners with

a capital gain of $2,104.4   Given this scenario, we find that

respondent's Rule 155 computation erroneously characterizes the

$2,105 distribution as capital gain, rather than as ordinary

dividend income.

IV. Capital Loss

     In 1989, petitioners sold their stock fund for $27,206.

Petitioners failed to report this transaction on their 1989

return.   In the notice of deficiency for 1989, respondent


4
     We note that the $1 difference      between the $2,105 dividend
distribution petitioner's failed to      report and the $2,104 capital
gain reflected in respondent's Rule      155 computation results from
the fact that we rounded the $2,105      amount up from $2,104.66.
See supra note 1.
                                 - 8 -

determined that petitioners had a $29,9041 unreported capital

gain.    However, respondent failed to give petitioners basis

credit in determining their capital gain on the sale of the

stock.    On brief, respondent conceded that petitioners had a

basis in the stock fund of $29,214 and therefore are entitled to

a $2,009 loss on the sale of the stock.       Accordingly, respondent

should have subtracted $31,913 from her $29,904 of determined

unreported capital gain income.    This adjustment will account for

petitioners' $2,009 capital loss.    However, as discussed above,

respondent's Rule 155 computation erroneously decreases

petitioners' capital gain by only $27,800.

     Accordingly, we sustain petitioners' Rule 155 computation

for 1990.    However, with respect to the Rule 155 computation for

1989, the parties shall make the necessary adjustments as

discussed herein.

     To reflect the foregoing,

                                         An order will be issued

                                 for 1989 and 1990 directing the

                                 parties to resubmit their Rule 155

                                 computations in accordance with the

                                 findings herein.




1
     We note that the record is unclear as to the source of the
additional $2,698 ($29,904 minus $27,206) of capital gain income.
