                       T.C. Memo. 1996-103



                     UNITED STATES TAX COURT



          D. SHERMAN AND MAXINE M. COX, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 30187-91.                  Filed March 6, 1996.


     John W. Schwartz, Jr., for petitioners.

     Anthony Gasaway, for respondent.


                       MEMORANDUM OPINION

     GOLDBERG, Special Trial Judge:     This case is before the

Court on petitioners' motion for an award of reasonable

litigation and administrative costs under section 7430.1    The

merits of the underlying case were decided in Cox v.
Commissioner, T.C. Memo. 1993-326, filed July 22, 1993, and to

the extent necessary for the disposition of this motion, the



1
     All section references are to the Internal Revenue Code for
the year in issue. All Rule references are to the Tax Court
Rules of Practice and Procedure.
                                  2

facts and holdings in T.C. Memo. 1993-326 are incorporated by

this reference.

     The issue in the prior case was whether petitioner D.

Sherman Cox (Mr. Cox) was entitled to deduct payments made to his

wife petitioner Maxine M. Cox (Mrs. Cox), and on behalf of his

law practice, for the rental of property owned by Mr. and Mrs.

Cox as tenants by the entireties.     The property at issue was

located in St. Louis, Missouri, and purchased by petitioners in

November 1980.    Mr. Cox's law practice occupied and paid "rent"

of $18,000 to petitioners for the property during 1987.     On their

joint 1987 Federal income tax return, petitioners reported

receipt of the $18,000 in rental income on their Schedule E.      Mr.

Cox reported the $18,000 in rental payments on his Schedule C for

his law practice as an ordinary and necessary business expense.

     Respondent disallowed the Schedule C rental expense of

$18,000 in its entirety because the payments were made for the

use of property to which Mr. Cox has title and in which he holds

an equity interest.   Respondent also deleted the corresponding

rental income reported by petitioners on Schedule E.     Contrary to

the positions argued by both petitioners and respondent, we held

that based on petitioners' interest in the property, as

determined by Missouri law and under section 162(a), Mr. Cox was

entitled to deduct one-half of the payments, and, in turn, one-

half of the payments was reportable as rental income on the joint

return.
                                  3

     Section 7430, as amended by the Technical and Miscellaneous

Revenue Act of 1988, Pub. L. 100-647, sec. 6239, 102 Stat. 3342,

3743-3746 (applicable to proceedings commenced after November 10,

1988), provides that in any court proceeding brought by or

against the United States, the "prevailing party" may be awarded

reasonable litigation costs.   To be a prevailing party,

petitioners must establish:    (1) That the position of the United

States in the proceeding was not substantially justified; (2)

that they substantially prevailed with respect to the amount in

controversy or with respect to the most significant issue

presented; and (3) that they met the net worth requirements of 28

U.S.C. section 2412(d)(2)(B)(1994) on the date the petition was

filed.   Sec. 7430(c)(4)(A).   In addition to being the prevailing

party, petitioners must establish that they exhausted the

administrative remedies available to them within the Internal

Revenue Service (IRS), that they did not unreasonably protract

the proceeding, and that the costs claimed are reasonable.    Sec.

7430(b)(1), (4), (c).   Petitioners must establish all of the

above elements in order to recover.   See Minahan v. Commissioner,

88 T.C. 492, 497 (1987); Prager v. Commissioner, T.C. Memo.

1994-420.

     For purposes of petitioners' motion, respondent concedes

that petitioners have exhausted their administrative remedies as

required by section 7430(b)(1) and have satisfied the net worth

requirement of section 7430(c)(4)(A)(iii).   Respondent further

concedes that petitioners have not unreasonably protracted these
                                  4

proceedings.   The issues remaining for our decision, therefore,

are (1) whether petitioners substantially prevailed as to the

amount in controversy or most significant issue, and (2) whether

the position of respondent was substantially justified.

     Section 7430(c)(7)(A) defines the "position of the United

States" to mean (A) the position taken by the United States in a

judicial proceeding (to which the section applies) and (B) the

position taken in an administrative proceeding (to which the

section applies) as of the earlier of (i) the date of the receipt

by the taxpayer of the notice of the decision of the Internal

Revenue Service Office of Appeals or (ii) the date of the notice

of deficiency.   In this case, there was no separate notice from

the IRS Office of Appeals prior to the issuance of the notice of

deficiency.    Therefore, for purposes of section 7430, the United

States is considered to have taken a position in the

administrative proceeding on October 11, 1990, the date the

notice of deficiency was issued by respondent.

     For civil tax cases commenced after December 31, 1985,

section 1551(d)(1) of the Tax Reform Act of 1986, Pub. L. 99-514,

100 Stat. 2085, 2752, changed the language referring to the

position of the United States from "unreasonable" to "not

substantially justified".   However, this Court has held that the

substantially justified standard does not represent a departure

from the reasonableness standard.     Sokol v. Commissioner, 92 T.C.

760, 763-764 n.7 (1989); Sher v. Commissioner, 89 T.C. 79, 84

(1987), affd. 861 F.2d 131 (5th Cir. 1988).
                                 5

     Petitioners bear the burden of proving that the position of

respondent was not substantially justified.    Rule 232(e); Baker

v. Commissioner, 83 T.C. 822, 827 (1984), vacated and remanded on

other grounds 787 F.2d 637 (D.C. Cir. 1986).   In order to meet

this burden, petitioners must show that legal precedent does not

substantially support the position of respondent given the facts

available to respondent.   Coastal Petroleum Refiners, Inc. v.

Commissioner, 94 T.C. 685, 688 (1990); DeVenney v. Commissioner,

85 T.C. 927, 930 (1985).   A determination of reasonableness must

be based upon all the facts and circumstances, as well as any

legal precedents relating to the case.   DeVenney v. Commissioner,

supra.   We may consider, among other factors, whether respondent

used the costs and expenses of litigation to extract unjustified

concessions from petitioners, whether respondent pursued the

litigation to harass or embarrass petitioners, or whether

respondent pursued the litigation for political reasons.      Rutana

v. Commissioner, 88 T.C. 1329 (1987); DeVenney v. Commissioner,

supra.   A position is "substantially justified" when it is

"justified to a degree that could satisfy a reasonable person".

Pierce v. Underwood, 487 U.S. 552, 565 (1988).    It is not enough

that a position simply possesses enough merit to avoid sanctions

for frivolousness;   it must have a "reasonable basis both in law

and fact".   Id.; see, e.g., Hanson v. Commissioner, 975 F.2d

1150, 1153 (5th Cir. 1992).

     Respondent's loss or concession of an issue does not, ipso

facto, render respondent's position not substantially justified.
                                 6

Wilfong v. United States, 991 F.2d 359, 364 (7th Cir. 1993);

Sokol v. Commissioner, supra at 767; Wasie v. Commissioner, 86

T.C. 962, 969 (1986).   The fact that respondent did not prevail

in the underlying litigation does not require a determination

that respondent's position was unreasonable, Broad Ave. Laundry &

Tailoring v. United States, 693 F.2d 1387, 1391 (Fed. Cir. 1982);

however, it remains a factor to be considered, Heasley v.

Commissioner, 967 F.2d 116, 120 (5th Cir. 1992), affg. in part

and revg. in part T.C. Memo. 1991-189; Estate of Perry v.

Commissioner, 931 F.2d 1044, 1046 (5th Cir. 1991); Powers v.

Commissioner, 100 T.C. 457, 471 (1993).

     Respondent's position was that petitioners were not entitled

to deduct a rental expense of $18,000 on the Schedule C for the

law practice of Mr. Cox because, under section 162(a)(3), Mr. Cox

is not permitted to deduct payments attributable to property in

which he owns an equity interest.    Respondent contended that by

deducting the rental payments as ordinary and necessary business

expenses and reporting a corresponding amount as rental income on

their Schedule E, petitioners were converting ordinary income

into passive income to take advantage of what otherwise would be

unused passive losses under section 469.   Respondent also argued

that because petitioners filed a joint return, they are precluded

from reallocating income among one taxable unit.   Petitioners

argued that a tenancy by the entirety exists as a separate legal

entity with which Mr. Cox's law practice may contract, and, thus,

their deduction of the rental payments should be allowed.
                                    7

      Citing U.S. Fidelity & Guar. Co. v. Hiles, 670 S.W.2d 134,

137 (Mo. Ct. App. 1984) and Rezabek v. Rezabek, 192 S.W. 107 (Mo.

Ct.   App. 1917), we reasoned that Mrs. Cox was entitled to one-

half of the rental proceeds, whether paid by an outsider or by

her husband, from the property at issue under the State law of

Missouri.   We held that Mr. Cox was entitled to deduct one-half

of the rent paid, on his Schedule C for his law practice, as an

expense, but not the remaining half due to his equity interest in

the property rented.   We stated:

      This Court has never before had the specific issue in this
      case before us. We have held, however, where rental
      payments were made by outsiders, that each party in a
      tenancy by the entirety was entitled to report one-half of
      the proceeds thereon on separately filed returns. The
      issue, obviously, has previously arisen solely in the
      context of husband and wife filing separate returns, since
      prior to the enactment of section 469 regarding passive
      losses, the receipt by the wife of income would be offset by
      the deduction for rent by the husband where joint returns
      were filed.

Cox v. Commissioner, T.C. Memo. 1993-326 (emphasis added).    In

further support of our decision, we cited respondent's Rev. Rul.

74-209, 1974-1 C.B. 46, and Rev. Rul. 72-504, 1972-2 C.B. 90,

which provide that parties can deduct rentals paid on property in

which they hold some equity interest.

      In their motion for litigation costs, petitioners contend

that they substantially prevailed as to the amount in controversy

and most significant issue, and that respondent's position was

not substantially justified.   In support of the first contention,

petitioners claim that our decision in Cox v. Commissioner,

supra, established Mrs. Cox's rights and interest in the tenants
                                  8

by the entirety property, and thereby resulted in "a one-hundred

percent (100%) win" for petitioners.

     As discussed above, the issue in the underlying case was

whether Mr. Cox could deduct $18,000 of rental payments as an

ordinary expense and whether Mrs. Cox was required to report the

same $18,000 as passive rental income.    Respondent denied the

amount in full, both as an expense for Mr. Cox and as income to

Mrs. Cox, while petitioners argued that they were entitled to the

full amounts as claimed and reported on their 1987 joint Federal

income tax return.   We determined that Mr. Cox was entitled to

deduct one-half, or $9,000, of the rental payments while Mrs. Cox

was required to report the same amount as rental income.    In so

doing, we stated:    "We think that both petitioners and respondent

are incorrect in their treatment of this item.    Both, we believe,

have elevated form over reality."     Cox v. Commissioner, supra.

     Accordingly, petitioners did not achieve a "100 percent win"

in the underlying case.    Rather, if we were grading our decision

on a percentage scale, the results would be closer to 50 percent

for petitioners and 50 percent for respondent.    Therefore, it is

questionable whether petitioners substantially prevailed with

respect to the amount in controversy or the most significant

issue or set of issues presented.

     Even assuming, arguendo, that petitioners did substantially

prevail in the underlying case, we conclude that they would not

be entitled to litigation costs because respondent's position was

substantially justified.   Petitioners argue that the position of
                                   9

respondent was not substantially justified because respondent

failed to cite any authority for the position that the filing of

joint returns precluded petitioners from reallocating income and

expenses in the manner reported on their 1987 return.      In support

thereof, petitioners cite a portion of our decision in Cox v.

Commissioner, supra:

      Respondent has not, however, pointed us to any authority
      that the filing of a joint return somehow changes the basic
      tax nature of the items in question, and we simply believe
      that respondent is incorrect in her position. * * *

Id.   Petitioners also contend that respondent "consistently

ignored the Tenancy By The Entirety property and the attributes

and benefits that go with said property".      We find petitioners'

arguments to be without merit.

      First, although respondent failed to cite any authority for

her alternative argument regarding petitioners' joint return, we

clearly stated that the issue was one of first impression before

this Court.   Notwithstanding our disagreement with respondent's

argument, we recognized that there were no cases directly on

point with respect to the issue in the underlying case.      If the

law is unclear, or the question raised is one of first

impression, the Commissioner has greater justification to

litigate the matter.   See Stebco, Inc. v. United States, 939 F.2d

686, 688 (9th Cir. 1991); Blanco Invs. & Land, Ltd. v.

Commissioner, T.C. Memo. 1988-175.

      We believe respondent's position was incorrect, but that

petitioner has not shown that respondent's position lacked a

reasonable basis in fact or law.       Respondent's position was based
                                 10

on the language of section 162(a)(3), which prevents taxpayers

from deducting expenses for rental payments for property to which

the taxpayer has taken title or in which the taxpayer has equity,

and Missouri property law which provides that petitioners, as

tenants by the entireties, are each "'the owner of the entire

estate; neither of whom have any separate or joint interest'".

Morgan v. Finnegan, 87 F. Supp. 274, 276 (E.D. Mo. 1949), affd.

182 F.2d 649 (8th Cir. 1950) (quoting Murawski v. Murawski, 209

S.W.2d 262 (Mo. Ct. App. 1948)).      Respondent concluded that

because Mr. Cox owned an interest in the property rented, he was

not entitled to claim a deduction for payments attributable

thereto.   To prevent an inequitable situation, respondent also

deleted from Mrs. Cox's rental income the amount at issue.

     Petitioner argues that our decision in Cox v. Commissioner,

supra, established that respondent intentionally disregarded the

rights of married women in general, and Mrs. Cox, in particular,

by refusing to recognize that the marital community is a distinct

entity with which Mr. Cox and his law practice may contract.

This statement is incorrect.    In fact, we clearly stated that

"Petitioners, likewise, have failed to convince us that the

marital community is an entity separate and apart from petitioner

wife and petitioner husband."    Id.
                                11

     Accordingly, we conclude that the position of respondent was

substantially justified.   Thus, petitioners are not entitled to

administrative or litigation costs under section 7430.

Petitioners' motion will be denied.

                                              An appropriate order

                                         will be issued.
