                       T.C. Memo. 1997-248



                     UNITED STATES TAX COURT



                   BIG HONG NG, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

                STRONG HOPE, LTD., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 20814-93, 21277-93.           Filed June 2, 1997.



     Albert C. Lum, for petitioners.

     Debra K. Estrem and James P. Thurston, for respondent.



                       MEMORANDUM OPINION


     JACOBS, Judge: In docket No. 20814-93, petitioner Big Hong Ng

(Ms. Ng) seeks a redetermination of the following revised tax

determinations made by respondent:
                                                  -2-
                                                 Additions to Tax
                       Sec.          Sec.          Sec.         Sec.        Sec.     Sec.      Sec.
Year   Deficiency   6651(a)(1)   6653(a)(1)(A)   6653(a)(1) 6653(a)(1)(B)   6654     6661      6662
                                                                   1
1986   $1,327,802   $331,951      $66,390          ---                      ---     $331,951   ---
                                                                   1
1987      830,395    207,850       41,570          ---                      ---      207,850   ---
1988      878,617    219,654        ---           $43,930         ---       ---      219,654   ---
1989    1,431,742    357,936        ---            ---            ---       ---      ---     $286,348
1990      256,186     64,047        ---            ---            ---     $16,869    ---       ---
        1
            50 percent of the interest on the portion of the underpayment attributable to negligence.

A substantial portion of the deficiencies and additions to tax was

asserted in respondent's amended answer.

        In docket No. 21277-93, petitioner                      Strong Hope, Ltd. (Strong

Hope), a Hong Kong corporation wholly owned by Ms. Ng, seeks a

redetermination of the following deficiency and additions to tax:
                                                         Additions to Tax
                Year      Deficiency              Sec. 6651(a)(1)      Sec. 6662
                1989      $262,298                    $52,460           $52,460


        The aforementioned docketed cases have been consolidated for

trial, briefing, and opinion.

        Following concessions by the parties, the issues remaining for

decision are: (1) Whether Ms. Ng had unreported income in the

amounts determined by respondent; (2) whether Ms. Ng is entitled to

claimed pass-through losses from her S corporation, Hong Kong

Restaurant, Inc.; (3) whether Ms. Ng is entitled to defer the gain

from the sale of certain real estate pursuant to section 1031; (4)

whether Ms. Ng received a liquidating distribution from Strong Hope

when that corporation transferred its interest in real estate to

her; (5) whether Ms. Ng is entitled to the entire investment

interest deduction claimed; (6) whether Ms. Ng is entitled to a

claimed net operating loss carryover; (7) whether Ms. Ng is liable

for an accuracy-related penalty and for additions to tax for
                                 -3-

negligence, substantial understatement, failure to file timely

returns, and failure to pay estimated tax; (8) whether Strong Hope

had discharge of indebtedness income; (9) whether Strong Hope's

basis in certain real estate that it transferred should be adjusted

as determined by respondent; (10) whether respondent properly

disallowed a net operating loss carryover to Strong Hope; and (11)

whether Strong Hope is liable for an accuracy-related penalty and

for an addition to tax for failure to file a timely return.

     All section references are to the Internal Revenue Code for

the years under consideration.   All Rule references are to the Tax

Court Rules of Practice and Procedure.

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

stipulations of facts and the attached exhibits are incorporated

herein by this reference.

                            Background

     Ms. Ng, also known as Don Hong Ng, Bik Hung Ng Leong, and

other names, resided in San Francisco, California, at the time she

filed her petition. Ms. Ng's tax returns for all years under

consideration were untimely filed.

     Ms. Ng was born in 1935 and came to the United States from

Hong Kong in approximately 1958. She studied English and music in

the United States, and became a resident alien shortly after her

marriage in 1962 to Sik Chong Leong in Reno, Nevada. They were

divorced in 1968 and had no children. Ms. Ng acquired her U.S.

citizenship in 1966.   Ms. Ng has a son, Timothy Lee, who was born
                                   -4-

in 1957.

      Strong Hope was incorporated in Hong Kong in 1981.               It owned

a   50-percent   undivided   interest    in   a    rental   property    at   850

Stockton Street in San Francisco during part of 1989.           Ms. Ng owned

the other half interest.     In its petition, Strong Hope states its

principal place of business to be c/o Poon and Company, CPAs, 43-59

Queens Road East, Hong Kong. Strong Hope's 1989 tax return was

untimely filed.

      Ms. Ng owned or controlled the following bank accounts during

the years under consideration:

      Account Title                      Bank

United States:

      Strong Hope                        Union Bank
      Strong Hope Limited (Calif.)       Bank of America
      Permanent Union Limited            Bank of the Orient
      Strong Hope Limited                Sumitomo Bank
      Ms. Ng                             Bank of America

Hong Kong:

      Ms. Ng                             Hang     Seng   Bank
      J.B. Wings                         Wing     Lung   Bank
      Strong Hope                        Wing     Lung   Bank
      Permanent Union Ltd. (HK)          Wing     Lung   Bank
      Don Hong Ng                        Wing     Lung   Bank
      Don Hong Ng                        Wing     Lung   Bank
      Ms. Ng and Sik Yuen Ng             Wing     Lung   Bank

      Ms. Ng owned interests in the following entities during the

years under consideration:

San Francisco:

      Golden Dragon Restaurant           50% ownership
      Permanent Union Ltd.               100%
      Strong Hope Limited (Calif.)       100%
                                      -5-

     Ocean City Restaurant                  5%

Seattle:

     Hong Kong Inv. Ltd.                    100%
     Hong Kong Restaurant, Inc.             100%
     Ocean City Restaurant                  8%
     Ocean City Investments                 unknown

Hong Kong:

     Permanent Union Limited                100%
     Ocean City Restaurant
        and Night Club Limited              at least 4.5%
     Strong Hope                            100%
     Bik Hung Investment Limited            100%
     J.B. Wings                             50%

     Ms. Ng directly or indirectly owned interests in the following

properties during the years under consideration:

     Property                               Owner

San Francisco:

     1610 Lombard                           Ms. Ng
     1733 Larkin                            Ms. Ng
     850 Stockton                           Ms. Ng and Strong Hope
     857 Clay                               Strong Hope Limited (Calif.)
     1835 Franklin                          Ms. Ng

Seattle:

     507 Maynard                            Hong Kong Investments
     609 South Weller                       Ocean City Investments

Hong Kong:

     Flat 1, 41A Stubbs Road                Ms. Ng
     Flat 2, 41A Stubbs Road                Ms. Ng

     Ms. Ng contends that she has difficulty understanding English,

which   is   not   her    native   language,        and    that    accounts   for

discrepancies      in    statements    she       made     during    respondent's

investigation. Although Ms. Ng's trial testimony was given largely
                                        -6-

through an       interpreter,    we   found     that   when     using    English   to

testify, she did not have any difficulty.

     For convenience and clarity, we have combined additional

findings of fact and opinion with respect to each issue.

Issue 1.   Unreported Income

     The largest adjustments to Ms. Ng's income are based on

respondent's determination that Ms. Ng failed to report substantial

amounts of income. Specifically, respondent determined that Ms. Ng

failed to report: (a) Self-employment income which was deposited

into bank accounts she controlled in the amounts of $54,849 in

1986, $50,444 in 1987, $563,513 in 1988, and $346,993 in 1989; (b)

income consisting of deposits from Hong Kong into bank accounts she

controlled, rental and interest income, and forgiveness of debt

income, not subject to self-employment tax in the amounts of

$168,300 in 1986, $247,761 in 1987, $170,545 in 1988, $212,459 in

1989, and $93,208 in 1990; and (c) income which was deposited into

the tip account, discussed infra, as well as other Hong Kong bank

accounts, in the amounts of $1,643,928 in 1986, $242,098 in 1987,

$245,355 in 1988, $719,163 in 1989, and $159,153 in 1990.

     In    the    amended     answer,      respondent     asserted       additional

unreported income, totaling $3,271,690 for the 5 years under

consideration,      from    unexplained       deposits    to   bank     accounts   in

foreign banks.       Of this amount, at least $2,577,089 arises from

deposits   to     the   tip     account,      discussed    in     detail,    infra.

Respondent bears the burden of proof with respect to the increase
                                          -7-

in the asserted deficiencies and additions to tax made in the

amended answer.       Ms. Ng bears the burden of proof with respect to

the deficiencies and additions to tax determined by respondent in

the notice of deficiency.           Rule 142(a).

      Ms. Ng claims that respondent's deficiency determination was

arbitrarily     derived,      and    as    a    result,     the   presumption    of

correctness generally attributed to the notice of deficiency should

disappear.     In this regard, the United States Court of Appeals for

the Ninth Circuit (where an appeal in Ms. Ng's case would lie) has

held that in order for the presumption of correctness to attach to

the   notice    of    deficiency      in       unreported    income     cases,   the

Commissioner     must       come     forward      with    substantive      evidence

establishing "some evidentiary foundation" linking the taxpayer to

the income-producing activity, Weimerskrirch v. Commissioner, 596

F.2d 358, 361-362 (9th Cir. 1979), revg. 67 T.C. 672 (1977), or

"demonstrating       that   the    taxpayer      received   unreported     income."

Edwards v. Commissioner, 680 F.2d 1268, 1270 (9th Cir. 1982), affg.

an Order of this Court; see also Rapp v. Commissioner, 774 F.2d

932, 935 (9th Cir. 1985), affg. an Order of this Court.                           We

therefore must examine the record to determine whether there is a

minimal      evidentiary           foundation       supporting        respondent's

determination of unreported income.

      In the instant case, we find the record contains substantive

evidence   to   support      respondent's        determination     of    unreported

income.    See Blohm v. Commissioner, 994 F.2d 1542, 1549 (11th Cir.
                                       -8-

1993), affg. T.C. Memo. 1991-636; Erickson v. Commissioner, 937

F.2d 1548, 1551 (10th Cir. 1991), affg. T.C. Memo. 1989-552.              We do

not find that respondent's determinations were arbitrary and thus

do not agree with Ms. Ng's assertion that the burden of proof

should shift to respondent.

      Ms. Ng transacted business using large amounts of cash.              She

commingled her personal funds with funds of entities she owned or

controlled in her U.S. and Hong Kong bank accounts, and she

commingled    the   funds   of   one    entity   with   those   of   another.

Moreover, she disregarded the legal ownership of the accounts when

writing checks.      For example, she deposited into Strong Hope's

checking account rents from property located at 857 Clay Street,

which was owned by Strong Hope Limited (Calif.) and wrote checks

from Strong Hope's checking account to pay expenses of property

located at 1610 Lombard Street which she wholly owned.                Ms. Ng

claims she "commingled funds and used cash and cashier's checks on

many occasions out of fear that the respondent or other creditors

would seize her accounts."

      Revenue Agent Theresa Martin (the revenue agent) reconstructed

Ms. Ng's income for the years under consideration by analyzing Ms.

Ng's bank deposits and cash expenditures. Use of the bank deposits

and   cash   expenditures   method      to   reconstruct   income    is   well

established. DiLeo v. Commissioner, 96 T.C. 858, 867 (1991), affd.

959 F.2d 16 (2d Cir. 1992); Parks v. Commissioner, 94 T.C. 654, 658

(1990); Nicholas v. Commissioner, 70 T.C. 1057, 1064 (1978); Estate
                                   -9-

of Mason v. Commissioner, 64 T.C. 651, 656 (1975), affd. 566 F.2d

2 (6th Cir. 1977).         Bank deposits are prima facie evidence of

income. Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). In a cash

expenditures analysis, the amount by which a taxpayer's cash

expenditures exceeds his known sources of income is assumed to be

taxable income, unless the taxpayer can show the expenditures were

made from a nontaxable source.      DeVenney v. Commissioner, 85 T.C.

927, 930 (1985).

     In analyzing the bank deposits, the revenue agent separated

cash, checks, cashier's checks, and wire transfers.           She examined

the source of each deposit. She separated those items subject to

self-employment     tax,    such   as    presumed   receipts    from   the

restaurants, from those items not subject to self-employment tax,

such as rental income. These appeared as separate adjustments in

the notice of deficiency with respect to Ms. Ng.

     To the extent possible the revenue agent eliminated those

items that had been reported or came from nontaxable sources, such

as transfers and refinancing proceeds.          The revenue agent also

subtracted from unidentified cash deposits the maximum amount of

reported rents that could have been paid in cash or by check;

moreover,   she   subtracted   substantiated    partnership    draws   paid

directly to Ms. Ng by Golden Dragon Restaurant.         We are satisfied

that the revenue agent gave Ms. Ng credit for every nontaxable

source of income that could be identified.          Moreover, before the

trial, respondent conceded certain nontaxable items that became
                                  -10-

apparent from records and documents summonsed from Hong Kong after

the notice    of   deficiency   was   issued   and   certain   other   items

ultimately substantiated by Ms. Ng.

     During a July 22, 1991, interview, Ms. Ng told the revenue

agent that she had only one foreign bank account from 1986 through

1989, and that only her salary from Ocean City Restaurant and Night

Club, Limited in Hong Kong (Ocean City HK) was deposited into that

account.   In response to a discovery request, Ms. Ng's counsel

informed respondent that Ms. Ng had signature authority over 2

foreign accounts, one account at Hang Seng Bank and one account at

Wing Lung Bank, which belonged to Ocean City HK.        Ms. Ng refused to

consent to the release of her foreign bank records until ordered to

do so by the U.S. District Court for the Northern District of

California.   The revenue agent ultimately discovered, and obtained

records showing, that Ms. Ng had one account at Hang Seng Bank and

six accounts at Wing Lung Bank.       The additional income asserted in

the amended answer involves deposits to Ms. Ng's bank accounts at

Hang Seng Bank and Wing Lung Bank.

     The revenue agent also analyzed Ms. Ng's cash expenditures.

Those expenditures that could not be traced to a nontaxable source

or reported income were considered unreported income. For example,

the revenue agent included $45,568.68 as unreported income for

1988, which was the amount Ms. Ng paid in cash for a cashier's

check on July 5, 1988, because the revenue agent could not trace

that cash purchase to a nontaxable source.
                                  -11-

       Tip Account

       One of the Hong Kong accounts the revenue agent examined was

referred to by the parties as the tip account.          The reason for such

nomenclature is because the deposits into this account came from

tips paid to employees of Ocean City HK.         Ms. Ng denies ownership

of this account.

       Ocean City HK has seating capacity for approximately 5,000

people and is the largest restaurant in Hong Kong.          Ms. Ng owned at

least a 4.5-percent interest in Ocean City HK and was employed

there as deputy managing director from 1978 until 1991. Her duties

included    supervision    of   personnel,      floor   shows,   and   food

preparation.    She signed checks on the restaurant's behalf but was

not involved in accounting.

       Ms. Ng and her brother, Sik Yuen Ng, who also was employed at

Ocean City HK, opened the tip account at Wing Lung Bank on March

11, 1981.      The account was in their names, and they each had

signature authority.

       Deposits to the tip account from 1986 through 1990 were

generally in cash as follows:

Year        Amount Deposited             Number of Deposits

1986          $1,543,418                 156   (6 noncash deposits)
1987             231,541                  57   (3 noncash deposits)
1988             228,910                  49   (all cash)
1989             567,919                  36   (3 noncash deposits)
1990               5,301                   1   (cash)

       All the withdrawals from the tip account which the revenue

agent could trace were for the benefit of Ms. Ng or a restaurant
                                      -12-

which she partially owned in the United States.             The withdrawals

occurring     from   1986   through    1989   fall   into   three   general

categories:

     * $491,752--transferred directly to Ms. Ng's personal bank
account in the United States or to American Express to pay her
personal American Express bills;

     * $535,012--paid for the direct benefit of U.S. restaurants in
which Ms. Ng had an ownership interest; and

       * $1,920,158--no information provided.

       In February 1991, Ms. Ng resigned from her position at Ocean

City HK and transferred a portion of her stock ownership to her

son.     This was apparently done as a result of a controversy

concerning her use of the tip account.          The managing director of

the restaurant, Jack Lee, also resigned and transferred ownership

of all of his stock to Ms. Ng's son in February 1991.            Ms. Ng and

Mr. Lee had been business partners since 1965.

       Sometime in 1990 or early 1991, Ocean City HK was reorganized

and new owners were brought into the business.              In May 1991, a

newly constituted board of directors decided to close the tip

account.

       The accounting firm of KPMG Peat Marwick (Peat Marwick) was

employed to conduct a financial audit of Ocean City HK for the year

ending March 31, 1991. James Arkoosh, Peat Marwick's Hong Kong

resident partner, testified that the tip account was included as an

asset of Ocean City HK on its balance sheet for the year ended

March 31, 1991.      He did not know whether the tip account had been
                                   -13-

treated as an asset of Ocean City HK for any of the years under

consideration, and no persuasive evidence was introduced for us to

conclude that the tip account belonged to the restaurant.

     In her posttrial brief, Ms. Ng claims that she did not own the

tip account but rather it was owned by Ocean City HK, that certain

deposits into the account were counted twice by respondent, and

that disbursements to her from the account were loans.       The record

in this case belies these claims.

     Ms. Ng and her brother had complete control over the tip

account. Although the source of deposits into the account may have

been tips received by Ocean City HK employees, a substantial

portion of the withdrawals from the account went to Ms. Ng or for

her benefit.     We therefore find that Ms. Ng controlled the tip

account and treated it as her own.

     The parties stipulated that $98,911 of the deposits in the tip

account were not included in respondent's adjustments because that

amount was transferred to Ms. Ng's Bank of America account and

already had been counted in determining her reconstructed income.

Ms. Ng has not shown that other amounts were counted twice.

Further, we are not convinced that the withdrawals from the tip

account were loaned to her, or that she intended to repay any such

alleged loans.

     Nonetheless,   we   believe   some   disbursements   from   the   tip

account were for the benefit of Ocean City HK shareholders other

than Ms. Ng, who in effect acted as agent for Ocean City HK in the
                                  -14-

United    States.   The    parties   stipulated   that    $530,603   in

disbursements from the tip account between 1986 and 1989 were paid

to Ocean City Restaurant in San Francisco, in which Ms. Ng had a 5-

percent ownership interest, or to its suppliers.         Accordingly we

find, and thus hold, that only 5 percent of the $530,603 deposited

into the tip account was income to Ms. Ng.

       The parties also agreed that $473,660 was paid directly to Ms.

Ng from the tip account. Ms. Ng claims that some of the $473,660

went to Ocean City Seattle and Ocean City San Francisco, as well as

to the Golden Palace Restaurant in Los Angeles, in which she had no

ownership interest.     Other than an exhibit showing that a $50,000

withdrawal from the tip account on November 30, 1987, was recorded

on the books of Ocean City HK as a loan to the Golden Palace, Ms.

Ng presented no evidence that any specific disbursement went to any

of these restaurants.     The funds were wired directly to Ms. Ng, and

there is no evidence that she transmitted the money to the Golden

Palace. Accordingly, we find, and thus hold, that all of the

$473,660 paid directly to Ms. Ng from the tip account is income to

her.

       The parties agreed that $4,409 was paid from the tip account

to Golden Dragon Restaurant or its suppliers.        Ms. Ng is a 50-

percent owner of the Golden Dragon, and we find, and thus hold,

that half of this $4,409 is income to her.

       The parties stipulated that $18,092 was disbursed from the tip

account to pay Ms. Ng's personal credit card bills.        We find, and
                                           -15-

thus hold, that the entire amount of those deposits is income to

Ms. Ng.

       To summarize, except for the amounts that we found are not

income to Ms. Ng, we find, and thus hold, that all of the tip

account deposits are income to Ms. Ng.

       Other Accounts

       The revenue agent used unexplained cash deposits to other bank

accounts Ms. Ng owned or controlled as the basis to reconstruct Ms.

Ng's income.

       Ms. Ng's personal checking account in the United States was at

the Bank of America in San Francisco.                  The deposits to the Bank of

America account, after reduction for reported and nontaxable rents

and    partnership        draws,     determined       to    be    unreported   income,

included:

                                 Number of      Rent, Draw        Unreported Income
Year       Cash Deposits         Deposits       Reduction            Adjustment
1986       $ 68,866                 58          ($14,017)            $ 54,849
1987         80,798                 30          ( 30,354)                50,444
                                                                      1
1988        121,760                 56          ( 34,925)               101,911
1989         61,210                 37              -0-                  61,210
       1   No explanation was given for the mathematical discrepancy.


       Ms. Ng controlled an account at Union Bank in San Francisco

that she opened in the name of Strong Hope, as well as an account

at Bank of the Orient in San Francisco in the name of Permanent

Union Ltd.         Both companies were wholly owned by Ms. Ng.                      The

revenue      agent     analyzed      the    deposits       to    these   accounts   and

determined that the following unexplained cash deposits made to
                                 -16-

each account (after reduction for the maximum reported rents that

could have been received in cash) represented unreported income of

Ms. Ng:

                1988 Cash Deposits

Union Bank (39 deposits)                     $59,157
Bank of the Orient (53 deposits)              67,545
Rent reduction                               (48,541)
Adjustment                                   $78,161

     Ms. Ng also made deposits of checks from her restaurants and

other identified and unidentified sources. She made wire transfers

of unidentified funds to Sumitomo Bank.            She used cash from

unidentified sources to purchase cashier's checks.              She made

contributions   to   capital   and   loans   to   her   restaurants   with

unidentified funds.     Ms. Ng made numerous check and cash deposits

into her accounts at Hang Seng Bank and Wing Lung Bank in Hong

Kong, and numerous wire deposits from the Hong Kong banks to her

Bank of America account in San Francisco.

     Cash and check deposits into Ms. Ng's account at Hang Seng

Bank were as follows:

                Year             Total Deposits
                1986                $170,910
                1987                 228,512
                1988                  42,835
                1989                  60,686
                1990                  21,350

The revenue agent reduced these deposits by $30,000 to account for

two transfers ($15,000 in 1986 and $15,000 in 1987), and the

revenue agent determined the remaining amounts to be unreported

income.
                                  -17-

       Deposits into one of Ms. Ng's accounts at Wing Lung Bank were

as follows:

                 Year             Total Deposits
                 1986                $260,442
                 1987                   1,558
                 1988                  11,141
                 1989                 167,515
                 1990                  34,754

       Wire transfers from Wing Lung Bank and Hang Seng Bank into Ms.

Ng's Bank of America account in San Francisco were as follows:

                 Year             Total Deposits
                 1986                $163,300
                 1987                 291,980
                 1988                 168,549
                 1989                 296,895

The revenue agent reduced the above amounts by $225,000 to account

for several nontaxable transactions that could be traced.

       Ms. Ng contends that partnership draws in cash from the Golden

Dragon Restaurant were improperly added to Ms. Ng's income by the

revenue agent.    In her bank deposits analysis, the revenue agent

subtracted substantiated partnership draws paid directly to Ms. Ng

from   Golden   Dragon   Restaurant     for   1987.   The   revenue    agent

requested    documents   that   would    substantiate   draws   from    the

restaurant for other years, but Ms. Ng did not provide them.           Under

the circumstances, we find that it was appropriate for the revenue

agent to subtract from her calculation of Ms. Ng's unreported

income only those partnership draws that were substantiated.

       Ms. Ng also contends that the revenue agent improperly treated

as income to Ms. Ng amounts that were deposited into accounts
                                      -18-

belonging to separate entities Ms. Ng owned.              However, Ms. Ng

treated accounts belonging to entities she owned as though they

were her personal accounts.       As stated previously, she disregarded

the legal ownership of the accounts and commingled personal funds

with funds of the entities she controlled.            She also disregarded

legal ownership of the accounts when writing checks. We find that

it was reasonable for respondent to treat the accounts as belonging

to Ms. Ng, as she herself had done.

     Upon review of all of respondent's adjustments and supporting

documentation, we conclude that with the exception of certain

amounts deposited into the tip account that we found should be

excluded   from    Ms.   Ng's   reconstructed   income,   and    $32,559   of

cancellation      of   indebtedness    income   for   1989,1    Ms.   Ng   had

     1
          Respondent determined that amounts deposited into
Strong Hope's account at Union Bank were the income of Ms. Ng.
On the books of Strong Hope the deposits were treated as loans to
Ms. Ng. To avoid being whipsawed, respondent increased the
amount Ms. Ng owed to Strong Hope to reflect that the amounts
deposited into Strong Hope's account at Union Bank and used for
her benefit were amounts Strong Hope loaned to Ms. Ng.
Respondent also adjusted the loan balance shown on the books of
Strong Hope as due from Ms. Ng to include expense items that had
been booked as loans from Ms. Ng to Strong Hope but which were
never substantiated by Ms. Ng. The net amount left owing to
Strong Hope by Ms. Ng was $32,559, and respondent took the
position that this debt was forgiven and/or canceled on May 9,
1989, when Strong Hope distributed its one-half interest in 850
Stockton Street to Ms. Ng.
     In her posttrial brief, respondent states that if we hold
that "the amounts deposited into Strong Hope's Union Bank account
are the income of Ms. Ng", then respondent concedes that the
forgiveness of income issue should be resolved in favor of Ms.
Ng.
     We find that the amounts deposited into Strong Hope's Union
                                                   (continued...)
                                   -19-

unreported income in the amounts determined by respondent.



     A final note with respect to the unreported income issue.              In

her posttrial brief, Ms. Ng asserts that "the nature of this case

cries out for a net worth analysis" and requests the Court to

"direct the parties to cooperate in an effort to do a net worth

analysis to reach a more accurate and just result."            We will not

accede to Ms. Ng's request.     Whatever Ms. Ng's net worth, it is not

relevant to whether the bank deposits and other income traced to

her during the years under consideration constitute income to her.

What happened to this income after Ms. Ng received it does not

change its character as income. Moreover, there is "no requirement

that the Commissioner use the net worth method for computing

income."   Estate of Mason v. Commissioner, 64 T.C. at 662.

Issue 2.   Hong Kong Restaurant Losses

     We now turn our attention to whether Ms. Ng is entitled to

claimed pass-through losses from her solely owned S corporation,

Hong Kong Restaurant, Inc. This, in turn, depends upon whether Ms.

Ng had sufficient basis in that corporation to claim the losses.

     Pursuant    to   section   1366,   S   corporation    income,    losses,

deductions,     and   credits   are     passed   through    pro      rata   to

shareholders.    The amount that can be claimed is limited to the sum

of a shareholder's adjusted basis in the corporate stock, and his

     1
      (...continued)
Bank account are the income of Ms. Ng.
                                    -20-

adjusted basis in any indebtedness that the corporation owes to the

shareholder.     Sec. 1366(d).

     Ms. Ng deducted losses from Hong Kong Restaurant, Inc., on her

individual tax returns as follows:

                        Year               Deduction
                        1986               $173,228
                        1987                149,993
                        1988                284,778
                        1989                129,328

     Ms. Ng established that she purchased 3,675 shares of stock in

Hong Kong Restaurant, Inc., a State of Washington corporation, for

$36,750 when that company was incorporated in 1983.           Sixteen other

investors also purchased stock at that time, and the company's

initial capitalization was $500,000.           Ms. Ng contends that she

later purchased all of the stock owned by the other investors and

invested at least $700,000 in the company.             There is no credible

evidence to support her claim.      Minutes of an August 3, 1984, board

of directors' meeting show Ms. Ng as the sole shareholder, but

there is no evidence as to how she acquired the additional shares

or how much she might have paid for them.

     Ms. Ng claims that a lack of evidence as to how the stock was

acquired "is not important for purposes of determining her initial

basis * * * for Federal income tax purposes."          Ms. Ng also contends

that preparation of tax returns by a reputable accounting firm

"supports an inference that the capital stock and loans from

shareholders reflected on the balance sheets would have been

reviewed   and    are   correct."      We    disagree.       See   Sperl   v.
                                   -21-

Commissioner, T.C. Memo. 1993-515.

     Ms. Ng has the burden of proving her basis in an investment.

With the exception of the initial $36,750 stock purchase, she has

presented   no   evidence   that   would   permit   us   to   make   such   a

determination.    Furthermore, prior to 1986, she claimed at least

$94,218 in accumulated losses which would result in a decrease in

her basis in the stock of (or loans to) Hong Kong Restaurant, Inc.

See secs. 1.1367-1(c)(2) and 1.1367-2(b)(1), Income Tax Regs.

     The record reveals that Hong Kong Restaurant, Inc., purchased

its restaurant assets from Fong & Fong Co., Inc., in November of

1983 for $700,000.     Ms. Ng claims that she borrowed $500,000 to

permit the company to purchase the assets.          The record, however,

does not support this claim.       Rather, the record reveals that Ms.

Ng borrowed $500,000 from Wing Lung Bank on February 4, 1985, which

was 15 months after the purchase of the assets, and according to

bank records that $500,000 loan was to be used for the remodeling

of Ocean City Restaurant in San Francisco.

     Ms. Ng's wholly owned corporation, Hong Kong Investments

Limited, obtained another $500,000 loan from Wing Lung Bank on

September 18, 1984.    However, we do not believe those funds were

loaned to Ms. Ng to invest in Hong Kong Restaurant, Inc., as she

contends.    Rather, we believe the proceeds of the additional

$500,000 loan were used to purchase the building that Hong Kong

Restaurant had been leasing from another party.

     Ms. Ng claims she further borrowed $100,000 from Hong Kong
                                      -22-

Investments, Limited to pay for Hong Kong Restaurant, Inc.                   The

evidence does not support this claim.

       To summarize, Ms. Ng proved an initial basis of $36,750 in the

stock of Hong Kong Restaurant, Inc. which was totally absorbed by

pass-through losses she claimed prior to 1986.              She did not prove

any additional contributions to capital or shareholder loans.

Accordingly, we hold that the deductions claimed during the years

under consideration were properly disallowed.

Issue 3.    Section 1031 Exchange

       Ms. Ng deferred gain from the sale of her Larkin and Lombard

Street properties in San Francisco pursuant to section 1031.                 The

deferred gain from the sale of her Larkin Street property in 1988

was $393,177, and the deferred gain from the sale of her Lombard

Street property in 1989 was $516,633.            Ms. Ng's sale of her Larkin

and    Lombard   Street    properties      was   followed   by   Strong   Hope's

conveyance of its one-half interest in an apartment building at 850

Stockton Street in San Francisco to Ms. Ng.            Ms. Ng owned the other

half    interest   in     the   Stockton    Street   property.      Respondent

determined that Ms. Ng was not entitled to the deferred gain on the

sale of these 2 properties on the ground that Ms. Ng did not intend

to exchange the properties for like-kind property, as required to

obtain deferral of gain under section 1031.             The underlying facts

support respondent's assertions.

       In July of 1988, Wing Lung Bank demanded that Ms. Ng satisfy

her delinquent bank loans.         Ms. Ng advised the bank that she would
                                    -23-

raise the cash needed to pay off her loans by selling the Larkin

Street and Lombard Street properties in an exchange transaction.

     Ms. Ng entered into a contract to sell the Larkin Street

property to David Mandel for $565,000 on September 2, 1988.                    She

subsequently   transferred    the     property   to    Independent       Exchange

Services, Inc. (IES), which in turn transferred the property to Mr.

Mandel on    November   10,   1988.      The   net    cash   due   Ms.    Ng   was

$85,317.57 after all existing loans and taxes were paid.

     Ms. Ng entered into a contract to sell the Lombard Street

property to JSM & Inter Realty Corporation for $990,000 on January

5, 1989.    She subsequently transferred the property to IES, which

in turn transferred the property to JSM & Inter Realty Corporation

on February 6, 1989.     The net proceeds from this sale to Ms. Ng

($304,178.26) were placed in an escrow account with Founders Title

Company (Founders).

     On January 11, 1989, Ms. Ng agreed to pay $1.1 million to

Strong Hope for the purchase of Strong Hope's 50-percent interest

in the Stockton Street property.         Also on January 11, Ms. Ng and

Strong Hope agreed to an addendum to the sale contract providing

that IES would be substituted for Ms. Ng as buyer, and that once

Strong Hope conveyed the property to IES, the property then would

be transferred from IES to Ms. Ng.

     Ms. Ng was required to pay $100,000 to the Internal Revenue

Service (IRS) on May 9, 1989, apparently to satisfy a tax lien, in

order to open her restaurant in San Francisco.               She also had to
                                 -24-

receive the exchange property by that time as required under

section 1031(a)(3)(B).     IES, Strong Hope, and Ms. Ng entered into

an agreement on that date providing that IES would purchase the

Stockton Street property from Strong Hope for $1.1 million, and

that Strong Hope would deed the property directly to Ms. Ng.      The

purchase price was to be paid as follows:

     $    400,088.33   Assumption of deed of trust
          389,343.80   Cash in escrow
         310,000.00    Promissory note from Ms. Ng to IES, assigned to
                       seller
            567.87     Paid by Ms. Ng
     $1,100,000.00

     Ms. Ng, as agent of Strong Hope, deeded Strong Hope's 50-

percent interest to herself on May 9, 1989. Ms. Ng wanted the

escrowed funds to be released on that date.      Founders refused to

pay the escrowed funds directly to Strong Hope because Founders

previously had been instructed to release the money only to IES.

On May 11, 1989, the escrow was canceled pursuant to instructions

from IES, and on May 16, 1989, Founders issued a check to IES for

$309,056.94, representing the proceeds from the sale of Ms. Ng's

Lombard Street property.

     The proceeds from the sale of the Larkin Street and Lombard

Street properties, ostensibly used to acquire the Stockton Street

property from Strong Hope in a section 1031 exchange, actually were

used by Ms. Ng for her own purposes as follows:

     *     January 12, 1989--IES issued a $85,165.54 check to Strong

Hope, representing net proceeds from the sale of the Larkin Street
                                     -25-

property.

     *      January 13, 1989--IES check deposited into Strong Hope's

Union Bank account, purportedly as a deposit toward the purchase

price of the Stockton Street property.           Ms. Ng purchased a money

order for $85,165.54 with funds from Strong Hope's Union Bank

account.     She used the money order to make a mortgage payment on

the Stockton Street property, one-half of which she owned outright.

One-half of the payment ($42,583.27)--benefiting the other 50-

percent interest in the Stockton Street property Strong Hope owned

--was recorded as a loan to Strong Hope from Ms. Ng.

     *      May    16,   1989--Founders       issued   check   to    IES    for

$309,056.94.

     *      May   23,    1989--IES   issued    check   to   Strong   Hope   for

$157,161.59, representing net proceeds after tax withholding from

sale of the Lombard Street property. Of the $303,828.26 disbursed,

IES withheld $110,000 for the IRS and $36,666.67 for the California

Franchise Tax Board.

     *      May 25, 1989--IES check for $157,161.59 deposited into

Strong Hope's Union Bank account, where the balance was $1,469

immediately prior to the deposit.           Ms. Ng purchased 3 cashier's

checks on May 25 with the deposited funds:             $100,000 payable to

Strong     Hope   Limited,   a   California     corporation    (Strong      Hope

Limited), which is not the same entity as petitioner Strong Hope,

Ltd., a Hong Kong corporation and purported seller of the Stockton

Street property; $25,000 payable to Strong Hope Limited; and
                                       -26-

$25,000 payable to Ms. Ng.       The 3 cashier's checks were treated as

follows:

            $100,000--booked by Strong Hope Limited as a loan

     from Ms. Ng.

            $25,000--deposited     into       Strong    Hope    Limited's

     account at Bank of America on May 25, 1989.

            $25,000--deposited into Ms. Ng's personal account at

     Bank of America on May 25, 1989.

     *      June 23, 1989--Check for $22,000 drawn on Strong Hope

Limited's account at Bank of America and deposited into Ms. Ng's

personal account at Bank of America.

     Section 1001(c) requires recognition of gain or loss on the

sale or exchange of property.            However, under section 1031(a),

nonrecognition is permitted if property held for productive use in

a trade or business or for investment is exchanged solely for like-

kind property also held for business or investment purposes.

     Section 1031(a) assumes that the new property is substantially

a continuation of the old investment.             See Commissioner v. P.G.

Lake, Inc., 356 U.S. 260, 268 (1958).           A taxpayer must satisfy the

specific requirements and underlying purpose of section 1031(a) to

qualify for deferral of gain.           Bolker v. Commissioner, 760 F.2d

1039,    1044   (9th   Cir.   1985),    affg.   81     T.C.   782   (1983).   A

transaction will not be treated as an exchange if the taxpayer had

control over the sale proceeds.           Coupe v. Commissioner, 52 T.C.

394, 409 (1969); see also Klein v. Commissioner, T.C. Memo. 1993-
                                      -27-

491. A transaction also will not qualify under section 1031 if the

person with whom the taxpayer made the exchange was acting as the

taxpayer's agent.     Coupe, 52 T.C. at 406.

     Ms. Ng's transactions did not meet the specific requirements

or the underlying purpose of section 1031.           She appropriated the

proceeds from the sale of the Larkin Street and Lombard Street

properties    for   her   own   use   immediately   after   the   money   was

deposited into Strong Hope's bank account, which Ms. Ng treated as

her own.     We do not believe she ever intended to pay the $310,000

promissory note she gave as part of the purchase price.              Strong

Hope acted as Ms. Ng's agent when it deeded the Stockton Street

property directly to Ms. Ng, contrary to the original agreement of

the parties.     Furthermore, Ms. Ng never intended to exchange her

Larkin Street and Lombard Street properties for property of like

kind. She sold those properties because she needed the proceeds to

satisfy her delinquent loans with Wing Lung Bank.

     We conclude that Ms. Ng did not satisfy the requirements or

underlying purpose of section 1031 and accordingly hold that she is

liable for gain on the sale of the Larkin Street and Lombard Street

properties.

Issue 4.   Strong Hope Liquidation

     The next issue we consider relates to the tax consequences of

Strong Hope's transfer of its interest in the Stockton Street

property to Ms. Ng.       Respondent determined that Strong Hope made a

liquidating distribution to Ms. Ng when it transferred the Stockton
                                    -28-

Street property to her.      Ms. Ng contends that because Strong Hope

sold its interest in the Stockton Street property to her, after the

sale, it had an asset, namely, the $110,000 that IES paid to the

IRS on Strong Hope's behalf and which Strong Hope claims should be

refunded to it.

     We previously determined that Ms. Ng did not acquire an

interest in the Stockton Street property from Strong Hope in a

section 1031 exchange transaction.          In our opinion, the correct

characterization of the transfer of Strong Hope's interest in the

Stockton Street property to Ms. Ng is a distribution of property,

not a sale.

     A liquidating distribution of property by a corporation to a

shareholder is taxable to the shareholder as gain from the sale or

exchange of property to the extent the distribution exceeds the

shareholder's basis in his stock. Any distribution that is part of

a series of distributions under a plan to redeem all outstanding

stock is treated as a liquidating distribution.                Sec. 346(a).

Liquidating   distributions    are   treated    as    full   payment   for   a

shareholder's     stock.     Sec.    331(a).     To    find    a   corporate

liquidation, there must be a manifest intention to liquidate and a

continuing    purpose   to   terminate     corporate    affairs,    and   the

corporation's activities must be directed to such termination.

Estate of Maguire v. Commissioner, 50 T.C. 130, 142 (1968).

     The parties stipulated that Strong Hope's sole U.S. business

activity was the rental of its individual one-half interest in the
                                      -29-

Stockton Street property.            There is nothing in the record to

suggest that Strong Hope had business activities outside the U.S.

     Upon the purported sale of its one-half interest in the

Stockton Street property to Ms. Ng, Strong Hope filed a final tax

return for 1989 and reported no tax liability for that year.

Emerald Lee, the accountant who prepared Strong Hope's return,

testified that she was informed that Strong Hope was going to be

liquidated.       Additionally, Ms. Ng stated in a 1990 Form 5471,

"Information Return of U.S. Persons With Respect To Certain Foreign

Corporations," that:

     Strong Hope has distributed all of its assets in early
     1990. The company has remained dormant for the remainder
     of calendar year 1990[,] * * * no longer conducts
     business of any kind and has no assets.

     The   fair    market    value   of   Strong    Hope's    interest     in    the

Stockton Street property was $1.1 million.                   Ms. Ng assumed a

$400,088 mortgage and had a $2 basis in her Strong Hope stock.                   The

liquidation   of    Strong    Hope    results      in   a   gain    of   $699,910.

Accordingly, we hold that Ms. Ng realized a gain of $699,910 from

the liquidation of Strong Hope.

Issue 5.   Investment Interest Deduction

     Respondent determined that Ms. Ng had $120 of interest income

in 1989, and that her investment interest deduction was limited

(pursuant to section 163(d)) to $2,000, plus the amount of net

investment    income,   or    a   total    of   $2,120.       Respondent        thus

disallowed $59,992 of claimed interest expense.                    Ms. Ng did not
                                         -30-

contest this issue either at trial or in her posttrial brief.

Accordingly, we sustain respondent's determination in this regard.

Issue 6.   Net Operating Loss Deduction

     Ms. Ng claimed a $13,182 net operating loss deduction in 1986

attributable    to   a    loss     carried      over    from     1985.       Respondent

disallowed this deduction.             Ms. Ng has presented no evidence to

substantiate the loss.           Because Ms. Ng did not meet her burden of

proof, the deduction was properly disallowed.

Issue 7.   Ms. Ng's Additions to Tax

     Respondent determined that Ms. Ng is liable for an accuracy-

related    penalty   and     for       additions       to    tax      for   negligence,

substantial understatement, failure to file timely returns, and

failure to pay estimated tax.

     For 1986 and 1987, section 6653(a)(1)(A) imposes an addition

to tax of 5 percent of the amount of any underpayment due to

negligence or disregard of rules or regulations, and section

6653(a)(1)(B)   provides         for   an   addition        of   50   percent   of   the

interest   payable       under    section    6601      on    the      portion   of   the

underpayment attributable to negligence.                    For 1988, a 5-percent

addition to tax for negligence or disregard of rules or regulations

applies pursuant to section 6653(a)(1).                For 1989, section 6662(a)

and (b)(1) and (2) imposes a penalty equal to 20 percent of the

portion of the underpayment that is attributable to negligence or

disregard of rules or regulations, or to substantial understatement

of tax.
                               -31-

     Negligence is defined as the failure to exercise the due care

that a reasonable, prudent person would exercise under similar

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

Cir. 1984), affg. 79 T.C. 714 (1982); Neely v. Commissioner, 85

T.C. 934, 947 (1985).   A taxpayer has the burden of proving that

respondent's determination is in error.   Luman v. Commissioner, 79

T.C. 846, 860-861 (1982).

     We are satisfied, and thus find, that the entire underpayment

is due to Ms. Ng's negligence and intentional disregard of the

Federal income tax rules and regulations.       Ms. Ng failed to

maintain adequate records.   She commingled her personal funds with

funds of entities she controlled.     She misrepresented material

facts to the revenue agent on more than one occasion.          She

concealed large amounts of taxable income on which she did not pay

tax. She concealed ownership of property.   We therefore hold that

Ms. Ng is liable for the additions to tax for negligence on the

entire underpayment for each of the years 1986 through 1988, and

for the accuracy-related penalty on the entire underpayment for

1989, excluding the amount by which any of the underpayments is to

be reduced in accordance with our findings herein.

     Section 6651(a)(1) provides for a 5-percent addition to tax

for each month a return is not filed, unless due to reasonable

cause, with a maximum addition to tax of 25 percent.   Because Ms.

Ng did not timely file her returns, section 6651(a)(1) applies to

each of the years under consideration.
                                      -32-

      Section 6654 provides for an addition to tax for failure to

pay estimated income tax.         Because Ms. Ng failed to pay estimated

tax for 1990, section 6654 applies.

      Finally,    respondent      determined    an    addition      to    tax   under

section 6661 for 1986, 1987, and 1988. Section 6661 provides for a

25-percent addition to tax for substantial understatement. We

sustain respondent's determination.

Issue 8.   Discharge of Indebtedness

      Respondent    determined      that     Strong   Hope    had    $516,903     in

discharge of indebtedness income in 1989.                    This discharge of

indebtedness income relates to debts Strong Hope owed to Strong

Hope Limited (the California corporation) and to Permanent Union

Limited, both of which were wholly owned by Ms. Ng.                      As of 1989,

Strong Hope owed $434,012 to Strong Hope Limited, and $82,891 to

Permanent Union Limited. Respondent contends that these debts were

discharged when Ms. Ng caused Strong Hope to distribute to her its

sole asset (i.e., the Stockton Street property) and thus liquidate.

Strong Hope argues that it was insolvent prior to the distribution,

that it did not liquidate in 1989, and that any discharge of

indebtedness was not U.S. source or business income.

      Gross income includes income from discharge of indebtedness.

Sec. 61(a)(12).     However, section 108(a) provides an exclusion if

the   discharge    of     indebtedness     occurs     when    the    taxpayer      is

insolvent.       Strong    Hope    contends    that    it    comes       within   the

insolvency exclusion of section 108.            We do not agree.
                                  -33-

      Strong Hope had assets of $1,173,122 and liabilities of

$916,991 prior to its distribution of the Stockton Street property.

The Stockton Street property was valued at $1.1 million, and

according to Strong Hope's books it had other assets totaling

$73,122.    The company had a mortgage of $400,088 and owed $516,903

to Strong Hope Limited and Permanent Union Limited. Based on these

facts, Strong Hope was not insolvent immediately prior to the

discharge of indebtedness.

      Strong Hope also contends that it did not liquidate in 1989,

and thus could not have discharge of indebtedness income.                We

disagree.     Following Strong Hope's distribution of its 50-percent

interest in the Stockton Street property to Ms. Ng on May 9, 1989,

it effectively ceased doing business and the amounts it owed to

Strong Hope Limited and Permanent Union Limited were effectively

discharged.    Whether a company actually liquidates is not the test

for   determining    whether   there   is    income   from   discharge   of

indebtedness.    A debt is discharged when it becomes apparent that

the debt will never have to be repaid.         Brountas v. Commissioner,

74 T.C. 1062, 1074 (1980), vacated and remanded 692 F.2d 152 (1st

Cir. 1982).

      Finally,    Strong   Hope   contends     that   any    discharge   of

indebtedness would not be U.S. source income under section 881(a)

or income effectively connected with the conduct of a trade or

business within the United States under section 882(a).          Again, we

do not accept this assertion.
                                     -34-

     The record clearly reveals that Strong Hope's only business

activity was the rental of the Stockton Street property in San

Francisco, and that the indebtedness to Strong Hope Limited and

Permanent    Union   Limited   was    related    to    that   activity.     We

accordingly find that Strong Hope's indebtedness was connected with

its business in the United States.

     To conclude, we hold that Strong Hope realized discharge of

indebtedness income of $516,903 in 1989.

Issue 9.    Stockton Property Basis

     For purposes of calculating the amount of gain realized by

Strong Hope    under    section    336(a)   on   the    distribution   of   the

Stockton Street property to Ms. Ng, respondent reduced Strong

Hope's adjusted basis in the Stockton Street property.                 In this

regard,    respondent   contends     that   Strong     Hope   understated   the

accumulated depreciation by $45,820 when it reported the sale of

its interest in the property, and second, that a roofing expense of

$10,729 which Strong Hope added to basis was not substantiated.

Strong Hope does not contest respondent's depreciation adjustment.

However, with respect to the roofing expense, Strong Hope asserts

that respondent knows that this expense was incurred. The evidence

is not sufficient to substantiate the claimed roofing expense.

Accordingly, we sustain respondent's adjustments to Strong Hope's

basis in the Stockton Street property.
                                   -35-

Issue 10.     Other Adjustments

        Respondent contends that Strong Hope could not substantiate

$41,194 of a claimed net operating loss carryover from 1988.

Strong Hope did not contest this determination.               We therefore

sustain respondent's determination to the extent the adjustment may

affect Strong Hope's 1989 tax year.

        Respondent also claims that Strong Hope should be taxed on

rental income of $2,977 that it received from Celadon Restaurant in

1988.     We do not have jurisdiction over Strong Hope's 1988 tax

year.     Accordingly, we do not sustain this adjustment.

Issue 11.     Strong Hope's Additions to Tax

        Respondent   determined   an   addition   to   tax   under   section

6651(a)(1) and a penalty under section 6662 against Strong Hope for

1989.

     Section 6651(a)(1) imposes an addition to tax for failure to

timely file a return. Strong Hope did not timely file its 1989

corporate tax return; thus, it is liable for the addition to tax

under section 6651(a)(1).

        Pursuant to section 6662, a penalty is imposed on that portion

of the underpayment that is attributable to negligence or disregard

of rules and regulations or to substantial understatement.             Like

Ms. Ng, Strong Hope was uncooperative during the audit, did not

provide adequate records, and misrepresented facts to respondent's
                               -36-

agent. We find that Strong Hope was negligent and disregarded rules

and regulations, and substantially understated its tax; thus, it is

liable for the penalty under section 6662.

     To reflect the foregoing and concessions,


                                          Decisions will be entered

                                      under Rule 155.
