                         T.C. Memo. 1999-223



                       UNITED STATES TAX COURT



ALTON M. TOWLES, JR., AND ESTATE OF BARBARA D. TOWLES, DECEASED,
    ALTON M. TOWLES, PERSONAL REPRESENTATIVE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3889-98.               Filed July 6, 1999.



     B. Gray Gibbs, for petitioners.

     Monica Howland and J. Scott Simpson, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     CHIECHI, Judge:    Respondent determined the following de-

ficiencies in, and accuracy-related penalties under section

6662(a)1 on, petitioners' Federal income tax (tax):


     1
      All section references are to the Internal Revenue Code in
effect for the years at issue. All Rule references are to the
                                                   (continued...)
                                - 2 -


                                        Accuracy-Related
            Year     Deficiency              Penalty
            1994       $8,619                 $934
            1995       10,939                2,188

     The issues remaining for decision are:

     (1)   Are petitioners entitled for each of the years at issue

to deduct under section 212 certain expenditures that they made

during each of those years with respect to certain real property

that they owned?   We hold that they are not.

     (2)   Are petitioners liable for each of the years at issue

for the accuracy-related penalty under section 6662(a)?    We hold

that they are.

                         FINDINGS OF FACT

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

     At the time the petition was filed, Alton M. Towles (Mr.

Towles) resided in Florida.

     Around March 1991, Barbara D. Towles (Ms. Towles), who died

on August 19, 1997, and her husband Mr. Towles acquired certain

real property located at 18 Paradise Lane, Treasure Island,

Florida (Paradise Lane property), which was zoned as a multi-

family property.   Located on that property at that time was a

two-story building consisting of about 6,250 square feet that was

configured as six apartment units, all of which were being leased


     1
      (...continued)
Tax Court Rules of Practice and Procedure.
                               - 3 -


to different tenants (tenants).   At the time Ms. Towles and Mr.

Towles acquired the Paradise Lane property, four of those units

were located on the second floor of the building situated on that

property, and two of them were located on the ground floor of

that building.   Two of the four second-floor apartment units were

two-bedroom units, and two of them were one-bedroom units.    When

Ms. Towles and Mr. Towles acquired the Paradise Lane property and

throughout the years at issue, there were six parking spaces that

were under cover and two parking spaces that were not under cover

on that property.

     In March 1993, a so-called no-name storm (storm) occurred

that ripped the dock for the Paradise Lane property from its

concrete pilings and caused certain water and wind damage to the

two ground-floor apartment units, but no damage to the four

second-floor apartment units, at that property.   Because of the

storm damage to the two ground-floor apartment units, the oc-

cupants had to vacate those units while repairs were made to

them.   Those tenants were able to move back into those apartment

units within ten days to two weeks after the storm.

     Although petitioners had insurance coverage for loss of

business income with respect to the Paradise Lane property, they

made no claim for any income lost as a result of the storm.

     In mid-May 1993, all of the tenants of the apartment units

at the Paradise Lane property, except Adrienne Renee Nichols (Ms.
                                 - 4 -


Nichols), received eviction notices or were advised that their

leases were not being renewed, including Charles E. Alexander,

Jr. (Mr. Alexander) who had lived in a two-bedroom, second-floor

unit since March 1991.   In August 1993, the remaining tenant Ms.

Nichols, who had lived since June 1987 in a one-bedroom, second-

floor apartment unit at the Paradise Lane property, received a

notice that her lease was not being renewed.

     Ms. Towles and Mr. Towles separately informed Mr. Alexander

that he was being evicted because they were converting the

Paradise Lane property into their principal residence.   Although

neither Ms. Towles nor Mr. Towles ever informed Ms. Nichols why

her lease was not being renewed, three other tenants of three

apartment units at that property, including Mr. Alexander,

advised Ms. Nichols that Ms. Towles and/or Mr. Towles advised

them that their respective leases were not being renewed because

Ms. Towles and Mr. Towles intended to convert the Paradise Lane

property into a single-family dwelling.   Neither Mr. Alexander

nor Ms. Nichols was ever informed that they were being asked to

vacate their respective apartment units because of storm damage

to the Paradise Lane property.

     On or about June 30, 1993, the tenants of five of the six

apartment units at the Paradise Lane property vacated their

respective apartment units pursuant to the notices that they had
                                - 5 -


received from Ms. Towles and Mr. Towles.    Ms. Nichols vacated her

apartment unit at that property on November 15, 1993.

     In September 1993, Ms. Towles and Mr. Towles moved into one

of the two ground-floor apartment units located at the Paradise

Lane property.   As of the time of the trial in this case, Mr.

Towles still resided at the Paradise Lane property.

     During the period July 1, 1993, until at least November 15,

1993, work that was unrelated to any damage from the storm that

occurred in March 1993 was done in the two two-bedroom, second-

floor apartment units at the Paradise Lane property, including

tearing down the walls within, and between, those two units and

gutting the kitchens and making structural changes to the bath-

rooms in those units.   By November 15, 1993, the two two-bedroom,

second-floor apartment units no longer existed.   Instead, the

wall between those units had been completely torn down so that

there was just one huge room where there had previously been two

apartment units.

     From the time he moved out of the apartment unit that he had

been renting at the Paradise Lane property on June 30, 1993,

until August 1996 when he moved to Miami Beach, Florida, Mr.

Alexander drove by the Paradise Lane property approximately ten

times a week.    During that period, he never saw either a for-sale

sign or a for-rent sign on that property.   From the time that she

moved out of the apartment unit that she was renting at the
                              - 6 -


Paradise Lane property on November 15, 1993, until the time of

the trial in this case, Ms. Nichols drove by the Paradise Lane

property every day on her way to work.   During that period, she

never saw either a for-sale sign or a for-rent sign on that

property.

     At some point during 1993, John L. Schultz, Jr. (Mr.

Schultz), a building code enforcement inspector for the City of

Treasure Island throughout 1993 and 1994 and most of 1995,

received a complaint that construction work was being done at the

Paradise Lane property without appropriate building permits.    Mr.

Schultz inspected that property and issued a stop work order on

April 5, 1994, with respect to "Changing use of six unit multi-

family to single family residence without permit".   Mr. Schultz

also sent a letter by certified mail to Ms. Towles and Mr.

Towles, dated June 29, 1994 (June 29, 1994 letter), regarding

"Multifamily Dwelling, 18 Paradise Lane".   That letter stated in

pertinent part:

          This letter is to inform you of the status of the
     above mentioned property owned by you. The "Stop Work
     Order" for construction without permits is still in
     effect. The Certified letter explaining your viola-
     tions and remedies sent to you on April 19, 1994 was
     returned unclaimed.

          The above dwelling is and will be considered a
     multifamily building with six units. To change from a
     six unit multifamily building to a single family res-
     idence, appropriate plans and permits must be submit-
     ted, approved and completed.
                               - 7 -


Mr. Schultz included in the last sentence quoted above a ref-

erence to changing the building to a single family residence

based upon statements that Mr. Towles had made to him.

     Prior to the trial in this case, Mr. Towles provided re-

spondent with a copy of what purported to be the June 29, 1994

letter.   Petitioner altered the copy of the June 29, 1994 letter

that he provided to respondent by whiting out, inter alia, the

following sentence from that letter:

     To change from a six unit multifamily building to a
     single family residence, appropriate plans and permits
     must be submitted, approved and completed.

     Around July 1997 and August 1998, Mr. Towles, who carried an

occupational license from the City of Treasure Island during the

years at issue until the time of the trial in this case, sub-

mitted to the building department of the City of Treasure Island

applications for building permits.     Those applications variously

described the proposed use of the Paradise Lane property as

"residence", "single family dwelling", and/or "home".    Attached

to the application for a building permit that Mr. Towles submit-

ted around August 1998 was a floor plan showing the second floor

of the building located on the Paradise Lane property.    That

floor plan did not describe any of the rooms on the second floor

as apartment units.   Instead, the rooms in that floor plan were

designated as "Living Room", "Dining Room", "Kitchen", "Pantry",
                                 - 8 -


"Family Room", "Study", "Bedroom", "Bath", "Dressing Room",

"Storage", and "Screen Porch".

     The zoning of the Paradise Lane property as a multifamily

property was grandfathered by the City of Treasure Island.    If

that property had been rezoned as a single-family residence, in

order for it to requalify as a multifamily property, it would

have to be rezoned as such.   The owner of property zoned by the

City of Treasure Island as a single-family residence is permitted

to obtain building permits from that city in order to do his/her

own building and repair work on such property.    The owner of

property zoned by the City of Treasure Island as a commercial

property, including multifamily property, is allowed to obtain

building permits from that city in order to do his/her own

building and repair work on such property only to the extent that

the total cost thereof does not exceed $25,000.

     The building located on the Paradise Lane property has not

been rented since the tenants moved out in 1993, nor has that

property been held out for rent since that time.

     With respect to the Paradise Lane property, during 1994 Ms.

Towles and Mr. Towles incurred legal expenses of $502.50, in-

surance expenses of $1,999.77, utility expenses of $804.35, a

license expense of $196, and power expenses of $2,150.86 and also

expended $43,569.84 for items, the nature of which is not dis-

closed by the record.   With respect to that property, during 1995
                               - 9 -


Ms. Towles and Mr. Towles incurred legal expenses of $4,332,

expenses for repairs and supplies of $2,038.40, utility expenses

of $1,927.99, landscaping expenses of $1,719.41, power expenses

of $2,731.84, and hazard insurance expense of $2,432.09 and also

expended $6,968.31 on items, the nature of which is not disclosed

by the record.

     Although Ms. Towles and Mr. Towles received rental income

from the Paradise Lane property for years prior to 1994, they did

not report any such income in their returns for those years.     Ms.

Towles and Mr. Towles filed a joint tax return (Form 1040) for

1994 and claimed in Schedule A a deduction in the amount of

$14,980 for "investment realty repair and maintenance costs."     In

1996, Ms. Towles and Mr. Towles filed an amended tax return (Form

1040X) for 1994 and claimed in Schedule E a rental loss of

$66,899.22.   Respondent has not accepted that amended return.

Ms. Towles and Mr. Towles filed a joint tax return for 1995 and

claimed in Schedule E a rental loss of $32,795.94.

     In the notice of deficiency issued to Ms. Towles and Mr.

Towles, respondent disallowed the deduction of $14,980 for

"investment, realty repair, and maintenance" costs that they

claimed in Schedule A of their 1994 return and the rental loss of

$32,7962 that they claimed in Schedule E of their 1995 return.



     2
      This amount was rounded to the nearest dollar.
                                - 10 -


Respondent also determined that they are liable for each of the

years at issue for the accuracy-related penalty under section

6662(a) on the underpayment for each of those years that is

attributable to, inter alia, that claimed Schedule A deduction

and that claimed rental loss.

                                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 the testimony of Mr. Towles and certain documentary

evidence.   Based on our observation of Mr. Towles' demeanor, we

did not find him credible.     Moreover, Mr. Towles' testimony was

contradicted by the testimony of Mr. Alexander and Ms. Nichols,

two of respondent's witnesses, and certain documentary evidence.

We found each of those two witnesses to be credible and their

testimony to be consistent.3    We also found Mr. Schultz, respon-

dent's remaining witness, to be credible.

     Petitioners contend that they are entitled to deduct under

section 212 the expenditures that the parties stipulated they




     3
      On Mar. 8, 1999, petitioners filed a motion to strike the
testimony of Mr. Alexander on the ground that he perjured himself
at the trial in this case. We shall deny that motion. Even if
we were to exclude the testimony of Mr. Alexander, our findings
and conclusions herein would not change.
                              - 11 -


made during 1994 and 1995 with respect to the Paradise Lane

property.   Respondent disputes that contention.

     Deductions are strictly a matter of legislative grace, and

petitioners bear the burden of proving that they are entitled to

the deductions claimed under section 212.    See INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992).    In the case of an in-

dividual, section 212 allows, inter alia, 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.    See sec. 212(2).

     The dispute between the parties is whether petitioners held

the Paradise Lane property during the years at issue for the

production of income within the meaning of section 212(2).    On

the record before us, we find that petitioners have failed to

show that that property was held for the production of income

within the meaning of that section.    We further find on that

record that petitioners have failed to establish that they are

entitled under section 212 to the deductions that they are

claiming for the years at issue.4




     4
      Assuming arguendo that petitioners had established that the
Paradise Lane property was held for the production of income
during 1994 and 1995, on the record before us, we find that
petitioners have failed to show that certain of the expenditures
incurred during those years do not constitute capital expendi-
tures that may not be deducted in their entirety for those years.
                             - 12 -


     Petitioners contend that they are not liable for each of the

years at issue for the accuracy-related penalty under section

6662(a) on the underpayment of tax for each such year that is

attributable to the deductions with respect to the Paradise Lane

property that they claimed in their returns for those years.    On

the record before us, we find that petitioners have failed to

establish that they had reasonable cause and that they acted in

good faith in claiming those deductions.   See sec. 6664(c)(1);

sec. 1.6664-4(a) and (b), Income Tax Regs.   We further find on

that record that petitioners have failed to show that they are

not liable for each of the years at issue for the accuracy-

related penalty under section 6662(a) on the underpayment of tax

for each such year that is attributable to the deductions with

respect to the Paradise Lane property that they claimed in their

1994 and 1995 returns.

     To reflect the foregoing and the concessions of the parties,

                                   An Order denying petitioners'

                              motion to strike testimony will be

                              issued, and decision will be

                              entered under Rule 155.
