                           T.C. Memo. 2003-209



                         UNITED STATES TAX COURT



           CURTIS R. AND LYNN BITKER, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

          JERRY D. AND COLEEN A. BITKER, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket Nos. 7321-00, 7334-00.               Filed July 15, 2003.


     Jon J. Jensen and Alexander F. Reichert, for petitioners.

     Blaine Holiday, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     JACOBS,    Judge:     Respondent   determined    deficiencies      in

petitioners’ Federal income taxes and accuracy-related penalties

under section 6662(a) for 1996 and 1997 as follows:1


     1
          Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect at all relevant times, and Rule
                                                     (continued...)
                                   - 2 -

                                                       Penalty
          Docket No./Year          Deficiency        Sec. 6662(a)

         Docket No. 7321-00
                 1996               $186,324          $37,264.80
                 1997                 53,547           10,709.40

         Docket No. 7334-00
                1996                 235,290              47,058.00
                1997                  59,632              11,926.40

     The issues to be decided2 are:

     1. Whether payments by Ray Bitker & Sons partnership (the

Bitker partnership) on petitioners’ debts should be characterized

(for tax purposes) as rental expenses of the Bitker partnership or

constructive partnership distributions to petitioners;

     2. whether petitioners received distributions from the Bitker

partnership in 1996 and 1997 that exceeded their bases in the

Bitker partnership; and

     3.    whether   petitioners    are    liable   for    accuracy-related

penalties under section 6662(a) for the years at issue.




     1
      (...continued)
references are to the Tax Court Rules of Practice and Procedure.
     2
          Other adjustments that respondent made to petitioners’
1996 and 1997 returns are computational; the resolution with
respect to these adjustments depends on our determination of the
issues for decision.
                                   - 3 -

                            FINDINGS OF FACT

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

stipulation    of   facts   and   the   exhibits   attached   thereto   are

incorporated herein by this reference.

A.      Petitioners and the Bitker Partnership

     Curtis Bitker and Lynn Bitker are husband and wife.            Jerry

Bitker and Coleen Bitker are husband and wife.         Curtis Bitker and

Jerry Bitker (petitioner husbands) are brothers.         All petitioners

resided in Minnesota when the petitions in these cases were filed.

     Petitioner husbands were raised on a farm in Norman County,

Minnesota, owned by their father, Ray Bitker.        Petitioner husbands

and their father formed the Bitker partnership on January 1, 1979.

Each owned a one-third interest in the Bitker partnership.              The

Bitker partnership’s principal business is farming; however, it

does not own any of the land that is farmed.

     In 1989, petitioner husbands acquired their father’s interest

in the Bitker partnership at no cost; each then held a one-half

interest in the partnership.        Although their father was no longer

a partner in the Bitker partnership, the partnership continued to

farm his land and pay him rent for the use thereof.

     In 1991, Lynn Bitker and Coleen Bitker (petitioner wives) each

obtained a 20-percent interest in the Bitker partnership at no

cost.     Since 1991, each petitioner husband has held a 30-percent
                                     - 4 -

interest in the Bitker partnership, and each petitioner wife has

held a 20-percent interest.

       During the years at issue, petitioner husbands conducted all

of their farming activity through the Bitker partnership.                        Jerry

Bitker is responsible for the day-to-day bookkeeping of the Bitker

partnership’s income and expenses.

       Some of the farm crops were processed and sold through several

cooperatives.    Only active farm operators could purchase shares

(and   thus   become    members)    of     these    cooperatives.           In     most

instances, shares of stock in the cooperatives were issued to

petitioner    husbands    (as   opposed      to    the    Bitker    partnership).

Nonetheless,    petitioners     accounted         for    their     shares     of     the

cooperatives’ income through the Bitker partnership.

B.     The Bitker Partnership’s Forms 1065

       Earl Mostoller, a certified public accountant, is a member of

Drees, Riskey    &     Vallager,    Ltd.,    an    accounting      firm     that     has

prepared the Bitker partnership tax returns since its formation.

Mr. Mostoller has prepared petitioners’ Forms 1040, U.S. Individual

Income Tax Return, and the Bitker partnership’s Forms 1065, U.S.

Partnership Return of Income, since 1985.                 Jerry Bitker provided

Mr. Mostoller with information as to the Bitker partnership’s

income and expenses, as well as loan records from the Farm Credit

Service.      Loans    made   for   partnership         purposes    were      made   in

petitioners’    names    rather     than    in     the    name     of   the    Bitker
                                     - 5 -

partnership.    All four petitioners are personally liable for the

Bitker partnership’s debts.

      Mr. Mostoller prepared and maintained a depreciation schedule

showing the historical cost of equipment, less depreciation taken

each year.     He verified loan balances by calling the Farm Credit

Service. Mr. Mostoller calculated the Bitker partnership’s capital

by subtracting the loan balances from the total adjusted cost bases

of   partnership    assets   (cost    basis   less   depreciation).     Mr.

Mostoller    determined    the   partners’    capital   contributions   and

distributions by taking each partner’s beginning capital account,

adding    thereto    (or     subtracting      therefrom)   the   partner’s

distributive share of the Bitker partnership’s net income (or net

loss) for the year, and subtracting the partner’s ending capital

account--the difference being the amount of the distribution to, or

the amount of the contribution by, the partner to the Bitker

partnership for the particular year.

      On Schedules K-1 attached to Forms 1065 filed by the Bitker

partnership for years prior to 1991, the amounts for “Partner’s

share of liabilities” and “Analysis of partner’s capital account”

were left blank.    Schedules K-1 attached to the Forms 1065 filed by

the Bitker partnership for years 1991-97 (the 1991-97 Schedules K-

1) reflect that each petitioner husband owned 30 percent of its

capital and that each was entitled to 30 percent of its profits and

losses.     The 1991-97 Schedules K-1 reflect that each petitioner
                              - 6 -

wife owned 20 percent of the capital of the Bitker partnership and

that each was entitled to 20 percent of its profits and losses.

The 1991-97 Schedules K-1 also reflect each “Partner’s share of

liabilities” and “Analysis of partner’s capital account” as follows

(discrepancies attributable to rounding):
                                                  - 7 -

                                               Curtis      Jerry        Lynn       Coleen       Total
1991
 Partner’s share of liabilities               $557,991    $557,991    $371,994    $371,994    $1,859,970
 Analysis of partner’s capital account:
  Capital account at beginning of year        (519,852)   (519,852)      -0-         -0-      (1,039,704)
  Capital contributed during year              117,284     117,284       -0-         -0-         234,568
  Partner’s share of net book income (loss)     19,149      19,149      12,766      12,766        63,830
  Withdrawals and distributions                  -0-         -0-      (268,377)   (268,377)     (536,754)
  Capital account at end of year              (383,418)   (383,418)   (255,611)   (255,611)   (1,278,058)
1992
 Partner’s share of liabilities               629,863     629,863     419,909     419,909     2,099,544
 Analysis of partner’s capital account:
  Capital account at beginning of year        (383,417)   (383,417)   (255,612)   (255,612)   (1,278,058)
  Capital contributed during year                -0-         -0-         -0-         -0-           -0-
  Partner’s share of net book income (loss)     11,246      11,246       7,497       7,497        37,486
  Withdrawals and distributions                (67,126)    (67,126)    (44,751)    (44,751)     (223,754)
  Capital account at end of year              (439,297)   (439,297)   (292,866)   (292,866)   (1,464,326)
1993
 Partner’s share of liabilities               457,122     457,122     304,749     304,749     1,523,742
 Analysis of partner’s capital account:
  Capital account at beginning of year        (439,296)   (439,296)   (292,866)   (292,866)   (1,464,324)
  Capital contributed during year               88,159      88,159      58,773      58,773       293,864
  Partner’s share of net book income (loss)     24,201      24,201      16,134      16,134        80,670
  Withdrawals and distributions                  -0-         -0-         -0-         -0-           -0-
  Capital account at end of year              (326,936)   (326,936)   (217,959)   (217,959)   (1,089,790)
1994
 Partner’s share of liabilities               691,441     691,442     460,961     460,961     2,304,805
 Analysis of partner’s capital account:
  Capital account at beginning of year        (326,296)   (326,936)   (217,959)   (217,960)   (1,089,151)
  Capital contributed during year                -0-         -0-         -0-         -0-           -0-
                                                  - 8 -

  Partner’s share of net book income (loss)    69,265       69,265      46,177       46,177      230,884
  Withdrawals and distributions              (255,431)    (255,431)   (170,287)    (170,287)    (851,436)
  Capital account at end of year             (512,462)    (513,106)   (342,070)    (342,071) (1,709,709)
1995
 Partner’s share of liabilities1              593,699      593,698     395,799      395,799    1,978,995
 Analysis of partner’s capital account:
  Capital account at beginning of year       (513,102)    (513,102)   (342,070)    (342,071) (1,710,345)
  Capital contributed during year              20,240       20,240      13,494       13,494       67,468
  Partner’s share of net book income (loss)   (75,354)     (75,355)    (50,236)     (50,236)    (251,181)
  Withdrawals and distributions                 -0-          -0-         -0-          -0-           -0-
  Capital account at end of year             (568,216)    (568,217)   (378,812)    (378,813) (1,894,058)
1996
 Partner’s share of liabilities1              554,358      554,357     369,571      369,571    1,847,857
 Analysis of partner’s capital account:
  Capital account at beginning of year       (568,216)    (568,217)   (378,812)    (378,813) (1,894,058)
  Capital contributed during year               -0-          -0-         -0-          -0-           -0-
  Partner’s share of net book income (loss)    58,559       58,559      39,039       39,039      195,196
  Withdrawals and distributions              (209,266)    (209,266)   (139,511)    (139,510)    (697,553)
  Capital account at end of year             (718,923)    (718,924)   (479,284)    (479,284) (2,396,415)
1997
 Partner’s share of liabilities1              551,278      551,278     367,518      367,518    1,837,592
 Analysis of partner’s capital account:
  Capital account at beginning of year       (718,923)    (718,924)   (479,284)    (479,284) (2,396,415)
  Capital contributed during year               -0-          -0-         -0-          -0-           -0-
  Partner’s share of net book income (loss)    45,089       45,087      30,059       30,059      150,294
  Withdrawals and distributions                (4,673)      (4,673)     (3,116)      (3,116)     (15,578)
  Capital account at end of year             (678,507)    (678,510)   (452,341)    (452,341) (2,261,699)
    1
          The partners’ shares of liabilities reflect only shares of long-term debt as shown on the
balance sheets on the Bitker partnership’s returns.
                              - 9 -

     None of the Bitker partnership’s Forms 1065 for years before

1992 showed balance sheets.   The balance sheets reported on the

1992-97 Forms 1065 show assets, liabilities, and partners’ capital

at yearend for 1991-97 as follows (discrepancies attributable to

rounding):
                                           - 10 -

                                          1991          1992          1993          1994
Assets:
 Cash                                      $70,073       $23,230       $22,089        $4,000
 Other current assets                      154,635        99,990        57,730       144,000
 Buildings & other depreciable assets    1,389,587     1,625,901     1,466,600     1,678,611
 Less accumulated depreciation          (1,032,382)   (1,113,910)   (1,112,469)   (1,232,151)
  Total assets                             581,913       635,220       433,950       594,460
Liabilities & capital:
 Short-term mortgages, notes, bonds      1,859,971     2,099,544     1,523,741       692,861
 Long-term mortgages, notes, bonds           -0-           -0-           -0-       1,611,944
 Partners’ capital accounts             (1,278,058)   (1,464,324)   (1,089,791)   (1,710,345)
  Total liabilities & capital              581,913       635,220       433,950       594,460

                                          1995          1996          1997
Assets:
 Cash                                      128,593        85,057        29,964
 Other current assets                      533,485       137,815       102,530
 Buildings & other depreciable assets    1,661,845     1,635,270     1,930,251
 Less accumulated depreciation          (1,299,147)   (1,367,442)   (1,453,207)
  Total assets                           1,024,776       490,700       609,538
Liabilities & capital:
 Short-term mortgages, notes, bonds        939,839     1,039,258     1,033,645
 Long-term mortgages, notes, bonds       1,978,995     1,847,857     1,837,592
 Partners’ capital accounts             (1,894,058)   (2,396,415)   (2,261,699)
  Total liabilities & capital            1,024,776       490,700       609,538
                                     - 11 -

     Of the $939,839 of short-term debt and $1,978,995 of long-term

debt reported on the 1995 Form 1065, $205,263 of short-term debt

and $756,759 of long-term debt were owed by petitioners in their

individual capacities.

     On   the    1996   Form     1065,    the   Bitker    partnership    reported

ordinary income of $132,754 that was attributable to its farming

activity.    On the 1996 Schedule F, Profit or Loss From Farming, the

Bitker    partnership     reported       $2,116,506      of   gross   income    and

$1,983,752      of   expenses.      The    expenses      included,    inter    alia,

$236,390 for rent or lease of land, animals, etc., $92,811 for

depreciation, and $223,411 for interest.

     On   the    1997   Form     1065,    the   Bitker    partnership    reported

ordinary income of $150,255 that was attributable to its farming

activity.    On the 1997 Schedule F, the Bitker partnership reported

$2,223,960 of gross income and $2,073,705 total expenses, which

expenses included, inter alia, $141,072 for rent or lease of land,

animals, etc., $85,267 for depreciation, and $211,622 for interest.

     Each year on their Forms 1040, petitioners reported the income

reflected on their Schedules K-1 from the Bitker partnership.                    On

their 1996 Forms 1040, in addition to the income from the Bitker

partnership, petitioners reported other income from rental real

estate on Schedules E.         On their 1996 Form 1040, Curtis and Lynn

Bitker reported $80,000 of rental income from farmland in Polk

County, Minnesota.        On their 1996 Form 1040, Jerry and Coleen
                                - 12 -

Bitker reported $80,000 of rental income from two parcels of

farmland in Norman County, Minnesota.       Petitioners did not report

any income from rental real estate on their 1997 Forms 1040.

C.    The Notices of Deficiency

      In September 1998, an agent of respondent began an examination

of   the   Bitker   partnership’s   1996   and   1997   Forms   1065   and

petitioners’ 1996 and 1997 Forms 1040.       Mr. Mostoller represented

both the Bitker partnership and petitioners during the examination.

     The agent requested that petitioners extend the period for

assessment of tax for 1996 and 1997.       They declined to do so.     As

a consequence, petitioners did not have an opportunity to have the

proposed changes for 1996 and 1997 reviewed by the Appeals Office

of the Internal Revenue Service.

     The agent calculated that, as of December 31, 1995, the

partners had negative capital accounts totaling $1,144,343 and the

Bitker partnership had short-term debt of $734,576 and long-term

debt of $1,222,236.     The agent determined that (1) for 1996 the

Bitker partnership had a profit of $334,263, interest income of

$12, and a short-term capital gain of $50,234 and (2) for 1997 it

had a profit of $260,411 and interest income of $39.            The agent

also determined that the following amounts constituted personal

expenses of petitioners and that the Bitker partnership’s payment

of the expenses constituted distributions by the partnership to the

partners (discrepancies attributable to rounding):
                                  - 13 -

                       Curtis     Jerry       Lynn      Coleen    Total
1996
  Payments on land    $121,347   $121,347       -0-       -0-    $242,694
  Repairs                2,723      2,723     $1,816    $1,816      9,078
  Supplies                 102        102         68        68        340
  Depreciation             296        296        197       197        986
  Utilities                734        734        490       490      2,448
  Medical insurance      1,780      1,780      1,187     1,187      5,934
   Total               126,982    126,982      3,758     3,758    261,480
1997
  Payments on land     64,494     64,494       -0-       -0-     128,988
  Repairs                 212        212        141       141        706
  Supplies                407        407        271       271      1,356
  Depreciation            277        277        184       184        922
  Utilities               708        708        472       472      2,360
  Medical insurance     1,304      1,304        870       870      4,348
   Total               67,402     67,402      1,938     1,938    138,680

     The agent reclassified the depreciation, as well as the

interest paid by the Bitker partnership on petitioners’ personal

mortgages on their farmland (the mortgages are on land that the

partnership farms), as rental expenses on petitioners’ Schedules E.

     Respondent issued notices of deficiency to petitioners for

1996 and 1997.    The statements of changes attached to the notices

reflect the following adjustments:

                                            12/31/96       12/31/97
     Curtis & Lynn Bitker
       Capital gain or loss                 $473,015       $89,312
       Exemptions                             14,076         1,590
       Itemized deductions                      --           2,171
       K-1 Ray Bitker & Sons (C)              60,453        33,046
       K-1 Ray Bitker & Sons (L)              40,302        22,031
       Schedule E rental expense            (101,453)      (25,000)
       Schedule F Curtis                        (947)       45,387
       Schedule F Lynn                        (2,645)          --
       SE AGI adjustment                         221        (5,332)
       Self-employ health                     (1,762)       (1,619)
        Total adjustments                    481,260       161,586
                                      - 14 -

      Jerry & Coleen Bitker                      12/31/96            12/31/97
        Capital gain or loss                     $473,015            $89,312
        Exemptions                                  5,100              1,060
        Itemized deductions                         6,770              2,535
        K-1 Ray Bitker & Sons (C)                  40,302             22,031
        K-1 Ray Bitker & Sons (J)                  60,453             33,047
        Schedule E rental                        (101,597)           (25,000)
        Schedule F Coleen                          (1,032)                 –
        Schedule F Jerry                           36,545             33,770
        SE AGI adjustment                          (2,542)            (4,511)
        Self-employ health                         (2,241)            (1,953)
        Standard deduction                         (6,700)               –
         Total adjustments                        508,073            150,291

      The explanations attached to the notices of deficiency state

that the income from the Bitker partnership should be increased

and   “We   have   adjusted    your         return   in    accordance      with    the

partnership    return,    which       has     also     been     examined.”3        The

adjustments   to   Schedules      F    were    explained       as   “Expenses     were

deducted on    Schedule    F   that     were     attributable       to    the    rental

activity.     These    expenses       are    allowed      on   Schedule    E.”     The

adjustments to the Schedule E rental expenses were determined to be

“Rental expenses, which you deducted elsewhere, are allowed as

rental expenses.      Losses are limited due to passive loss rules.”

      The explanations attached to the notices of deficiency state

that adjustments were made with respect to capital gain or loss

because “Amounts distributed by partnership, which are in excess of


      3
          The examination report showing adjustments resulting from
the examination of the Bitker partnership returns was not attached
to the notices of deficiency. The notices of deficiency do not
otherwise show or explain the adjustments made to the partnership
returns.
                              - 15 -

the partners’ bases, have resulted in a capital gain.    See Exhibit

3 to show you how we figured the gain.”    Exhibit 3 computes the

gain as follows:

                                           12/31/96   12/31/97
     Curtis & Lynn Bitker
       Short-term capital gain or loss     $506,139     $87,801
       Short-term capital loss carryover       -0-         -0-
       Net short-term capital gain or       506,139      87,801

       Long-term capital gain or loss         7,378       6,238
       Long-term capital loss carryover        -0-         -0-
       Net long-term gain or loss             7,378       6,238

       Net capital gain or loss             513,517      94,039
       Capital loss limitation                 -0-         -0-
       Capital gain or loss as corrected    513,517      94,039
       Capital gain or loss per return       40,501       4,727
       Adjustment to income                 473,015      89,312

     Jerry & Coleen Bitker
       Short-term capital gain or loss      504,634      89,312
       Short-term capital loss carryover       -0-         -0-
       Net short-term capital gain or       504,634      89,312

       Long-term capital gain or loss         9,634      10,521
       Long-term capital loss carryover        -0-         -0-
       Net long-term gain or loss             9,634      10,521

       Net capital gain or loss             514,268      99,833
       Capital loss limitation                 -0-         -0-
       Capital gain or loss as corrected    514,268      99,833
       Capital gain or loss per return       41,253      10,521
       Adjustment to income                 473,015      89,312
                                   - 16 -

                                  OPINION

I.   Burden of Proof: Rule 142(a); Sections 7522 and 7491

     As a general rule, the Commissioner’s determinations in a

notice of deficiency are presumed correct, and the burden is on the

taxpayer to prove otherwise.       Rule 142(a); Welch v. Helvering, 290

U.S. 111, 115 (1933).       However, this rule does not apply for new

matters raised by the Commissioner after the issuance of the notice

of   deficiency.     Rule    142(a).     In    addition,   under      certain

circumstances,     the   burden   of   proof   or   production   is   on   the

Commissioner.    See secs. 7522, 7491.4

     A.   Section 7522

     Section 7522 requires a notice of deficiency to “describe the

basis” for the tax deficiency.         In some situations, this Court has

held that failure to describe the basis for the tax deficiency in

the notice of deficiency is analogous to the raising of a new

matter under Rule 142(a).      Shea v. Commissioner, 112 T.C. 183, 197

(1999); Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500, 507

(1989); Estate of Ballantyne v. Commissioner, T.C. Memo. 2002-160.

In this regard, we stated that a new matter is raised when the

basis or theory upon which the Commissioner relies is not stated or



     4
          Sec. 7491 applies to court proceedings arising in
connection with examinations beginning after July 22, 1998.
Internal Revenue Service Restructuring and Reform Act of 1998, Pub.
L. 105-206, sec. 3001(a), 112 Stat. 726.       In this case, the
examination of petitioners’ returns began after July 22, 1998.
Accordingly, sec. 7491 is applicable to this case.
                                        - 17 -

described in the notice of deficiency and the new theory or basis

requires the presentation of different evidence. Wayne Bolt & Nut

Co. v. Commissioner, supra at 507.               In such a situation, the burden

of proof is placed on the Commissioner with respect to that issue.

Id.

      The adjustments to petitioners’ income were made primarily on

the   basis    of   adjustments        to   the    income   reported    on   Bitker

partnership tax returns for 1996 and 1997.                    Knowledge of the

specific adjustments to the income of Bitker partnership for the

years   at    issue     is   necessary      to    resolve   the   correctness   of

respondent’s determinations.

      Petitioners assert that, because the notices of deficiency did

not include a copy of the examination report for the Bitker

partnership or otherwise specify the adjustments to its income,

respondent did not adequately describe the basis for, or explain,

the   adjustments       in     the   notices     of   deficiency.      Petitioners

conclude, therefore, that the burden is on respondent pursuant to

section 7522 and Rule 142(a).

      We agree that it would have been helpful if respondent either

had   attached      a   copy    of   the    examination     report   showing    the

adjustments to partnership income to the notices of deficiency or

had included the computations and adjustments from the Bitker

partnership in the explanations of the adjustments.                    See, e.g.,

Brodsky v. Commissioner, T.C. Memo. 2001-240 (each notice of
                                - 18 -

deficiency included schedules that listed for each of the years at

issue the Commissioner’s position regarding the sources of the

deposits into the taxpayer’s accounts during each year and the

total amount of the deposits during each year from each source).

But we do not find respondent’s failure to do so in this case

constitutes the raising of new matter.

     The purpose of section 7522 is to give the taxpayer notice of

the Commissioner’s basis for determining a deficiency.     Shea v.

Commissioner, supra at 196.       In the situation before us, Mr.

Mostoller represented petitioners during the examination of their

returns, as well as the examination of the Bitker partnership

returns, and he had a copy of the examination report related to the

partnership returns.      The notices of deficiency, in conjunction

with the partnership examination report to which petitioners had

access through Mr. Mostoller, gave petitioners sufficient notice of

respondent’s basis for determining the deficiencies.    Under these

circumstances, we are satisfied that the notices of deficiency

sufficiently described the basis of the deficiencies within the

meaning of section 7522.

     B.    Section 7491

           1.   Penalties

     Under section 7491(c), the Commissioner has the burden of

production with respect to an individual’s liability for any

penalty.   Respondent acknowledges having the burden of production
                                      - 19 -

with    respect     to   the    accuracy-related      penalties    under   section

6662(a).

               2.   Factual Issues

        Pursuant to the general rule of section 7491(a)(1), if the

taxpayer introduces credible evidence with respect to any factual

issue relevant to ascertaining the taxpayer’s liability for income

tax, the Commissioner bears the burden of proof with respect to

that issue.         The preceding rule applies, however, only if the

taxpayer has: (1) Complied with requirements under the Internal

Revenue Code to substantiate any item; (2) maintained all records

required by the Internal Revenue Code; and (3) cooperated with

reasonable requests by the Secretary for information, documents,

and meetings.        Sec. 7491(a)(2).          Taxpayers bear the burden of

proving    that     these      requirements    have    been   met.      Snyder    v.

Commissioner, T.C. Memo. 2001-255 (citing H. Conf. Rept. 105-599,

at 240-241 (1998), 1998-3 C.B. 747, 994-995).

        Respondent contends that the burden of proof remains on

petitioners with respect to all factual issues in this case because

petitioners failed to comply with the substantiation requirements,

failed to maintain all records required by the Internal Revenue

Code,    and    failed    to    cooperate     with    reasonable     requests    for

information and documents.

       In this case, there are multiple factual issues relevant to

determining petitioners’ tax liabilities. We will define those
                                      - 20 -

factual issues       and apply section 7491(a) to each on the basis of

the circumstances involved.

II.   Factual Issues in This Case

      Respondent determined deficiencies in petitioners’ Federal

income     taxes    and    self-employment     taxes.    The    adjustments      to

petitioners’ income resulted from adjustments made to the income of

the Bitker partnership as reported on its tax returns for 1996 and

1997 and from a determination that it made distributions to the

partners.

      For purposes of Federal income tax liability, a partnership is

not   taxed    at    the    entity   level.      Sec.   701.     Instead,     the

partnership’s income is passed through to its partners, and each

partner is individually taxed on his/her distributive share of

partnership income.         Secs. 701-704, 761(a).

      An    individual’s      self-employment     income   is    subject    to    a

self-employment tax in addition to Federal income tax.              Sec. 1401.

Subject to exclusions not relevant to this case, self-employment

income means net earnings from self-employment. Sec. 1402(b). Net

earnings from self-employment include, inter alia, an individual’s

distributive share, whether or not distributed, of income or loss

(as described in section 702(a)(8)) from any trade or business

carried on by a partnership in which the individual is a partner.

Sec. 1402(a).
                                       - 21 -

       A.     Whether Payments Made by the Bitker Partnership on
              Indebtedness Owed by Petitioners Are Rental Expenses of
              the Bitker Partnership or Constructive Distributions to
              Petitioners From the Bitker Partnership

       The Bitker partnership claimed a deduction for interest it

paid   on     mortgages     against    petitioners’      farmland.         Respondent

disallowed the deduction. That disallowance resulted in increases

in petitioners’ distributive shares of partnership farming income,

which is reported on Schedule F.

       Respondent determined that the interest on the mortgages

represented      petitioners’       individual    expenses        (as     opposed    to

partnership expenses) reportable as             rental expenses on Schedule E

of petitioners’ returns and that the deductibility of that interest

is   subject    to    the   passive    loss    rules    of   section      469.    Those

adjustments resulted in           increases in petitioners’ self-employment

tax. The parties agree that the interest payments totaled $242,964

in 1996 and $128,988 in 1997 and that petitioner husbands each

constructively received half of each year’s payment.                        Moreover,

petitioners concede the reclassification of the claimed Schedule F

interest expenses on the Bitker partnership’s returns as Schedule

E    rental     expenses     on    petitioners’        returns;        further,   they

acknowledge that the losses from their rental real estate activity

are subject      to   the    passive    loss    limitations       of    section     469.

Petitioners contend, however, that the principal and interest paid

by the Bitker partnership should be treated as payments by it for

use of petitioners’ land.             In effect, petitioners are asserting
                                  - 22 -

that   the   payments   are    rental   income   to    petitioners     and   an

additional rental expense of the Bitker partnership.

       Payments a partner receives from a partnership generally fall

into one of three categories.            First, a partner may receive

payments representing distributions of his/her distributive share

of partnership income.         See sec. 731.         Second, a partner may

receive payments in circumstances where he/she is not treated as a

partner.      Sec.   707(a).     And    third,   a    partner   may   receive

guaranteed payments for services or use of capital that do not

represent distributions of partnership income.            Sec. 707(c).

       Payments made to a partner either in his capacity other than

as a partner under section 707(a) or as guaranteed payments under

section 707(c) must satisfy the requirements of section 162(a)

before such payments may be deducted by the partnership.              Cagle v.

Commissioner, 63 T.C. 86, 91, 95 (1974) (no deduction is allowed if

the payment by the partnership to a partner constitutes a capital

expenditure), affd. 539 F.2d 409 (5th Cir. 1976).

       Section 1.707-1(a), Income Tax Regs., provides in part:

       Where a partner retains the ownership of property but
       allows the partnership to use such separately owned
       property for partnership purposes (for example, to obtain
       credit or to secure firm creditors by guaranty, pledge,
       or other agreement), the transaction is treated as one
       between partnership and a partner not acting in his
       capacity as a partner.

       Here, petitioners retained ownership of their farmland but

allowed the Bitker partnership to use the land in connection with
                                  - 23 -

its farming activity.        Pursuant to section 707(a), this type of

transaction is treated as one between the Bitker partnership and

petitioners acting other than in their capacity as partners.

Consequently,     payments    made   to    petitioners   by   the   Bitker

partnership for use of the farmland could constitute          ordinary and

necessary rental expenses incurred in the conduct of its trade or

business that are deductible under section 162.

     Petitioners maintain that the Bitker partnership’s payments of

principal and interest on petitioners’ land mortgages should be

treated as payments of land rent.           Petitioners, however, have

offered no evidence, testimonial or otherwise, that (a) the Bitker

partnership made the payments as rent for such use or (b) the

payments represented fair rental value.         Moreover, the record is

silent as to the number of acres used by the Bitker partnership.

Simply stated, petitioners have failed to provide any information

or substantiation that would permit us to estimate the allowable

deductions as permitted under Cohan v. Commissioner, 39 F.2d 540,

543-544 (2d Cir. 1930).      See Vanicek v. Commissioner, 85 T.C. 731,

742-743 (1985).    Since petitioners have failed to provide evidence

on the factual issue as to the amount of rent, if any, paid by the

Bitker partnership for use of the land, section 7491(a) does not

place the burden of proof on respondent with respect to this issue.

     Accordingly, in computing petitioners’ tax liabilities, (1)

petitioners’ shares of income from the Bitker partnership will not
                                 - 24 -

be reduced for rent of the farmland, (2) petitioners’ income from

their rental real estate activity will not be increased for such

rent,     and   (3)   petitioners’   distributions   from    the   Bitker

partnership will include the partnership’s payments of petitioners’

personal debt.

     B.     Whether Distributions Petitioners Received From the
            Bitker Partnership in 1996 and 1997 Exceeded Their Bases
            in Their Partnership Interests

     Section 731(a) sets forth the circumstances under which a

partner recognizes gain or loss from partnership distributions. In

the case of a distribution by a partnership to a partner, gain is

recognized only to the extent that the money (including marketable

securities) distributed exceeds the adjusted basis of a partner’s

interest in the partnership immediately before the distribution.

Sec. 731(a)(1); Jacobson v. Commissioner, 96 T.C. 577, 584 (1991),

affd. 963 F.2d 218 (8th Cir. 1992).         Any gain recognized under

section 731(a) is considered gain from the sale or exchange of the

partnership interest of the distributee partner.            Sec. 731(a);

P.D.B. Sports, Ltd. v. Commissioner, 109 T.C. 423, 441 (1997).         In

the case of a sale or exchange of an interest in a partnership,

gain recognized to the transferor partner is generally treated as

gain from the sale or exchange of a capital asset.            Sec. 741;

Colonnade Condo., Inc. v. Commissioner, 91 T.C. 793, 814 (1988).

     Section 705(a) states a general rule for determining the

adjusted basis of a partner’s interest.      In relevant part, section
                                      - 25 -

705(a) provides that the adjusted basis of a partner’s interest in

a   partnership    is   the   basis    as       determined   under   section   7225

(relating   to    contributions       to    a    partnership)   or   section   7426

(relating to transfers of partnership interests) (1) increased by

the partner’s distributive share of partnership income for the

current and prior years and (2) decreased (but not below zero) by

the amount of distributions from the partnership under section 7337

and by the partner’s distributive share of partnership losses for

the current and prior years.




      5
          Sec. 722 provides that the basis of a partnership
interest acquired by contribution of property, including money, is
“the amount of such money and the adjusted basis of such property
to the contributing partner at the time of the contribution”. For
purposes of sec. 722, a contribution of money includes: “Any
increase in a partner’s share of the liabilities of a partnership,
or any increase in a partner’s individual liabilities by reason of
the assumption by such partner of partnership liabilities”. Sec.
752(a).
      6
          Sec. 742 provides: “The basis of an interest in a
partnership acquired other than by contribution shall be determined
under part II of subchapter O (sec. 1011 and following).”        In
general, the basis of property acquired by gift is the same as it
was in the hands of the donor.       Sec. 1015.   For purposes of
determining loss, however, if that basis is greater than the fair
market value of the property at the time of the gift, then the
basis is the fair market value at the time of the gift. Id.
      7
          In the case of a distribution by a partnership to a
partner other than in liquidation of a partner’s interest, the
adjusted basis of the partner is reduced by the amount of money
distributed to that partner. Sec. 733. Additionally, any decrease
in a partner’s share of the liabilities of a partnership is
considered a distribution of money to the partner by the
partnership. Sec. 752(b).
                                 - 26 -

        Section 705(b) grants the Secretary the authority to prescribe

regulations under which the adjusted basis of a partner’s interest

in a partnership may be determined by reference to the partner’s

proportionate share of the adjusted basis of partnership property

upon a termination of the partnership. The regulations promulgated

to implement this section (found in section 1.705-1(b), Income Tax

Regs.) provide that an alternative method (the alternative rule)

may be used in circumstances where (a) a partner cannot practicably

apply the general rule set forth in section 705(a) and section

1.705-1(a), Income Tax Regs., or (b) from a consideration of all

the facts, the Commissioner reasonably concludes that the result

will not vary substantially from the result obtainable under the

general rule.       Sec. 1.705-1(b), Income Tax Regs.             Where the

alternative rule is used, certain adjustments may be necessary to

reflect discrepancies arising as a result of contributed property,

transfers of partnership interests, or distributions of property to

the partners.    Id. Petitioners maintain that their bases should be

determined under the alternative rule.

        Respondent asserts that petitioner wives’ bases in their

partnership interests can be determined under the general rule of

section 705(a) from their Schedules K-1 for 1991-97.        On the other

hand, petitioners maintain that petitioner wives’ bases should be

determined under the alternative rule.          Respondent posits that,

since    petitioner   wives   neither   paid   their   husbands    for   the
                                    - 27 -

interests nor contributed any property to the Bitker partnership,

the bases   of    their   partnership    interests      are   equal   to   their

respective shares of partnership debt.          We disagree.

      The 20-percent interests that petitioner wives acquired in

1991 included 20-percent interests in the Bitker partnership’s

existing capital--property interests that had been owned by their

husbands at the time the wives became partners.                Under Minnesota

law, a presumption exists that money or property transferred by a

husband to his wife (or a parent to his/her child) is a gift.

State v. One Oldsmobile Two-Door Sedan, 35 N.W.2d 525 (Minn. 1948);

Stahn v. Stahn, 256 N.W. 137 (Minn. 1934); Jenning v. Rohde, 109

N.W. 597 (Minn. 1906); Kiecker v. Estate of Kiecker, 404 N.W.2d 881

(Minn. Ct. App. 1987); see also Matarese v. Commissioner, T.C.

Memo. 1975-184.

      Here, the facts show that petitioner wives paid nothing for

their respective 20-percent interests in the Bitker partnership.

We   conclude,   therefore,    that   petitioner     wives     acquired    their

interests in the Bitker partnership as gifts from their husbands.

Consequently,    pursuant     to   section   1015(a),    for      purposes    of

determining gain, the basis of each wife’s 20-percent interest was

two-fifths of her husband’s basis in his partnership interest.

This conclusion is supported by the fact that the Schedules K-1 for

1991 reflect that petitioner wives each held a 20-percent interest

for the entire year and that petitioner wives were each treated as
                                  - 28 -

partners of the Bitker partnership for the entire year.        Moreover,

petitioner wives each reported (on their respective individual

income tax returns) 20 percent of the partnership income and

deductions for 1991.     The 1991 Schedules K-1 do not accurately

reflect the partners’ capital accounts--the beginning year negative

capital   accounts   shown   on   petitioner   husbands’   Schedules   K-1

reflect their 50-percent interests before gifts to their wives, not

their 30-percent interests following the gifts.            Moreover, the

reported contributions from petitioner husbands to the Bitker

partnership, as well as the distributions to petitioner wives were

erroneous--the numbers used were “plugged in” in by Mr. Mostoller

to account for the changes in ownership.       Mr. Mostoller’s approach

to reporting the partners’ capital accounts, contributions, and

distributions for 1991 was not correct.          The partners’ capital

accounts for 1991 are more accurately reflected as follows:
                                                 - 29 -

                                              Curtis        Jerry        Lynn         Coleen      Total
1991
 Analysis of partner’s capital account
  Capital account at beginning of year      ($311,911)    ($311,911)   ($207,941)   ($207,941) ($1,039,704)
  Capital contributed during year
  Partner’s share of net book income (loss)    19,149       19,149       12,766       12,766        63,830
  Distributions                               (90,656)     (90,656)     (60,436)     (60,436)     (302,184)
  Capital account at end of year             (383,418)    (383,418)    (255,611)    (255,611)   (1,278,058)
 Partner’s share of liabilities               557,991      557,991      371,994      371,994     1,859,970
                               - 30 -

     Respondent argues on brief that, pursuant to the principle

known as duty of consistency, petitioners are bound as to the

amounts of the capital accounts and distributions reported on the

1991 return.   We disagree.

     A taxpayer is under a duty of consistency when:

     (1) the taxpayer has made a representation or reported an
     item for tax purposes in one year,

     (2) the Commissioner has acquiesced in or relied on that fact
     for that year, and

     (3) the taxpayer desires to change the representation,
     previously made, in a later year after the statute of
     limitations on assessments bars adjustments for the initial
     tax year. * * * [Beltzer v. United States, 495 F.2d 211, 212
     (8th Cir. 1974).]

The duty of consistency is an affirmative defense that should be

raised in pleadings before trial.   Sec. 7453; Rule 39; LeFever v.

Commissioner, 100 F.3d 778 (10th Cir. 1996), affg. 103 T.C. 525

(1994).   In the instant case, respondent’s answer contained no

affirmative defenses or any allegation that respondent has relied

upon the capital accounts and distributions reported on the 1991

Schedules K-1. Consequently, because the duty of consistency is an

affirmative defense and was not pleaded by respondent, nor tried by

consent of the parties, it is deemed waived.        Rule 39; Monahan v.

Commissioner, 109 T.C. 235, 250 (1997); Green v. Commissioner, T.C.

Memo. 1998-274   (collateral   estoppel),   affd.    without   published

opinion 201 F.3d 447 (10th Cir. 1999); see also Gustafson v.

Commissioner, 97 T.C. 85, 89-92 (1991) (if an affirmative defense
                                            - 31 -

is not pleaded, it is deemed waived).                   We conclude therefore that

petitioners are not bound by the duty of consistency to the capital

accounts and distributions reported on the 1991 tax return.

     The Bitker partnership was formed in 1979. The records of the

partnership do not show the amounts of cash contributions or the

bases in property contributed by petitioner husbands and their

father,       Ray   Bitker,    to     the    partnership       when    it   was     formed.

Moreover, a calculation of the distributions made to each partner

each year since its formation cannot be made.                      The partnership tax

returns in the record cover only the years 1984-97.                         Only the tax

returns       for    1992-97        show     balance     sheets.            Under     these

circumstances, it is appropriate to apply the alternative rule set

forth    in    section      1.705-1(b),       Income     Tax    Regs.,      in    order    to

establish       petitioners’        adjusted         bases    in    their    partnership

interests.

        Regardless     of     where    the    burden     of    proof     may     lie,     the

preponderance of the evidence establishes that the distributions

petitioners received in 1996 and 1997 did not exceed their bases in

their partnership interests.

        The    parties      agree     that    the     Bitker       partnership had the

following assets and liabilities as of December 31, 1995-97:
                                    - 32 -

                                      12/31/95     12/31/96     12/31/97
Assets:
 Cash                                 $128,593      $85,057      $29,964
 Adjusted basis of buildings and
    other depreciable assets           362,698      267,828      477,044
 Basis of other assets
   Farm Services stock                 134,345      137,815      102,530
   Unit Retains                        186,834      172,934      151,696
   USWP stock                            --           --          68,333
  Total assets                         812,470      663,634      829,567
Liabilities:
 Short-term debt                        734,576     988,477    1,189,635
 Long-term debt                       1,222,236   1,069,820    1,232,633
  Total liabilities                   1,956,812   2,058,297    2,422,268

     On   the   basis    of   the    Bitker   partnership’s    assets      and

liabilities as of the beginning and end of each year at issue (as

agreed to by respondent) and its income (as adjusted during the

examination of the partnership return), the cash distribution to

petitioners (including the deemed distribution for payment of

petitioners’ personal expenses) is $634,830 for 1996 and $458,488

for 1997.    The amounts of the distributions to petitioners are

computed as follows:

                                       12/31/95    12/31/96      12/31/97
Assets:
 Cash                                  $128,593    $85,057        $29,964
 Adjusted basis of buildings and
    other depreciable assets            362,698    267,828        477,044
 Basis of other assets
   Farm Services stock                  134,345     137,815       102,530
   Unit Retains                         186,834     172,934       151,696
   USWP stock                             --          --           68,333
  Total assets                          812,470     663,634       829,567
Liabilities:
 Short-term debt                        734,576      988,477    1,189,635
 Long-term debt                       1,222,236    1,069,820    1,232,633
  Total liabilities                   1,956,812    2,058,297    2,422,268
                                 - 33 -

Partners’ capital                 (1,144,342)   (1,394,663)   (1,592,701)
Analysis of partners’ capital:
 Net income per books                              384,509     260,450
 Distributions                                    (634,830)   (458,488)
 Balance at year end                             (1,394,663) (1,592,701)
 Beginning year balance                         (1,144,342) (1,394,663)

In order for the distributions to have exceeded $634,830 for 1996

and $458,488 for 1997, the Bitker partnership would have had to

have depleted its assets, incurred additional debt, or earned more

income.

     Under the alternative computation, a partner’s basis is equal

to the partner’s proportionate share of the adjusted basis of

partnership property upon a termination of the partnership.8        That

basis may equal his/her negative capital account plus his/her share

of partnership liabilities.      Long v. Commissioner, 77 T.C. 1045,

1084 (1981) (basis equaled negative capital account plus taxpayer’s

     8
          Section 705(a) sets forth the general rule for
determining a partner’s basis in his partnership interest. Any
increase or decrease in a partner’s share of partnership
liabilities is deemed either a cash contribution by the partner to
the partnership or a distribution to the partner by the
partnership. Sec. 752(a) and (b). The partner’s basis in his/her
partnership interest is increased by the amount of the deemed
contribution or reduced by the deemed distribution.
     This is not true as to the partner’s capital account, however.
The capital account generally reflects a partner’s equity
investment in the partnership and is not increased by his/her share
of partnership liabilities. Tapper v. Commissioner, T.C. Memo.
1986-597. Thus, it is possible for partners, like petitioners in
this case, to have negative capital accounts while maintaining
positive tax bases in their partnership interest.
     Unlike a partner’s basis, which can never be less than zero,
a partner’s capital account will be negative if the sum of the
capital contributions credited to him on the partnership’s books
and his share of “book” profits is less than the sum of the amounts
distributed to him and his share of “book” losses.
                                 - 34 -

share of partnership liabilities); see also Tapper v. Commissioner,

T.C. Memo. 1986-597; cf. Coleman v. Commissioner, T.C. Memo.

1974-78 (Court refused to apply alternative computation because

taxpayer failed to provide proof of partnership’s asset basis),

affd. 540 F.2d 427 (9th Cir. 1976).       The computation may require

adjustments to reflect “any significant discrepancies arising as a

result of contributed property, transfers of partnership interest,

or distributions of property to partners.” Sec. 1.705-1(b), Income

Tax Regs.

     The record contains no evidence that any contributions were

entered on the Bitker partnership’s books at other than their tax

bases.   Nor does the record reflect any differences between the

financial and tax accounting treatment of partnership income or

expense items or partnership losses (before the year in issue) that

were not previously deductible by reason of section 704(d). Nor is

an adjustment required for Ray Bitker’s transfer of his interest in

the Bitker partnership to petitioner husbands in 1989 or for

petitioner husbands’ transfers to petitioner wives in 1991 because

all of those transfers were gifts.          (The respective bases of

petitioners   are   determined   using    transferred   bases   for   the

interests received by gifts. Secs. 742, 1015(a); cf. Tapper v.

Commissioner, supra (adjustment required to reflect retirement of

former partner’s interest in prior year).)
                                       - 35 -

     On    the      basis   of   the    Bitker   partnership’s     assets    and

liabilities as of the beginning and end of each year at issue as

agreed    to   by    respondent,   its    income   as   adjusted   during    the

examination of the partnership return, and the cash distributions

to petitioners of $634,830 for 1996 and $458,488 for 1997, which

necessarily      included    the   deemed   distribution    for    payment    of

petitioners’ personal expenses, we conclude that the distributions

did not exceed petitioners’ bases in their partnership interests.

The computations we have used in reaching this conclusion               are as

follows:
                                                  - 36 -

1996                                        Total1      Curtis (30%)   Jerry (30%)   Lynn (20%)   Coleen (20%)

Assets at beginning of year:
 Cash                                      $128,593        $38,578      $38,578      $25,719        $25,719
 Adjusted basis of buildings and
    other depreciable assets                362,698        108,809      108,809       72,540         72,540
 Basis of other assets:
   Farm Services stock                      134,345         40,304       40,304       26,869         26,869
   Unit Retains                             186,834         56,050       56,050       37,367         37,367
   USWP stock                                  --             --           –-           –-              --
  Total assets                              812,470        243,741      243,741      162,495        162,495
Liabilities at beginning of year:
 Short-term debt                             734,576       220,373      220,373       146,915       146,915
 Long-term debt                            1,222,236       366,671      366,671       244,447       244,447
  Total liabilities                        1,956,812       587,044      587,044       391,362       391,362
Partners’ capital at beginning of year    (1,144,342)     (343,303)    (343,303)     (228,867)     (228,867)
Change in liabilities:
  Liabilities at beginning of year        1,956,812        587,044      587,044      391,362        391,362
  Liabilities at year end                 2,058,297        617,489      617,489      411,659        411,659
   Increase (decrease)                      101,485         30,445       30,445       20,297         20,297
Partners’ bases at beginning of year        812,470        243,741      243,741      162,495        162,495
1996 Income (as adjusted)                   384,509        115,353      115,353       76,902         76,902
Contributions:
 Cash/property                                -0-            -0-          -0-          -0-            -0-
 Deemed by increase in liabilities          101,485         30,445       30,445       20,297         20,297
Partners’ bases before distributions      1,298,464        389,539      389,539      259,694        259,694
Distributions:
 Cash                                      (634,830)      (190,449)    (190,449)     (126,966)     (126,966)
 Deemed by reduction in liabilities           -0-            -0-          -0-           -0-           -0-
Partners’ bases after distributions         663,634        199,090      199,090       132,728       132,728
     1
           Differences due to rounding.
                                                  - 37 -

1997                                         Total1     Curtis (30%)   Jerry (30%)   Lynn (20%)   Coleen (20%)

Assets at beginning year:
 Cash                                       $85,057        $25,517      $25,517      $17,011        $17,011
 Adjusted basis of buildings and
    other depreciable assets                267,828        80,348        80,348       53,566         53,566
 Basis of other assets:
   Farm Services stock                      137,815         41,345       41,345       27,563         27,563
   Unit Retains                             172,934         51,880       51,880       34,587         34,587
   USWP stock                                 --             --           --           --             --
  Total assets                              663,634        199,090      199,090      132,727        132,727
Liabilities:
 Short-term debt                             988,477      296,543       296,543       197,695       197,695
 Long-term debt                            1,069,820      320,946       320,946       213,964       213,964
  Total liabilities                        2,058,297      617,489       617,489       411,659       411,659
Partners’ capital at beginning of year    (1,394,663)    (418,399)     (418,399)     (278,933)     (278,933)
Change in liabilities:
  Liabilities at beginning of year        2,058,297        617,489      617,489      411,659        411,659
  Liabilities at year end                 2,422,268        726,680      726,680      484,454        484,454
   Increase (decrease)                      363,971        109,191      109,191       72,795         72,795
Partners’ bases at beginning of year        663,634        199,090      199,090      132,728        132,728
1997 Income (as adjusted)                   260,450         78,135       78,135       52,090         52,090
Contributions:
 Cash/property                                -0-            -0-          -0-          -0-            -0-
 Deemed by increase in liabilities          363,971        109,191      109,191       72,795         72,795
Partners’ bases before distributions      1,288,058        386,416      386,416      257,613        257,613
Distributions:
 Cash                                      (458,488)     (137,546)     (137,546)     (91,698)       (91,698)
 Deemed by reduction in liabilities           -0-           -0-           -0-           -0-           -0-
Partners’ bases after distributions         829,570       248,870       248,870      165,915        165,915
     1
           Differences due to rounding.
                                    - 38 -

       Respondent argues that because petitioners erroneously treated

$962,022 of personal debt as the Bitker partnership’s liabilities,

the adjustment that was made to remove the $962,022 of liabilities

from the      partnership’s     balance   sheet   should    be   treated   as a

distribution under section 752(b).           We disagree.

       When     a     partnership   assumes    an    individual      partner’s

liabilities, the assumption of those liabilities results in a

deemed distribution to the partner of the amount assumed by the

partners.       Sec. 752(b).     Conversely, when a partner assumes the

partnership’s liabilities, the assumption of such liability results

in a deemed contribution by the partner to the partnership of the

amount assumed.          Sec. 752(a).     Additionally, any increase or

decrease in a partner’s share of partnership liabilities is deemed

either a cash contribution by the partner to the partnership or a

distribution to the partner by the partnership.              Sec. 752(a) and

(b).     The partner’s basis in his/her partnership interest is

increased by the amount of the deemed contribution or reduced by

the    deemed       distribution.   Secs.     705,   722,   733;    Barron   v.

Commissioner, T.C. Memo. 1992-598; Moore v. Commissioner, T.C.

Memo. 1987-499.

       Section 1.752-1(f), Income Tax Regs., provides:

       (f) Netting of increases and decreases in liabilities
       resulting from same transaction. If, as a result of a
       single transaction, a partner incurs both an increase in
       the partner’s share of the partnership liabilities (or
       the partner’s individual liabilities) and a decrease in
       the partner’s share of the partnership liabilities (or
                                 - 39 -

      the partner’s individual liabilities), only the net
      decrease is treated as a distribution from the
      partnership and only the net increase is treated as a
      contribution of money to the partnership.

Section   1.752-1(g),   Income   Tax   Regs.,   provides    the   following

example of the effect of netting:

      Example 1. Property contributed subject to a liability;
      netting of increase and decrease in partner’s share of
      liability. B contributes property with an adjusted basis
      of $1,000 to a general partnership in exchange for a
      one-third interest in the partnership. At the time of
      the contribution, the partnership does not have any
      liabilities outstanding and the property is subject to a
      recourse debt of $150 and has a fair market value in
      excess of $150.     After the contribution, B remains
      personally liable to the creditor and none of the other
      partners bears any of the economic risk of loss for the
      liability under state law or otherwise. Under paragraph
      (e) of this section, the partnership is treated as having
      assumed the $150 liability. As a result, B’s individual
      liabilities decrease by $150. At the same time, however,
      B’s share of liabilities of the partnership increases by
      $150. Only the net increase or decrease in B’s share of
      the liabilities of the partnership and B’s individual
      liabilities is taken into account in applying section
      752. Because there is no net change, B is not treated as
      having contributed money to the partnership or as having
      received a distribution of money from the partnership
      under paragraph (b) or (c) of this section. Therefore
      B’s basis for B’s partnership interest is $1,000 (B’s
      basis for the contributed property).

      Petitioners were at all times personally liable for the debts

erroneously included as partnership liabilities.           Netting results

in a complete offset (i.e., no change) for the deemed contributions

and   distributions   when   petitioners’   personal   liabilities      are

assumed by the Bitker partnership and when the liabilities are

removed from the partnership.     In essence, the total distributions
                                          - 40 -

to petitioners in 1996 are unaffected by the adjustment to the

amount of partnership liabilities.

         Since we conclude that petitioners had sufficient bases taking

into account only the assets and liabilities agreed to by the

parties, we need not decide other arguments made by petitioners

regarding this issue.

         C.     Whether Petitioners Are Liable for The Accuracy-Related
                Penalties Under Section 6662(a) for The Years at Issue.

         Respondent       contends   that    petitioners       are    liable   for   an

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

burden of production under section 7491(c) and must come forward

with evidence sufficient for us to sustain the section 6662(a)

penalty. See Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001);

Emerson v. Commissioner, T.C. Memo. 2003-82.

         As   pertinent     here,    section     6662(a)   imposes      a   20-percent

penalty        on   the    portion   of     an   underpayment        attributable    to

negligence or disregard of rules or regulations, sec. 6662(b)(1),

or   a     substantial       understatement        of   tax,   sec.    6662(b)(2).

Negligence includes any failure to make a reasonable attempt to

comply with the provisions of the Internal Revenue Code, including

any failure to keep adequate books and records or to substantiate

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

Regs.         An “understatement” is the excess of the amount of tax

required to be shown in the tax return over the amount of tax shown
                                   - 41 -

in the tax return, sec. 6662(d)(2)(A), and is “substantial” in the

case of an individual if the understatement exceeds the greater of

10 percent of the tax required to be shown or $5,000, sec.

6662(d)(1)(A).

     The penalty under section 6662(a) does not apply to any

portion of an understatement of tax if it is shown that there was

reasonable cause for the taxpayer’s position and that the taxpayer

acted in good faith with respect to that portion. Sec. 6664(c)(1).

The determination of whether a taxpayer acted with reasonable cause

and in good faith is made on a case-by-case basis, taking into

account   all    the   pertinent   facts     and   circumstances.   Sec.

1.6664-4(b)(1), Income Tax Regs.       The most important factor is the

extent of the taxpayer’s effort to assess his/her proper tax

liability for the year.     Id.

     Reasonable cause requires that the taxpayer exercise ordinary

business care and prudence as to the disputed item.         United States

v. Boyle, 469 U.S. 241 (1985); see also Neonatology Associates,

P.A. v. Commissioner, 115 T.C. 43, 98 (2000), affd. 299 F.3d 221

(3d Cir. 2002).        The good faith reliance on the advice of an

independent, competent professional as to the tax treatment of an

item may meet this requirement.        United States v. Boyle, supra;

sec. 1.6664-4(b), Income Tax Regs.          Whether a taxpayer reasonably

relies on advice of a professional depends on the facts and

circumstances of the case and the law applicable thereto.            Sec.
                              - 42 -

1.6664-4(c)(1)(i), Income Tax Regs.    The taxpayer must prove that:

(1) The adviser was a competent professional who had sufficient

expertise to justify reliance, (2) the taxpayer provided necessary

and accurate information to the adviser, and (3) the taxpayer

actually relied in good faith on the adviser's judgment.    Ellwest

Stereo Theatres, Inc. v. Commissioner, T.C. Memo. 1995-610; see

also Rule 142(a)(1).   To show good faith reliance, the taxpayer

must show that the return preparer was supplied with all the

necessary information and the incorrect return was a result of the

preparer’s mistakes.   Pessin v. Commissioner, 59 T.C. 473, 489

(1972); sec. 1.6664-4(c)(1)(i), Income Tax Regs.

     In this case, the understatement of tax is attributable to the

disallowance of the Bitker partnership’s deduction of interest on

petitioners’ individual debt on the farmland they owned. We do not

believe that petitioners reasonably relied on Mr. Mostoller with

respect to this disallowance.   The farmland was not shown as an

asset of the Bitker partnership on the partnership return prepared

by Mr. Mostoller. Consequently, we believe Mr. Mostoller knew that

the Bitker partnership did not own any farmland.

     Mr. Mostoller verified loan balances by calling Farm Credit

Services. Petitioners have failed to establish, however, that they

furnished Mr. Mostoller with necessary and relevant information to

identify any of the loans as mortgages on their individually owned

farmland.   Moreover, petitioners have failed to show that the
                              - 43 -

incorrect treatment of the interest paid on those mortgages was due

to Mr. Mostoller’s mistakes. Accordingly, we hold that petitioners

are liable for the section 6662(a) accuracy-related penalty with

regard to the increases in income tax and self-employment tax

resulting from the disallowance of the deduction claimed by the

Bitker partnership for interest on petitioners’ debt.

     To reflect the foregoing and concessions by the parties,


                                         Decisions will be entered

                                    under Rule 155.
