                         T.C. Memo. 1999-31



                       UNITED STATES TAX COURT



       GEORGE R. AND DONELLE C. HAWTHORNE, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 5695-97, 18426-97.      Filed February 2, 1999.



     George R. and Donelle C. Hawthorne, pro sese.

     Katherine Holmes Ankeny and J. Robert Cuatto, for

respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     CHIECHI, Judge:    Respondent determined the following defi-

ciencies in petitioners' Federal income tax (tax):

                         Year     Deficiency
                         1992          $265
                         1993         5,116
                         1994         3,094


     The issues remaining for decision are:
                                 - 2 -

     (1)    Did petitioners erroneously include in dividend income

in their tax returns (returns) for 1992 and 1993 cash distribu-

tions (cash distributions) received during those years on certain

stock?     We hold that they did not except to the extent stated

herein.

     (2)    Did petitioners erroneously include in dividend income

in their returns for 1992, 1993, and 1994 dividends in stock

received during those years under dividend reinvestment programs?

We hold that they did not.

     (3)(a)     Should respondent's determination with respect to

certain interest income reported by petitioners in Schedule C of

their return for 1992 be sustained?      We hold that it should.

          (b)   Should respondent's determinations with respect to

the expenses claimed by petitioners in Schedules C of their

returns for 1992, 1993, and 1994 be sustained?      We hold that they

should.

                           FINDINGS OF FACT1

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

     Petitioners resided in Santa Fe, New Mexico, at the time the

petition was filed.

     Petitioners filed joint returns for 1992, 1993, and 1994.




1
   Unless otherwise indicated or needed for clarity, our Findings
of Fact and Opinion pertain to 1992, 1993, and 1994, the years at
issue.
                               - 3 -

Cash Distributions on Certain Stock

     Cash Distributions From Gulf States Utilities Company

     During 1992, petitioner George R. Hawthorne (Mr. Hawthorne)

owned shares of two classes of preferred stock of Gulf States

Utilities Company (Gulf States).   During 1992, Gulf States, which

had not paid any dividends to its preferred stockholders since

December 15, 1986, paid Mr. Hawthorne (1) $14,454 with respect to

the shares of one of the classes of Gulf States preferred stock

that he owned and (2) $12,648 with respect to the shares of the

other class of Gulf States preferred stock that he owned, or a

total of $27,102.   Gulf States reported the total amount that it

paid to Mr. Hawthorne as "Ordinary dividends" in Form 1099-DIV

for 1992.   In their 1992 return, petitioners included the amount

reported in that form as dividend income.

     A letter dated June 19, 1992, from Entergy Corporation

(Entergy) to "Fellow Stockholder" stated in pertinent part:

     Entergy Corporation and Gulf States Utilities Company
     entered into a definitive agreement on June 5, 1992,
     providing for the combination of the two companies.
     * * *

     Under the terms of the agreement, Entergy and GSU will
     form a new holding company that will acquire all of the
     common stock of Entergy and GSU. The new holding
     company, which will be renamed "Entergy," will own all
     of the common stock of GSU * * *.

     Completion of the transaction is subject to, among
     other things, the approval of the common stockholders
     of Entergy and GSU and the receipt of all required
     governmental and regulatory approvals. * * *

     In the transaction, GSU common stockholders can elect
     to receive $20 in either cash or shares of common stock
     of the new holding company for each share of GSU common
     stock. The maximum amount of cash to be paid to GSU
                              - 4 -

     common stockholders is $250 million, and the agreement
     provides for the proration of cash in the event that
     GSU stockholders elect, in the aggregate, to receive
     more cash than the $250 million.

        *      *       *           *    *          *         *

     Each of the shares of GSU preferred stock outstanding
     at closing will continue as outstanding stock of GSU.
     Each share of Entergy common stock will be converted
     into the right to receive one share of new holding
     company common stock.

     Cash Distributions From Centerior Energy
     Corporation and Portland General Corporation

     During 1993, Mr. Hawthorne owned shares of common stock of

Centerior Energy Corporation (Centerior Energy).       During that

year, Centerior Energy paid Mr. Hawthorne $1,440 with respect to

those shares, $830.09 of which it reported as "Ordinary divi-

dends" in Form 1099-DIV CORRECTED for 1993 and $609.91 of which

it reported in that form as "Nontaxable distributions".       Mr.

Hawthorne received Form 1099-DIV CORRECTED for 1993 after peti-

tioners filed their 1993 return.

     During 1993, Mr. Hawthorne owned shares of common stock of

Portland General Corporation (Portland General).       During that

year, Portland General paid Mr. Hawthorne $240 with respect to

those shares, all of which it reported as "NON-TAXABLE DISTRIBU-

TIONS" in a corrected copy of Form 1099-DIV for 1993.

     Petitioners reported as dividend income in their 1993 return

the entire respective amounts of $1,440 and $240 that Mr. Haw-

thorne received from Centerior Energy and Portland General during

1993.
                                - 5 -

Dividends in Stock Under Dividend Reinvestment Programs

     Prior to the years at issue, petitioners enrolled in the

respective dividend reinvestment programs of various companies in

which they owned shares of stock.   Pursuant to those programs,

petitioners elected to receive dividends on those shares in

stock, rather than in cash.    Pursuant to those elections, peti-

tioners received dividends in the amounts of $8,324.76,

$8,123.74, and $8,759.81 during 1992, 1993, and 1994, respec-

tively, that were paid in stock.    They reported those respective

amounts as dividend income in their returns for those years.

Schedule C Income and Expenses Claimed by Petitioners

     Schedule C Income Claimed by Petitioners

     Around 1980, Mr. Hawthorne sold a motel and reported no gain

from that sale.   Pursuant to the terms of the real estate con-

tract relating to that sale, Mr. Hawthorne received $1,957.68 in

interest income during 1992.   Petitioners reported that income in

Schedule C of their 1992 return.    Petitioners did not report any

other income in that Schedule C or in the Schedules C of their

1993 and 1994 returns.

     Schedule C Expenses Claimed by Petitioners

     Mr. Hawthorne owned one or more real properties (properties)

in different locations throughout the United States, including

Cape Coral, Florida; Pagosa Springs, Colorado; and Elephant

Butte, Santa Fe, and Albuquerque, New Mexico.   Mr. Hawthorne and

petitioner Donelle C. Hawthorne (Ms. Hawthorne) owned one prop-

erty in Cape Coral, Florida, as community property.   At least
                               - 6 -

certain of the locations in which the properties were located

were vacation areas.   Mr. Hawthorne also owned certain mineral

rights in property located in Ohio.

     During the years at issue, Mr. Hawthorne did not sell any of

the properties or advertise any of them for sale.   Throughout

those years and thereafter to the time of the trial in this case,

Mr. Hawthorne had not decided what he wanted to do with any of

the properties (e.g., use as a vacation home, give away to family

members, retain, or sell), although he preferred to give the

properties away to family members, rather than pay tax on any

gains that he would realize if he sold or otherwise disposed of

them.

     Although Mr. Hawthorne had not decided what he wanted to do

with any of the properties, he performed a variety of services

under the name "Hawthorne Enterprises" with respect to certain of

those properties, for which he was not compensated.   Those

services included:   (1) With respect to certain property in

Florida, surveying the land and performing routine planning with

local government and with contractors; (2) with respect to

certain property in Colorado, installing a gas line and surveying

the land for a sewer line and a driveway; and (3) with respect to

certain property in New Mexico, installing a septic tank, sewer

lines, electrical wiring, balconies, garage doors, and a shingled

roof and building a fence and a driveway.   Mr. Hawthorne also

rented a warehouse in which he stored building materials used by

Hawthorne Enterprises.   In order to pay for the activities that
                                 - 7 -

he conducted under the name Hawthorne Enterprises, Mr. Hawthorne

deposited $1,000 every other month into a checking account in the

name of Hawthorne Enterprises.

     Petitioners claimed in Schedules C of their returns for

1992, 1993, and 1994 expenses that Mr. Hawthorne incurred under

the name Hawthorne Enterprises totaling $13,337.59, $13,098.76,

and $9,981.94, respectively.   Included in the expenses claimed in

Schedule C for 1992 were $716.32 for "Legal and professional

services", $2,775.04 for "Taxes and licenses", and $3,106.06 for

"Depreciation".   Included in the expenses claimed in Schedules C

for 1993 and 1994 were $3,621.18 and $2,064.25, respectively, for

"Taxes and licenses" and $3,106.06 for "Depreciation".

     In Schedules E of their 1992, 1993, and 1994 returns,

petitioners reported rental income and various expenses with

respect to certain real properties listed in those schedules,

including $549.32 claimed in Schedule E of their 1992 return for

"Legal and other professional fees" with respect to property

identified as "315 Princeton S E, Albq".

Notices of Deficiency

     In the notice of deficiency (notice) issued to petitioners

for 1992, respondent, inter alia, disallowed all of the expenses

that petitioners claimed in Schedule C of their return for that

year because respondent determined that those expenses were not

incurred in the operation of a trade or business.   However,

respondent allowed petitioners to include those disallowed

Schedule C expenses as Schedule A deductions subject to appropri-
                                - 8 -

ate adjustments for the 2-percent adjusted gross income limita-

tion for miscellaneous deductions under section 67(a)2 and the 3-

percent adjusted gross income limitation under section 68(a).3

Respondent also determined, inter alia, in the notice for 1992

that certain interest income that Mr. Hawthorne received during

that year and reported in Schedule C of petitioners' 1992 return

is Schedule B interest income for that year.

     In the notice issued to petitioners for 1993 and 1994,

respondent, inter alia, disallowed all of the expenses that

petitioners claimed in Schedules C of their returns for those

years because petitioners did not establish that those expenses

were ordinary and necessary expenses incurred in the ordinary

course of business.   Respondent did not allow petitioners to

include any of those disallowed Schedule C expenses as Schedule A

deductions for 1993 and 1994.

                                OPINION

     Petitioners bear the burden of proof on the issues pre-

sented.   Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933).   Petitioners attempted to satisfy their burden of proof

through testimonial and documentary evidence.   Except for ex-

tremely limited testimony from Ms. Hawthorne, Mr. Hawthorne was

2
   All section references are to the Internal Revenue Code in
effect for the years at issue. All Rule references are to the
Tax Court Rules of Practice and Procedure.
3
   Respondent conceded at trial that $2,775.04 of real estate
taxes that petitioners claimed in Schedule C of their 1992 return
and that respondent allowed in Schedule A are not subject to the
2-percent adjusted gross income limitation for miscellaneous
deductions under sec. 67(a).
                               - 9 -

the only witness.   We found Mr. Hawthorne's testimony to be

general, conclusory, and/or vague in certain material respects.

Before turning to the various issues presented, we note that we

have considered all of petitioners' arguments that are not

discussed herein and find them to be without merit.

Cash Distributions on Certain Stock

     Petitioners reported as dividend income (1) in their return

for 1992 all cash distributions that Mr. Hawthorne received from

Gulf States during that year and (2) in their return for 1993 all

cash distributions that he received from Centerior Energy and

from Portland General during that year.    With respect to the cash

distributions that Mr. Hawthorne received during 1992 from Gulf

States, petitioners contend that those distributions are liqui-

dating distributions, and not dividends.   With respect to $609.91

of the cash distributions totaling $1,440 that Mr. Hawthorne

received from Centerior Energy and all of the cash distributions

that he received from Portland General during 1993, petitioners

contend that those distributions do not constitute dividend, or

any other kind of, income.   That is because, according to peti-

tioners, the respective payors of those cash distributions

reported them in corrected Forms 1099-DIV as nontaxable distribu-

tions.

     Turning first to the cash distributions that Mr. Hawthorne

received from Gulf States during 1992 on the shares of preferred

stock that he owned in that company, the record establishes that

Gulf States reported those distributions in Form 1099-DIV as
                               - 10 -

dividends.   To support their position that those distributions

are liquidating distributions, and not dividends, and that that

form is wrong, petitioners rely principally on a letter to

stockholders from Entergy, dated June 19, 1992.    That letter

describes an agreement between Entergy and Gulf States to form a

holding company that would acquire all of the outstanding common

stock of Entergy and Gulf States and that would own all of the

common stock of Gulf States after the closing of the transaction.

The letter in question stated in pertinent part:    "Each of the

share of GSU [Gulf States] preferred stock outstanding at closing

will continue as outstanding stock of GSU."   Thus, the preferred

stockholders of Gulf States, including Mr. Hawthorne, remained as

such after the transaction described in that letter was closed

and were unaffected thereby.   On the present record, we find that

petitioners have failed to show that the cash distributions that

Mr. Hawthorne received during 1992 from Gulf States are not

dividends.

     Turning now to the respective cash distributions at issue

that Mr. Hawthorne received during 1993 from Centerior Energy and

from Portland General, which petitioners reported as dividend

income in their 1993 return and which they now claim are not

taxable, respondent does not dispute on brief that those distri-

butions do not constitute dividend income.    However, respondent

disputes petitioners' position that those distributions are not

taxable.   According to respondent, the respective cash distribu-

tions at issue from Centerior Energy and from Portland General
                              - 11 -

constitute gains from the sale or exchange of property under

section 301(c)(3)(A) because petitioners have failed to establish

the respective bases that Mr. Hawthorne had in the shares of

common stock which he owned in Centerior Energy and in Portland

General.   Consequently, according to respondent, there is no

basis in any of those shares against which to apply the respec-

tive cash distributions at issue that he received from those

companies pursuant to section 301(c)(2).   We agree with respon-

dent.4

     Petitioners have not introduced any evidence regarding Mr.

Hawthorne's respective bases in the shares of common stock of

Centerior Energy and of Portland General which he owned and with

respect to which those companies made cash distributions to him

during 1993.   On the record before us, we find that petitioners

have failed to satisfy their burden of establishing that $609.91

of the cash distributions totaling $1,440 that Mr. Hawthorne

received from Centerior Energy and all of the cash distributions

that he received from Portland General during 1993 are not

includible in petitioners' income for 1993.   On that record, we

4
   We note that the corrected copy of Form 1099-DIV which
Portland General sent to Mr. Hawthorne explained the tax
treatment of amounts that were identified in that form as "NON-
TAXABLE DISTRIBUTIONS", as follows:

     This part of the distribution is nontaxable because it
     is a return of your cost (or other basis). You must
     reduce your cost (or other basis) by this amount for
     figuring gain or loss when you sell your stock. But if
     you get back all your cost (or other basis), you must
     report future nontaxable distributions as capital
     gains, even though this form shows them as nontaxable.
     * * *
                                - 12 -

sustain respondent's position on brief that those distributions

are gains from the sale or exchange of property.     Sec. 301(c)(2)

and (3)(A).

Dividends in Stock Under Dividend Reinvestment Programs

     Prior to the years at issue, petitioners enrolled in the

respective dividend reinvestment programs of various companies in

which they owned shares of stock.    Pursuant to those programs,

petitioners elected to receive dividends on those shares in

stock, rather than in cash.   Pursuant to those elections, peti-

tioners received dividends in the amounts of $8,324.76,

$8,123.74, and $8,759.81 during 1992, 1993, and 1994, respec-

tively, that were paid in stock.    They reported those respective

amounts as dividend income in their returns for those years.

Petitioners now claim that their return positions for the years

at issue were wrong and that those dividends in stock are not

includible in their income for those years.    Respondent dis-

agrees.

     Where dividends from a corporation are payable, at the

election of a stockholder, in stock or property, the distribution

of such dividends will be treated as a distribution of property

to which section 301 applies.    Sec. 305(b)(1).   On the record

before us, we find that the dividends in stock that petitioners

received under dividend reinvestment programs constitute dividend

income, as reported in their returns for the years at issue.       Id.
                              - 13 -

Schedule C Income and Expenses Claimed by Petitioners

     Schedule C Income Claimed by Petitioners

     Around 1980, Mr. Hawthorne sold a motel and reported no gain

from that sale.   Pursuant to the terms of the real estate con-

tract relating to that sale, Mr. Hawthorne received $1,957.68 in

interest income during 1992, which petitioners reported in

Schedule C of their 1992 return.   Respondent determined in the

notice that that interest income is Schedule B interest income

for 1992.   Petitioners contend that that determination is wrong.

     On the record before us, we find that petitioners have

failed to show that the interest income in question was attribut-

able to the carrying on of a trade or business at the time around

1980 when Mr. Hawthorne sold the motel or at any other time.

Accordingly we sustain respondent's determination in the notice

that that interest income for 1992 is Schedule B interest income.

     Schedule C Expenses Claimed by Petitioners

     In Schedules C of their 1992, 1993, and 1994 returns,

petitioners claimed expenses totaling $13,337.59, $13,098.76, and

$9,981.94, respectively.   Included in the expenses claimed in

Schedules C for 1992 were $716.32 for "Legal and professional

services", $2,775.04 for "Taxes and licenses", and $3,106.06 for

"Depreciation".   Included in the expenses claimed in Schedules C

for 1993 and 1994 were $3,621.18 and $2,064.25, respectively, for

"Taxes and licenses" and $3,106.06 for "Depreciation".

     In the notice for 1992, respondent disallowed all of the

expenses that petitioners claimed in Schedule C of their return
                               - 14 -

for that year because respondent determined that those expenses

were not incurred in a trade or business.   However, respondent

allowed petitioners to include those expenses as Schedule A

deductions subject to the 2-percent adjusted gross income limita-

tion for miscellaneous deductions under section 67(a) and the 3-

percent adjusted gross income limitation under section 68(a).5

In the notice for 1993 and 1994, respondent disallowed all the

expenses that petitioners claimed in Schedules C of their returns

for those years because petitioners did not establish that those

expenses were ordinary and necessary expenses incurred in the

ordinary course of business.   In that notice, respondent did not

allow petitioners to include any of those disallowed expenses as

Schedule A deductions.

     Petitioners contend that respondent improperly disallowed

the Schedule C expenses that they claimed for the years at issue.

Petitioners also assert that they are entitled for 1992 to

additional expenses of $323.97 and $200 for legal fees and

engineering fees, respectively, that they did not claim in

Schedule C of their return for that year.   Respondent disagrees.

     Deductions are strictly a matter of legislative grace, and

petitioners bear the burden of proving that they are entitled to

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

79, 84 (1992).   Section 162(a) allows a deduction for ordinary

and necessary expenses paid or incurred during the taxable year

5
   See supra note 3 for respondent's concession regarding the
real estate taxes of $2,775.04 that petitioners claimed in
Schedule C of their 1992 return.
                               - 15 -

in carrying on a trade or business.     An activity qualifies as a

trade or business if the taxpayer's primary purpose for engaging

in the activity is for income or profit and the activity is

performed with continuity and regularity.     Commissioner v.

Groetzinger, 480 U.S. 23, 35 (1987).    A hobby does not qualify as

a business.   Id.   Determining whether a taxpayer's activities

rise to the level which constitutes "carrying on a business"

requires an examination of the facts in each case.     Higgins v.

Commissioner, 312 U.S. 212, 217 (1941).

     In determining the nature of a taxpayer's activities with

respect to real property, courts consider the following factors:

     the nature and purpose of the acquisition of the prop-
     erty and the duration of the ownership; the continuity
     of sales or sales-related activity over a period of
     time; the volume and frequency of sales; the extent to
     which the taxpayer or his agents have engaged in sales
     activities by developing or improving the property,
     soliciting customers, and advertising; and the substan-
     tiality of sales when compared to other sources of
     taxpayer's income. * * * [Polakis v. Commissioner, 91
     T.C. 660, 670 (1988).]

     Although during the years at issue Mr. Hawthorne performed a

variety of services relating to certain of the properties, for

which he was not compensated, he did not sell, or advertise for

sale, any of those properties during those years.    Indeed, Mr.

Hawthorne had not decided throughout the years at issue and

thereafter to the time of the trial in this case what he wanted

to do with the properties in question, although he preferred to

give them away to family members, rather than pay tax on any

gains that he would realize if he sold or otherwise disposed of

them.   On the record before us, we find that petitioners have
                              - 16 -

failed to show (1) that Mr. Hawthorne was engaged during the

years at issue in carrying on a trade or business with respect to

the properties in question within the meaning of section 162 and

(2) that the claimed expenses are ordinary and necessary expenses

paid or incurred in carrying on a trade or business within the

meaning of that section.   Consequently, we sustain respondent's

determinations disallowing the deductions that petitioners

claimed in Schedules C of their returns for the years at issue6

and reject their position that they are entitled to additional

Schedule C deductions for 1992 for legal and engineering fees.7

6
   Consistent with respondent's concession at trial with respect
to the real estate taxes claimed by petitioners in Schedule C of
their 1992 return, see supra note 3, respondent concedes on brief
that if the Court were to find that the expenses claimed by
petitioners in Schedules C of their returns for 1993 and 1994 are
not deductible under sec. 162, the expenses that they claimed in
those schedules for "Taxes and licenses", which consisted of real
estate taxes, would be deductible as itemized Schedule A
deductions that are not subject to the 2-percent adjusted gross
income limitation for miscellaneous deductions under sec. 67(a).
7
   Even if petitioners had established that they are otherwise
entitled under sec. 162 to the claimed Schedules C expenses for
the years at issue, they have not established on the record
before us that those expenses are currently deductible. See sec.
1.446-1(a)(4)(ii), Income Tax Regs.

  With respect to the additional legal and engineering fees that
petitioners are claiming for 1992, even if petitioners had shown
that they are entitled under sec. 162 to those fees as Schedule C
expenses, we find on the instant record that petitioners have
failed to prove that they did not already claim those fees in
Schedule C or Schedule E of their 1992 return.

  With respect to the depreciation that petitioners claimed in
Schedules C of their returns for 1993 and 1994, even if
petitioners had established (1) that the properties were used in
a trade or business or (2) that they were held for the production
of income, which we find below they have not, we find on the
present record that petitioners have not established their
                                                   (continued...)
                              - 17 -

     Petitioners contend in the alternative that if the Court

were to sustain respondent's determinations disallowing the

expenses that they claimed in Schedules C of their 1993 and 1994

returns, they should be allowed to deduct those expenses as

Schedules A deductions for those years.   Respondent disagrees

except for the real estate taxes conceded by respondent, see

supra note 6.

     Section 212(2) allows a deduction for all the ordinary and

necessary expenses paid or incurred during the taxable year for

the management, conservation, or maintenance of property held for

the production of income.   Whether property is held for the

production of income is a question of fact to be determined from

all the facts and circumstances.   Sec. 1.212-1(c), Income Tax

Regs.   In order to be entitled to a deduction under section

212(2), the taxpayer must have a bona fide profit-making motive

in holding the property in question.   Riss v. Commissioner, 56

T.C. 388, 421 (1971), affd. in part and remanded 478 F.2d 1160

(8th Cir. 1973), and affd. sub nom. Commissioner v. Transport

Manufacturing & Equip. Co., 478 F.2d 731 (8th Cir. 1973).

     We have found that throughout the years at issue and there-

after to the time of the trial in this case Mr. Hawthorne had not

decided what to do with the properties.   On the present record,


7
 (...continued)
respective bases in the properties and have not shown how any
such bases are to be allocated between nondepreciable land and
depreciable buildings. Consequently, they are not entitled under
sec. 167 to depreciation deductions with respect to the
properties for 1993 and 1994.
                              - 18 -

we find that petitioners did not prove that during the years at

issue Mr. Hawthorne was holding those properties for the produc-

tion of income.   We further find that, except for the real estate

taxes conceded by respondent, see supra note 6, they are not

entitled for 1993 and 1994 to deduct as Schedule A deductions the

expenses that they claimed in Schedules C of their returns for

those years.8

     To reflect the foregoing and the concessions of the parties,



                                         Decisions will be entered

                                    under Rule 155.




8
   In so holding, we reject petitioners' contention that they
should be allowed to deduct as Schedule A deductions the Schedule
C expenses that respondent disallowed for 1993 and 1994 because
in the notice for 1992 respondent allowed petitioners to deduct
as Schedule A deductions the Schedule C expenses that respondent
disallowed for that year. Respondent's determination for 1992
does not bind this Court for 1993 and 1994.
