                          T.C. Memo. 1997-268



                        UNITED STATES TAX COURT



         TERRY AND KATHRYN A. RODITSKI DILOZIR, Petitioners v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3632-96.                          Filed June 12, 1997.



     Terry Dilozir, pro se.

     Michael P. Breton, for respondent.



                          MEMORANDUM OPINION


     PANUTHOS, Chief Special Trial Judge:       This case was heard

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

181, and 182.1    Respondent determined a deficiency in

     1
        All section references are to the Internal Revenue Code
in effect for the year in issue, unless otherwise indicated. All
Rule references are to the Tax Court Rules of Practice and
                                                   (continued...)
                                - 2 -

petitioners' 1993 Federal income tax in the amount of $3,538 and

an accuracy-related penalty under section 6662(a) in the amount

of $708.   The issues for decision are:   (1) Whether petitioners

are entitled to deduct certain claimed Schedule C expenses; (2)

whether petitioners underreported capital gain income on Schedule

D by the amount of $22,116; and (3) whether petitioners are

liable for the accuracy-related penalty under section 6662(a).

     For clarity and convenience, we have combined the findings

of fact and discussion of pertinent legal issues.   Some of the

facts have been stipulated and are so found.   The stipulation of

facts and the attached exhibits are incorporated herein by this

reference.   Petitioners resided in Avon, Connecticut, at the time

the petition was filed.

     We begin by noting that petitioners bear the burden of

proving that respondent's determination is erroneous.   Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).    Moreover,

deductions are a matter of legislative grace, and petitioners

bear the burden of proving that they are entitled to any

deductions claimed.    INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

84 (1992).

1. Schedule C Deductions

     Petitioner Terry Dilozir (petitioner) was self-employed as a

real estate agent during the year in issue.    Petitioner worked in

     1
      (...continued)
Procedure.
                                - 3 -

the office of RE/MAX Realtors, located in Farmington,

Connecticut.    On Schedule C for the 1993 tax year, petitioner

reported income and expenses as follows:

                                           Amount    Total Amount
Income:
  Gross receipts                         $8,638.00
  Other income                            1,950.00
                                                     $10,588.00

Expenses:
  Advertising                             2,287.65
  Bad debts                               1,000.00
  Depreciation                            1,760.00
  Employee benefit programs                 562.15
  Insurance                                 850.00
  Office expense                          5,445.55
  Pension and profit-sharing plans          525.00
  Rent or lease                           3,521.23
  Repairs and maintenance                   874.32
  Supplies                                  743.56
  Taxes and licenses                      1,515.00
  Travel, meals, entertainment              157.14
                                                          19,241.60
                                                      1
     Net loss                                          (8,653.60)
     1
        Petitioners' return miscalculated expenses as totaling
$18,431.60, resulting in total losses claimed in the amount of
$7,753.60.

In the notice of deficiency, respondent disallowed the claimed

rent expense in the amount of $3,521.23, and the claimed bad debt

deduction in the amount of $1,000.

     Section 162(a) provides that there shall be allowed as a

deduction all the ordinary and necessary expenses paid or

incurred during the taxable year in carrying on any trade or

business.   Section 6001 requires that a taxpayer liable for any

tax shall maintain such records, render such statements, make
                                - 4 -

such returns, and comply with such regulations as the Secretary

may from time to time prescribe.

        (a)   Claimed Rent Expense

     Section 162(a)(3) allows a taxpayer to deduct rental

expenses incurred in connection with a trade or business.

Petitioner argues that in exchange for his use of the RE/MAX

office, he had agreed to pay to RE/MAX 35 percent of any

commissions earned, resulting in a deductible rental expense in

the amount of $3,271.90.   To support this assertion, petitioner

introduced into evidence a letter purportedly written by Rosemary

Slade of the RE/MAX office where petitioner worked.   With respect

to petitioner's 1993 rent expense, the letter states:

          The payments in question are the payments that were
     taken out of commissions earned by and applied toward Fixed
     Expenses. I have enclosed a copy of your Independent
     Contractor Agreement that explains what Fixed Expenses are.
     * * * Our agreement with you, stated that 35% of each
     commission would be applied to that amount as is documented
     on your Ledger Card which I have also enclosed.

The letter then indicates that petitioner paid "fixed expenses"

out of commissions earned in the amount of $3,271.90, as well as

"personal expenses" in the amount of $4,382.48, for combined

total expenses paid to RE/MAX in the amount of $7,654.38 for

1993.   Petitioner explained at trial that the term "fixed

expenses", as used in the letter, referred to rent expenses,

while the term "personal expenses" referred to expenses for

secretaries, fax machines, and photocopies, and served as the

primary basis of petitioner's claim for office expenses.
                                - 5 -

     Respondent argues that petitioner's claimed rent expense

represents a duplication of his claimed office expense,

previously allowed by respondent.

     The amount of office expenses claimed by petitioner and

allowed by respondent, $5,445.55, is greater than the "personal

expenses" in the amount of $4,382.48 indicated in the letter.

Moreover, respondent has allowed petitioner's claims for other

expenses in addition to office expenses.    Consequently, we

conclude that petitioner's claimed rent expense represents a

duplication of expenses previously allowed by respondent.2

     Petitioners have failed to establish that they are entitled

to the claimed rental expense deduction in the amount of

$3,271.90.   Rule 142(a).   We, therefore, sustain respondent's

determination on this issue.

     (b)   Claimed Bad Debt Deduction

     On June 2, 1992, petitioner and an associate, Peter

Kostochko, agreed to purchase a dwelling located at 107 Mill

Street, Glastonbury, Connecticut, for $99,000.3   Petitioner paid

     2
        We are also troubled by a discrepancy between the figures
indicated in the letter and other items in the record. The
amount indicated as "fixed expenses" in the letter, $3,271.90, is
greater than 35 percent of $8,638, the amount of gross
commissions indicated on the Form 1099. Respondent objected to
the admissibility of the letter on the basis of hearsay. While
we have admitted the letter, we have previously concluded that
the claimed expenses are a duplication of other expenses claimed
by petitioner and allowed by respondent.
     3
         The record does not indicate the precise nature of Mr.
                                                    (continued...)
                                - 6 -

a deposit to the seller's real estate agent, Frank Dibble, in the

amount of $1,000.    Petitioner's obligation under the agreement

was contingent upon an inspection of the subject property and

approval of financing.    If petitioner could not obtain financing,

the agreement required petitioner to notify the seller within a

specified period of time.

     After petitioner signed the purchase and sale agreement, the

property in question was inspected, revealing that the dwelling

had been damaged by termites.    As a result, petitioner could not

obtain financing.    Nevertheless, petitioner wanted to buy the

property, and he renegotiated a purchase price in the amount of

$67,000, again contingent upon approval of financing.    On three

occasions, the seller agreed with petitioner to extend the

deadline for obtaining financing, while petitioner sought to

obtain a lender.    Sometime in early 1993, petitioner had not

obtained financing, and he failed to notify the seller within the

notification period specified in their amended agreement.

Petitioner was then informed that because the time for notifying

the seller had lapsed, the $1,000 deposit could not be refunded.

     Petitioner did not believe that he was entitled to a return

of the deposit.    Accordingly, petitioner did not institute legal

action against either Mr. Dibble or the seller.    Petitioner


     3
      (...continued)
Kostochko's relationship with petitioner with respect to this
transaction.
                                - 7 -

claimed a bad debt deduction on Schedule C in the amount of

$1,000 relating to the surrendered deposit.     Upon examination,

respondent disallowed the claimed bad debt deduction, asserting

that petitioners had not established that the forfeited deposit

constituted a bad debt or was otherwise deductible.

     As a general rule, section 166 allows a deduction for any

bad debt that becomes worthless during the taxable year.     Sec.

166(a)(1).    To establish entitlement to a bad debt deduction, a

taxpayer must prove that a bona fide debt existed, and that the

debt became worthless in the year that the deduction is claimed.

Rule 142(a); American Offshore, Inc. v. Commissioner, 97 T.C.

579, 593 (1991); sec. 1.166-1(c), Income Tax Regs.     A bona fide

debt is defined as one which arises from a debtor-creditor

relationship based upon a valid and enforceable obligation to pay

a fixed or determinable sum of money.    Sec. 1.166-1(c), Income

Tax Regs.

     Petitioner admitted at trial that his deposit was properly

surrendered, and that he was not entitled to a return of the

proceeds.    Therefore, the forfeited deposit did not give rise to

a claim for a bad debt deduction under section 166.

     Upon petitioner's admission at trial that he was not

entitled to a return of the deposit, we asked petitioner to

explain the basis of characterizing the forfeited deposit as a

bad debt.    In response, petitioner stated:   "I expended [the

deposit].    I -- I spent the money in trying to pursue a
                                  - 8 -

profitable venture.     I don't know if it's called a bad debt, but

it's an expense."     We interpret petitioner's statement as an

assertion that the surrendered deposit somehow gave rise to a

deduction under the general provisions of either section 162(a)

or section 212.     Section 212 generally permits a taxpayer to

deduct ordinary and necessary expenses incurred either for the

production of income or for the management, conservation, or

maintenance of property held for the production of income.      There

is no indication in the record that petitioner sought to purchase

the property in question as part of his trade or business or with

the intent to produce income.      Petitioners have failed to meet

their burden of proving that they are entitled to the claimed

deduction.     Rule 142(a).   We, therefore, sustain respondent on

this issue.

2.   Schedule D Gains and Losses

      (a)    Demand Note

      On November 8, 1989, petitioner agreed to lend $5,700 to the

Connecticut Gold Chip Co. (CGCC).      In return, petitioner received

a demand note.     The note provided that the principal was payable

on or after December 31, 1989, upon the demand of the payee or

holder.     The note further provided that a late payment penalty

was payable at the rate of 5 percent on any unpaid principal as

of December 31, 1989, and upon default, interest would accrue at

an annual rate of 18 percent on any unpaid balance.      Petitioner

did not receive any repayments of principal or interest on the
                                - 9 -

loan and learned in 1993 that CGCC had recently filed for

bankruptcy.    On Schedule D of their 1993 return, petitioners

claimed a long-term capital loss in the amount of $11,400

relating to the demand note.

     Upon examination, respondent allowed petitioners to claim

$5,700 of the $11,400 as a capital loss, representing the

principal amount of the promissory note, and disallowed the

remaining claimed loss in the amount of $5,700.    Respondent does

not dispute petitioners' characterization of the loss as a long-

term capital loss.

     Although petitioners did not claim the loss as a bad debt,

we believe the provisions of section 166 pertain to this

transaction.    Section 166(b) provides that the basis for

determining the amount of the deduction for any bad debt shall be

the adjusted basis provided in section 1011 for determining the

loss from the sale or other disposition of property.     The

"adjusted basis" of property is the property's unadjusted basis,

adjusted as provided in section 1016.    Sec. 1011(a).   Typically,

a taxpayer's basis in property is the cost of that property.

Sec. 1012; sec. 1.1012-1(a), Income Tax Regs.    In this instance,

petitioners bear the burden of proving petitioner's basis in the

demand note.    Rule 142(a).

      Petitioners indicated a cost basis in the demand note in

the amount of $11,400.    At trial, petitioner explained that he

was entitled to increase his basis in the demand note for
                               - 10 -

"opportunity cost".   In this regard, petitioner argues that his

basis in the note, for the purpose of determining loss from the

transaction, should include not only the unpaid principal as

allowed by respondent, but also the interest which CGCC should

have paid to petitioner under the terms of the note.    Petitioners

cite no case or statute to support this position.    We find that

petitioners have failed to establish that petitioner's basis in

the note was greater than $5,700, the amount determined by

respondent.4   Rule 142(a).   We, therefore, sustain respondent on

this issue.

     (b)   Sale of the Simsbury Property

     During the 1993 tax year, Mr. Kostochko, in the capacity of

trustee, sold property located at 48 Country Road, Simsbury,

Connecticut, for the amount of $69,700.    Petitioner and Mr.

Kostochko maintain that they shared equal ownership in the

property as partners.5   On Schedule D of their 1993 return,

petitioners indicated that petitioner's share of the sale


     4
        We also note that a taxpayer cannot claim a deduction
with respect to a worthless debt arising from unpaid wages,
salaries, fees, rents, and similar items of income which have not
been reported by the taxpayer as income. Sec. 1.166-1(e), Income
Tax Regs. This principle applies to interest owed to a taxpayer
but never reported as income. W.L. Moody Cotton Co. v.
Commissioner, 2 T.C. 347, 353-357 (1943), affd. 143 F.2d 712 (5th
Cir. 1944). Therefore, we could sustain respondent's
determination on this basis as well.
     5
        There is no partnership tax return or partnership
agreement in the record. We assume that the parties were co-
owners of the property in question.
                              - 11 -

proceeds was $32,567.38.   Petitioners claimed a cost basis in the

property in the amount of $16,414.42 and reported a net capital

gain with respect to the sale in the amount of $16,152.96.

Petitioners indicated on the return that petitioner had acquired

his interest in the property on October 15, 1991.

     Upon examination, respondent determined additional capital

gain in the amount of $16,414.42.    Respondent asserted that

because petitioner offered no proof of his cost basis in the

property, the entire amount of the sale proceeds constituted

taxable gain.

     The parties agree that the amount realized from the sale of

the Simsbury property was $32,567.38.    The record does not

contain any purchase and sale agreement pertaining to

petitioner's purchase of the property and does not contain the

trust instrument which appointed Mr. Kostochko as trustee.

Petitioners, however, offered into evidence an undated settlement

statement pertaining to the sale of the property in 1993.

Respondent objected to the settlement statement as inadmissible

hearsay.   Even if the Court were to consider this document, it

would not support petitioners' position because it provides no

information regarding petitioner's basis in the property.

Petitioners have not presented any other evidence to establish

petitioner's basis in the property.    Petitioners have failed to

meet their burden on this issue.    Rule 142(a).   We, therefore,

sustain respondent's determination.
                                - 12 -

3.   Accuracy-Related Penalty Under Section 6662(a)

      Respondent determined that petitioners were liable for the

accuracy-related penalty under section 6662(a) for 1993.       The

accuracy-related penalty is equal to 20 percent of any portion of

an underpayment attributable to a taxpayer's negligence or

disregard of rules or regulations.       Sec. 6662(a) and (b)(1).    The

term "negligence" includes any failure to make a reasonable

attempt to comply with the provisions of the Internal Revenue

Code, and the term "disregard" includes any careless, reckless,

or intentional disregard.     Sec. 6662(c).    The penalty does not

apply to any portion of an underpayment for which there was

reasonable cause and with respect to which the taxpayer acted in

good faith.   Sec. 6664(c).    Generally, the Commissioner's

determination imposing the accuracy-related penalty is presumed

correct, and taxpayers bear the burden of proving that they are

not liable for the accuracy-related penalty imposed by section

6662(a).   Rule 142(a); Tweeddale v. Commissioner, 92 T.C. 501,

505 (1989).

      In this instance, petitioners have offered no evidence that

they made a reasonable attempt to report the items of income and

deductions in issue.   Petitioners have failed to meet their

burden of proving that they are not liable for the accuracy-

related penalty.   We, therefore, sustain respondent's

determination on this issue.

      To reflect the foregoing,
- 13 -

          Decision will be entered

     for respondent.
