                            T.C. Memo. 1998-133



                          UNITED STATES TAX COURT



               KENNETH R. AND CAROL L. BAUER, Petitioners v.
                COMMISSIONER OF INTERNAL REVENUE, Respondent


       Docket No. 26285-96.                       Filed April 6, 1998.


       Kenneth R. and Carol L. Bauer, pro se.


       J. Scott Hargis, for respondent.


                            MEMORANDUM OPINION


       NAMEROFF, Special Trial Judge:     This case was heard pursuant

to the provisions of section 7443A(b)(3)1 and Rules 180, 181, and

182.       Respondent determined a deficiency in petitioners’ 1993

Federal income tax in the amount of $2,916.         The issue for

       1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year at issue. All
Rule references are to the Tax Court Rules of Practice and
Procedure.
                                 - 2 -


decision is whether petitioners are entitled to a nonbusiness

bad debt deduction pursuant to section 166.

                             Background

     Some of the facts have been stipulated, and they are so

found.   The stipulation of facts and the attached exhibits are

incorporated herein by this reference.    Mr. Bauer resided in

Riverside, California, and Mrs. Bauer resided in Laughlin,

Nevada, at the time they filed their petition.

     Mrs. Bauer is a real estate broker.    Mr. Bauer is a

machinist.    During the year at issue, Mr. Bauer spent his

weekends with Mrs. Bauer in Laughlin, Nevada, and in Bullhead

City, Arizona, a town located directly across the Colorado River

from Laughlin.

     Petitioners, but especially Mrs. Bauer, frequently dined at

a restaurant in Bullhead City named The Diamond Lil’s Drunken

Lobster (the Drunken Lobster).    The Drunken Lobster was an

upscale restaurant specializing in steak and lobster that opened

in 1990.    The Drunken Lobster was owned and operated by father

and son, Salvatore and John Dubato (John) (collectively referred

to as the Dubatos), who also were petitioners’ personal friends.

     During 1991, the Drunken Lobster was having financial

problems.    The Dubatos approached petitioners for a loan, and

petitioners decided to advance them funds for use in their

business.    Petitioners made a series of four interest-free loans
                                - 3
                                  3 -


to the Dubatos.2    Within the time promised (i.e., 30 or 60 days),

the Dubatos repaid petitioners the full amount of each loan.

Petitioners made the loans because they wanted to help their

friends and because Mrs. Bauer wanted a nice restaurant close by

to which she could take her real estate clients.    Petitioners,

however, were not in the business of lending money.

     During 1992, the Dubatos continued having financial

problems.    Through a series of nine payments, petitioners

advanced a total of $10,901.39 to, or on behalf of, the Dubatos

between the months of March and August 1992.3    These advances

were not supported by written loan documents.    Petitioners

expected to be repaid within 30 to 60 days and to receive an

annual interest rate of 15 percent.




     2
        The first of these loans was for $500, to be repaid
within 30 days.
     3
          Petitioners made the following advances during 1992:

  Date             Amount         Form and Purpose of Payment

March 16         $2,000.00      Cash to cover payroll
March 28          2,800.00      Rent check to Hesling Fam. Trust
April 22            866.62      Cashier’s check for insurance
May 22            2,000.00      Cashier’s check for supplies
May 22            2,000.00      Cashier’s check for supplies
April/May           462.00      Check to publications for adver.
May/June            115.67      Check to florist for decorations
June/July           477.10      Check to publications for adver.
August              180.00      Check to publications for adver.

  Total          10,901.39
                                - 4
                                  4 -


       After the initial advance was made in March 1992, John

orally promised to either repay petitioners within a month or

else transfer to them a 15-percent interest in the Drunken

Lobster.    John did not fulfill his promise.   In May or June 1992,

John again orally promised to repay petitioners in one of three

ways:    (1) Full cash repayment by May 1993; (2) the transfer of

an interest in the restaurant in lieu of payment; or (3) payment

through an installment plan of $500 per month, plus interest.

John never fulfilled his promise, and the Dubatos never repaid

petitioners for any portion of these advances.    Moreover,

petitioners did not receive an equity interest in the Drunken

Lobster.

       While the Drunken Lobster started out successfully, the

excitement of a new restaurant in the area quickly wore off.      The

Drunken Lobster was no longer attracting the customers it once

did.    Although it was consistently crowded for breakfast, the

lunch crowd was starting “to slack off a little bit” and the

dinner hour no longer had a waiting list.    Beginning in April

1992, Mrs. Bauer did what she could to assist the Dubatos and

even performed work for the Drunken Lobster when it was short

staffed.    She created advertisements, wrote and printed menus,

organized holiday events (i.e., a Mother’s Day and a July 4th

holiday meal), and cleared and bused tables.    Mrs. Bauer was not

compensated for her time or reimbursed for her expenditures.
                                - 5
                                  5 -


     By the end of May 1992, petitioners began to suspect that

the Dubatos were having serious financial problems because they

started “letting people go” and because they were not meeting

many of their expenses.    At that point, Mrs. Bauer went to

Drunken Lobster once a week, not so much to assist, but to “bug”

the Dubatos for payment.    Petitioners offered to accept $500

every other week, without interest, if the Dubatos would just

start paying them back.    The Dubatos, offering only excuses, did

not agree with that arrangement.

     Throughout 1993, the Drunken Lobster ran on a skeleton

budget and crew.   In fact, there were days that the Drunken

Lobster did not open.   The Dubatos permanently closed the Drunken

Lobster in October 1993.    At no time during 1993, did petitioners

advance the Dubatos additional funds, despite the fact that the

Dubatos requested them to do so.

     Petitioners did not take legal steps to collect on the debts

(other than possibly writing one demand letter) because the

Dubatos had no assets from which to satisfy their debts.

Petitioners’ personal observations of the Dubatos’ financial

situation revealed that they owned no assets outright and that

they had leased everything, including the three-bedroom house in

which they lived, the premises where the Drunken Lobster was

located, and all the Drunken Lobster’s property and equipment

(i.e., kitchen equipment, tables, chairs, tablecloths,
                                 - 6
                                   6 -


silverware, and dishes).     Petitioners were aware that other

creditors of the Dubatos were also dunning them for payment.

This included a meat supplier, a food supplier, and a State

revenue officer who, Mrs. Bauer saw, “came in and took the money

right out of the drawer for sales tax”.     The Dubatos continued

living in Bullhead City for some part of 1994, but later on

during the year, they eventually moved.     At the time of trial,

petitioners were unaware of the Dubatos’ whereabouts.

     On their 1993 Federal income tax return, petitioners claimed

a $10,901 business bad debt deduction.     In the notice of

deficiency, respondent, inter alia, disallowed the bad debt

deduction.    At trial, petitioners conceded that their advances

were nonbusiness debts, and they now seek only a nonbusiness bad

debt deduction.    All other adjustments in the notice of

deficiency have been resolved.

                              Discussion

     The Commissioner’s determinations are presumed correct, and

petitioners bear the burden of proving that those determinations

are erroneous.     Rule 142(a); Welch v. Helvering, 290 U.S. 111,

115 (1933).

     Section 166(a) permits a deduction for any bona fide debt

that becomes worthless within the taxable year.       To qualify for

the bad debt deduction, there must be a debtor-creditor

relationship.     Sec. 1.166-1(c), Income Tax Regs.   Whether a bona
                               - 7
                                 7 -


fide debtor-creditor relationship exists is a question of fact

which ultimately requires a determination as to whether there was

a genuine intention to create a debt, with reasonable expectation

of repayment, and whether that intent comports with the economic

reality of creating a debtor-creditor relationship.   Litton Bus.

Sys., Inc. v. Commissioner, 61 T.C. 367, 377 (1973); see also

A.R. Lantz Co. v. United States, 424 F.2d 1330, 1334 (9th Cir.

1970); Fisher v. Commissioner, 54 T.C. 905, 909 (1970).        There

is no standard test or formula for determining worthlessness

within a given taxable year; the determination depends upon the

particular facts and circumstances of the case.   Crown v.

Commissioner, 77 T.C. 582, 598 (1981).   Generally, however, the

year of worthlessness is fixed by identifiable events that form

the basis of reasonable grounds for abandoning any hope of

recovery.   United States v. S.S. White Dental Manufacturing Co.,

274 U.S. 398 (1927); American Offshore, Inc. v. Commissioner, 97

T.C. 579, 593 (1991); Crown v. Commissioner, supra.   Moreover, a

debt will generally be considered worthless only when it can be

reasonably expected that the debt is without possibility of

future payment and legal action to enforce the debt would not

result in satisfaction.   Hawkins v. Commissioner, 20 T.C. 1069

(1953); sec. 1.166-2(b), Income Tax Regs.

     Respondent asserts that petitioners are not entitled to a

bad debt deduction because:   (1) Petitioners have failed to
                               - 8
                                 8 -


establish that their advances were bona fide debts as opposed to

gifts; and (2) assuming the Court finds the existence of bona

fide debt, the debt did not become worthless during 1993.

Petitioners, on the other hand, contend that the debt became

worthless during 1993, thereby entitling them to a deduction.

     Upon review of the record, we hold that petitioners are

entitled to a nonbusiness bad debt deduction for 1993.     The

record demonstrates that there was a bona fide debtor-creditor

relationship between petitioners and the Dubatos.   While

petitioners’ nine payments to, or on behalf of, the Dubatos were

not supported by notes or other physical evidence of

indebtedness, we are convinced that petitioners intended them to

be loans for which they reasonably expected repayment.

Petitioners advanced the $10,901.36 only after they were timely

and fully repaid by the Dubatos on their four previous loans.

Moreover, the Dubatos had an operating business from which

petitioners could reasonably expect repayment.   Lastly,

petitioners expected to receive interest and made numerous

demands for payments once the Dubatos failed to timely repay the

loans.   These facts suggest that a bona fide debtor-creditor

relationship existed.   Respondent’s contention that the advances

were gifts to Dubatos is simply not supported by the record.

     We also find that the debt became worthless in 1993.
                                 - 9
                                   9 -


We believe that identifiable events, occurring in 1993, formed a

reasonable basis for petitioners to abandon all hope of recovery

during that year.   It was during 1993 that the Drunken Lobster

ran on a skeleton crew and permanently ceased its operations.

Although the Dubatos were having financial problems during 1992,

it was not until the closure of the Drunken Lobster that the

Dubatos’ means with which to repay petitioners were eliminated.

The Dubatos had no other assets from which petitioners could

collect on their debts.   Moreover, there is sufficient evidence

for us to find that legal action to enforce payment would be

futile.   Accordingly, petitioners are entitled to a nonbusiness

bad debt deduction for 1993.4

     To reflect the foregoing,

                                              Decision will be entered

                                         under Rule 155.




     4
        We note that a nonbusiness bad debt deduction is treated
as a short-term capital loss subject to the capital loss
limitation of sec. 1211(b). Sec. 166(d); sec. 1.166-5(a)(2),
Income Tax Regs. Sec. 1211(b) restricts petitioners’ deduction
to the extent of their capital gains plus (if losses from sales
or exchanges of capital assets exceed such gains) the lesser of
$3,000 or the excess of such losses over such gains.
Petitioners, however, are permitted to carry over any capital
loss in excess of this amount to the succeeding taxable year.
Sec. 1212(b).
