                        T.C. Memo. 2000-104



                      UNITED STATES TAX COURT



        LAURO G. AND GAYLE W. GUADERRAMA, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

                STEVE H. BENAVIDEZ, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 16255-97, 20939-97.     Filed March 28, 2000.



     Towner Leeper, for petitioners in docket No. 16255-97.

     Ramon Acosta, for petitioner in docket No. 20939-97.

     Rosemary Schell, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   In separate notices of deficiency,

respondent took a protective position and determined deficiencies

in petitioners’ Federal income taxes as follows:
                                 - 2 -

          Docket No.      Year           Deficiency

          16255-97        1993               $35,452
                          1994                17,053
                                             1
          20939-97        1992                12,339
                          1993                 1,054
     1
       This amount is based on a $16,046 adjustment to income
under the indirect method (the source and application of funds
method). In the stipulation of facts, however, respondent and
petitioner Steve H. Benavidez (Benavidez) agree that Benavidez
failed to report taxable income of $8,646, rather than $16,046,
for the 1992 taxable year.

     These cases have been consolidated for purposes of trial,

briefing, and opinion.

     After concessions by Benavidez,1 the issue for our

consideration is whether the transaction between petitioners

should be treated as a sale-leaseback or a financing arrangement.

                         FINDINGS OF FACT2

     Petitioners Lauro and Gayle Guaderrama (the Guaderramas) and

Benavidez resided in Las Cruces, New Mexico, at the time their

petitions were filed in these consolidated cases.

     Prior to 1991, Benavidez owned a restaurant and bar called

Steve’s Tavern.   Steve’s Tavern burned down in 1989.     Steve’s

Tavern was insured, and Benavidez received the insurance proceeds

approximately 6 to 8 months after the fire.      The insurance


     1
      The parties have stipulated that petitioner Steven H.
Benavidez (Benavidez) is not entitled to a deduction for
amortization of the cost of his liquor license.
     2
       The stipulation of facts and exhibits attached thereto are
incorporated herein by this reference.
                                - 3 -

proceeds, however, were not used to construct a new restaurant

and bar because by the time the insurance company paid Benavidez

the liquor license would have possibly lapsed due to inoperation

of the bar.

     Benavidez purchased a tract of real property located in Dona

Ana County, New Mexico, from Rodolfo Saenz (Saenz) to be the site

for a new restaurant and bar.   Under the contract dated July 31,

1990, Benavidez was to pay Saenz $35,000 for the land.   This

payment was structured to require a $10,000 downpayment, with the

$25,000 balance payable in equal annual installments of $6,594.94

for a period of 5 years, the first payment being due on July 15,

1991.   Saenz deeded the land to Benavidez on July 31, 1990.

     After obtaining the land from Saenz in July 1990, Benavidez

attempted to obtain financing through banks to build a new

restaurant but was turned down by two or three different banks.

The banks would not provide financing to Benavidez because they

were unwilling to accept the only asset he had--his liquor

license--as collateral.   Benavidez had purchased his liquor

license in 1985 for approximately $45,000.   The availability of

alcoholic beverages, in general, attracts more business to a

restaurant, and a liquor license can cost as much as $100,000 to

$200,000 in Dona Ana County, New Mexico.

     Consequently, Benavidez entered into negotiations with Lauro

Guaderrama (Guaderrama), a farmer in New Mexico during the years
                               - 4 -

in question, regarding construction of a new restaurant and bar

to be named Severo’s.   Guaderrama had never constructed

commercial property before, but he studied the proposed

transaction and concluded that it would be a good investment.

Guaderrama and Benavidez subsequently entered into several

agreements.   On July 26, 1991, Benavidez deeded the tract of land

in Dona Ana County to the Guaderramas.   Guaderrama then lent

Benavidez $25,000 to pay off the outstanding amount under the

real estate contract between Benavidez and Saenz.   On October 9,

1991, Guaderrama entered into a construction agreement with JVG

Construction Co. providing for the construction of Severo’s.    JVG

Construction Co. is operated by Guaderrama’s nephew, and

Guaderrama financed the construction of Severo’s with his

savings.   Benavidez designed the floor plan for Severo’s, while a

contractor designed the rest of the restaurant.

     On December 4, 1991, the Guaderramas leased the land in Dona

Ana County to L&G Investments Ltd. (L&G).   L&G, a New Mexico

corporation wholly owned by the Guaderramas, was incorporated on

December 13, 1991, and is structured as an S corporation for

Federal income tax purposes.   L&G does not have bank accounts and

did not file a Form 1120-S, U.S. Income Tax Return for an S

Corporation, for the 1993 tax year.

     On December 10, 1991, Benavidez sold his liquor license to

L&G for $10 and assigned the trade name “Severo’s” and its
                               - 5 -

telephone number to L&G for no consideration.   At the same time,

Guaderrama, as president of L&G, executed a lease with Benavidez

that provided for monthly rental payments of $3,031.34 by

Benavidez.   Although the lease agreement was between Benavidez

and L&G, Benavidez’ payments were made directly to Guaderrama.

Under the lease agreement, Benavidez agreed to make payments for

a period of 15 years.   The monthly payments represented an

amortization of the construction costs of Severo’s, calculated at

a 15-percent interest rate.   In a letter from Guaderrama’s

attorney, Steven Fairfield (Fairfield), to Benavidez, Fairfield

referred to the payments as Guaderrama’s costs plus an interest

component.   After 10 years, Benavidez had the option to purchase

Severo’s for 125 percent of the remaining balance.   Benavidez

intended to exercise the option to purchase Severo’s and sought

financing from the Small Business Administration (SBA).

     The lease agreement was subsequently amended in May and June

1992 to account for additions to Severo’s and loans made by

Guaderrama to Benavidez for furniture to be used in Severo’s.

The final lease agreement provided for monthly payments of

$3,821.70.   This monthly payment was based on Guaderrama’s total

construction costs of $272,237.26, which included the $25,000

that Guaderrama lent Benavidez to pay off the note for the land,

and again also included an interest component on Guaderrama’s

expenses at a rate of 15 percent.
                               - 6 -

     Under the lease agreement, all costs, expenses, and

obligations relating to Severo’s, including taxes, utilities, and

insurance, were to be paid by Benavidez.   Guaderrama was to be

indemnified by Benavidez for any costs or expenses paid by

Guaderrama.   If Severo’s was partially or totally destroyed and

had to be repaired or rebuilt, Benavidez was not allowed to abate

the rent.   Under the lease agreement, Guaderrama was not liable

for any damage to persons or property arising from any cause.

If there was an accident on the premises, Benavidez, not

Guaderrama, would be liable.

     The Guaderramas reported the transaction as a lease on their

Federal income tax returns for taxable years ending January 31,

1993 and 1994.   Benavidez reported the transaction consistent

with a financing arrangement on his Federal income tax return for

the 1992 and 1993 taxable years.

     Respondent took a protective position in his notices of

deficiency and with respect to the Guaderramas, treated the

transaction as a sale and with respect to Benavidez, treated the

transaction as a lease.   In the notice of deficiency issued to

the Guaderramas, respondent increased capital gain income for the

year ended January 31, 1993, and increased interest income for

the years ended January 31, 1993 and 1994.   In the notice of

deficiency issued to Benavidez, respondent disallowed interest

expense and depreciation deductions for the 1992 and 1993 taxable
                               - 7 -

years.   At the time the notices of deficiency were issued,

respondent believed the transaction was a sale of the premises,

liquor license, and equipment by the Guaderramas back to

Benavidez that resulted in capital gains.   After trial, however,

respondent in his brief took the position that Benavidez did not

relinquish ownership of the property and liquor license to the

Guaderramas, and therefore the transaction was not a sale, but

rather a financing arrangement between petitioners.

                              OPINION

     We must decide whether the parties’ transaction was in

substance a “sale-leaseback”3 or a financing arrangement.     The

Guaderramas contend that the transaction was a lease, while both

respondent and Benavidez contend that the transaction was a

financing arrangement.

I.   Standard of Proof

     Before we analyze the transaction, we must first determine

whether Benavidez or respondent should be allowed to ignore the


     3
       The transaction could not be a true sale-leaseback because
petitioner Lauro G. Guaderrama (Guaderrama) constructed a
building on the land that was transferred by Benavidez, and
therefore Severo’s was not “sold” to Guaderrama and then
subsequently leased back to Benavidez. However, when taking into
account the transfer by Benavidez of the land, liquor license,
trade name and telephone number, all of which petitioners Lauro
G. and Gayle W. (the Guaderramas) argue were subsequently
“leased” back to Benavidez, the form of this transaction is
analytically similar to a sale-leaseback. Thus, it is
appropriate to consider those factors traditionally associated
with sale-leaseback transactions for purposes of determining the
proper characterization of this transaction.
                               - 8 -

transactional form where, as here, the transaction was labeled a

“lease”.   A party seeking to overcome the form of an agreement

must present “strong proof” for the substance to prevail.     Ullman

v. Commissioner, 264 F.2d 305, 308 (2d Cir. 1959), affg. 29 T.C.

129 (1957); Coleman v. Commissioner, 87 T.C. 178, 202 (1986),

affd. without published opinion 833 F.2d 303 (3d Cir. 1987).      A

party has adduced “strong proof” when he has essentially shown

that the terms of the written agreement do not have “some

independent basis in fact or some arguable relationship with

business reality such that reasonable * * * [people], genuinely

concerned with their economic future, might bargain for such an

agreement.”   Schulz v. Commissioner, 294 F.2d 52, 55 (9th Cir.

1961), affg. 34 T.C. 235 (1960).

     The Guaderramas argue that we should instead apply the more

restricted view of the Court of Appeals for the Third Circuit in

Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), vacating

and remanding 44 T.C. 549 (1965).4     This Court, however, has

refused to apply the standard of Danielson except under the

holding of Golsen v. Commissioner, 54 T.C. 742, 756-757 (1970),



     4
       Under the “Danielson rule”, a party can challenge the tax
consequences of his or her agreement as construed by the
Commissioner only by adducing proof which in an action between
the parties to the agreement would be admissible to alter that
construction or to show its unenforceability because of mistake,
undue influence, fraud, duress, etc. See Commissioner v.
Danielson, 378 F.2d 771, 775 (3d Cir. 1967), vacating and
remanding 44 T.C. 549 (1965).
                               - 9 -

affd. 445 F.2d 985 (10th Cir. 1971), in cases appealable to the

Court of Appeals for the Third Circuit or other circuits which

have adopted Danielson.   Since the Court of Appeals for the Tenth

Circuit, to which this case is appealable absent stipulation to

the contrary, has not explicitly adopted Danielson, we decline to

apply that standard here.5

     In this case, one, namely petitioner Benavidez, of two

competing petitioners and respondent both seek to ignore the

transactional form.   We have observed that “the taxpayer may have

less freedom than the Commissioner to ignore the transactional

form that he has adopted.”   Bolger v. Commissioner, 59 T.C. 760,

767 n.4 (1973); Coleman v. Commissioner, supra at 202.     The

strong proof doctrine, however, is not applied to the

Government’s attack on the form of a transaction.     The present

case is a consolidated proceeding, and each petitioner is

litigating against the Government.     Because the form of the

transaction in this case is being attacked by the Government, and

because both the “lessor” and “lessee” are parties to this

proceeding, the strong proof doctrine is not applicable.     Cf.


     5
       The Guaderramas cite Munroe v. Commissioner, 961 F.2d 220
(10th Cir. 1992), as standing for the proposition that the Court
of Appeals for the Tenth Circuit has adopted Commissioner v.
Danielson, supra. Munroe, however, simply references Danielson
in a string citation and does not explicitly adopt the standard
enunciated in Danielson. Further, Munroe is an unpublished order
of the Court of Appeals which specifically states that it has no
precedential value. Thus, we do not read Munroe as adopting
Danielson.
                                - 10 -

Freeport Transport Inc. v. Commissioner, 63 T.C. 107 (1974)

(Danielson rule did not apply in circumstances in which both

parties to the agreement were before the Court and respondent did

not object to the presentation of evidence varying the terms of

the agreement); Peterson Machine Tool, Inc. v. Commissioner, 79

T.C. 72, 82 (1982) (“in view of the fact that both the buyer and

the sellers are parties to this proceeding, there is even less

reason to apply the ‘strong proof’ rule”).      Thus, this Court may

look to the substance of the transaction in order to determine

the correct tax consequences.    See Hamlin’s Trust v.

Commissioner, 209 F.2d 761, 764 (10th Cir. 1954) (“It is well

settled that the incidence of taxation depends upon the substance

of a transaction * * * that the Government may look at the

realities of a transaction and determine its tax consequences

despite the form or fiction with which it was clothed.”), affg.

19 T.C. 718 (1953).

II.   Sale-Leaseback or Financing Arrangement

      The Guaderramas contend that the documents in this case

label the transaction a lease, that they clearly possessed the

benefits and burdens of ownership of Severo’s, and therefore the

transaction should be viewed as a lease.   Benavidez, on the other

hand, argues that he possessed the benefits and burdens of

ownership of Severo’s and that the transaction should therefore

be viewed as a financing arrangement.    Respondent also takes the
                                - 11 -

position that the substance of the transaction is a financing

arrangement.

     As stated above, the labels used in formal written documents

do not necessarily control the tax consequences of a given

transaction; this Court may look to the substance of the

transaction in order to determine the correct tax consequences.

It is well established that the economic substance of a

transaction, rather than its form, controls for Federal tax

purposes.     See Gregory v. Helvering, 293 U.S. 465 (1935); Frank

Lyon Co. v. United States, 435 U.S. 561 (1978).     Thus, the fact

that the documents contain labels that the transaction is a lease

does not govern, and this Court must consider the substance of

the transaction between petitioners.6

         Whether a transaction is a sale-leaseback or a financing

arrangement for Federal tax purposes depends on all of the facts

and circumstances.     See Frank Lyon Co. v. United States, supra


     6
       Nominally, there are three parties to the transaction at
issue--the Guaderramas, Benavidez, and L&G. While some corporate
formalities with respect to L&G appear to have been satisfied,
L&G lacks any real economic involvement in this transaction. It
was incorporated after the transaction was completed, had no
employees, conducted no business, was formed solely for this
transaction and, according to Guaderrama, functioned for the
purpose of shielding the Guaderramas from liability for the
liquor sales. Furthermore, payments by Benavidez under the
“lease” were made directly to the Guaderramas. Despite the lack
of corporate formalities, however, it is unnecessary for us to
decide whether L&G should be disregarded for Federal tax purposes
because it is a pass-through entity and thus, any taxable income
from the transaction is attributed to the Guaderramas, the real
parties in interest to the transaction.
                              - 12 -

(the Supreme Court utilized a factual analysis in determining

that the transaction was a sale-leaseback).   This Court has

traditionally treated a sale-leaseback as a sham transaction if

the taxpayer was motivated by no business purpose other than tax

benefits and if the transaction has no economic substance because

no reasonable possibility of a profit exists.   See Rice’s Toyota

World Inc. v. Commissioner, 81 T.C. 184 (1983), affd. in part,

revd. in part 752 F.2d 89 (4th Cir. 1985).    In deciding whether a

transaction should be treated as a sale-leaseback or a financing

arrangement for Federal tax purposes, we often consider factors

such as:   (1) Whether the purchase price of the original sale-

leaseback received by the “lessee” is less than the fair market

value of the property; (2) who bears the risks and

responsibilities of ownership; (3) the terms under which the

payments are made; (4) whether the repurchase price is less than

the fair market value of the property; (5) who participates in

the profits or appreciation in value of the property; and (6) the

intent of the parties.   See, e.g., Helvering v. F.& R. Lazarus &

Co., 308 U.S. 252 (1939); Sun Oil Co. v. Commissioner, 562 F.2d

258 (3d Cir. 1977), revg. T.C. Memo. 1976-40; American Realty

Trust v. United States, 498 F.2d 1194 (4th Cir. 1974); Illinois

Power Co. v. Commissioner, 87 T.C. 1417 (1986); Hilton v.

Commissioner, 74 T.C. 305 (1980), affd. 671 F.2d 316 (9th Cir.
                               - 13 -

1982); Belz Inv. Co. v. Commissioner, 72 T.C. 1209 (1979), affd.

661 F.2d 76 (6th Cir. 1981).

       In examining whether the transaction between the two

petitioners was a sale-leaseback or a financing arrangement, we

find the following factors to be particularly persuasive:

Conveyance of the Liquor License

       In Helvering v. F.& R. Lazarus & Co., supra, the Supreme

Court found a transaction to be a financing arrangement instead

of a sale-leaseback in part because the instrument under which

the taxpayer purported to convey legal ownership to the bank was

in reality given and accepted as security.     Here, the conveyance

of the liquor license reflects a financing arrangement rather

than a bona fide arm’s-length sale.     While Benavidez purchased

the liquor license for approximately $45,000, the purchase price

paid by Guaderrama to Benavidez for the liquor license was only

$10.    According to Benavidez, liquor licenses in Dona Ana County

currently average between $100,000 to $200,000.     While we do not

necessarily accept Benavidez’ testimony as establishing the worth

of a New Mexico liquor license, the fact that Guaderrama was

willing to hold it as collateral towards an approximately

$272,000 debt indicates that $10 is far from its fair market

value.    Thus, although legal title of the liquor license may have

been transferred to Guaderrama, it was not an arm’s-length
                               - 14 -

purchase, but rather simply a transfer of property to be held as

collateral in a financing arrangement.

Risks and Responsibilities

     For purposes of determining the tax consequences of the

transaction, another factor we consider is who bears the risks

and burdens of ownership.    Under the arrangement between the two

parties, Benavidez is responsible for all taxes, utilities, and

insurance and assumed the full burden and cost of keeping the

premises in good condition.   Benavidez is also responsible for

all repairs or any damage to the premises, and Guaderrama is not

liable for any damage to persons or property arising from any

cause whatsoever.   Benavidez agreed to indemnify and hold

harmless Guaderrama from any and all claims and liability for

damage to persons or property arising from any cause.   Moreover,

diminution of rental payments even in the event of a casualty or

total destruction is not allowed.   Thus, inconsistent with

customary leases, this “lease” imposes essentially all of such

burdens, risks, and responsibilities for the property upon

Benavidez.

The Terms of the Payments

     The rental payment in this transaction is based on the

construction costs of the restaurant plus 15 percent interest.

The inclusion of an interest component is indicative of a

financing arrangement.   See Judson Mills v. Commissioner, 11 T.C.
                              - 15 -

25 (1948).   Under the terms of the “lease”, payments are to be

made over a 15-year period, beginning in May 1992, and consist of

monthly payments of $3,821.70.   In determining the monthly

payment, the cost of construction, $272,237.26, was amortized

over a 15-year period at a 15-percent interest rate.    The rents

have no ascertainable connection to the economic value of the

property but instead are related to a fixed interest return on

the advances or costs of constructing the property.    This is

consistent with a financing arrangement, not a lease.

The Option To Purchase

     A repurchase provision of a sale-leaseback transaction often

serves the same function as a loan when the repurchase price is

geared to the unamortized principal advanced by the “lessor”.

See Sun Oil Co. v. Commissioner, supra.     In this case, Benavidez

has the absolute right to purchase Severo’s and the liquor

license during the final 60 months of the term of the “lease”.

If the option is exercised, the purchase price of Severo’s is the

remaining balance due from Benavidez to Guaderrama plus an amount

equal to 25 percent of the unpaid balance.    Thus, the option to

purchase is directly related to the unpaid balance, not to the

fair market value of the property.     If Benavidez exercises the

option 1 month before the 15-year term ends, he can purchase

Severo’s for approximately $4,700, nowhere near the fair market
                               - 16 -

value of the going business concern.    This is indicative of a

financing arrangement, not a lease.

The Potential for Profit or Loss

     A significant factor to be used in determining ownership of

property is the extent to which the taxpayer has potential for

profit or loss as a result of holding the property.    See Frank

Lyon Co. v. United States, 435 U.S. at 579; Sun Oil Co. v.

Commissioner, 562 F.2d at 268.

     In this case, the transaction severely limits Guaderrama’s

ability to participate in any appreciation in the value of the

property.    Because of the repurchase option at less than fair

market value, it is a virtual certainty that Benavidez will

exercise the option and repurchase Severo’s.    Thus, any

appreciation in value will be realized by Benavidez, not

Guaderrama.    Furthermore, all rental payments are at a fixed

amount, with no allowance for inflation or increases in property

value.

     In addition, the transaction was structured so that profits

and losses resulting from the operation of the premises will

inure to Benavidez.    Benavidez owns the right to operate and use

the restaurant however he sees fit, and any profits or losses

resulting from the operation of the restaurant belong to

Benavidez.    Guaderrama, on the other hand, has a fixed rate of

return.   Regardless of how successful Severo’s is, Guaderrama is
                                - 17 -

entitled to the same amount of rent.     Thus, any appreciation in

the property over the term of the lease is likely to accrue to

Benavidez, not to Guaderrama, upon exercise of the option.

Guaderrama does not appear to be an equity participant with any

real profit or loss opportunities, and thus the transaction is

inconsistent with a lease.

Intent of the Parties

     The record indicates that Benavidez intended for this

transaction to be a financing arrangement.    He had sought

financing from banks on two or three separate occasions but had

been turned down because they would not accept the liquor license

as collateral.   Benavidez testified that it was his intent to

have Guaderrama finance the construction of the new restaurant

and for Benavidez to pay him back over a period of time.

     While Guaderrama’s intent is less clear, he indicated in his

testimony that he viewed the liquor license the same way that

Benavidez did--as collateral.    Guaderrama further explained that

he had been getting a return of 6 or 7 percent on his savings and

was willing to use his savings to build the restaurant for

Benavidez if he charged 15 percent interest as opposed to the 6

or 7 percent return he was receiving.    Thus, Guaderrama was

willing to finance the construction of Severo’s in exchange for a
                               - 18 -

15-percent return on his investment.7   This is consistent with a

financing arrangement.

Conclusion

     As “lessee”, Benavidez bore the burdens, risks, and

responsibilities for Severo’s, including the obligation to

provide Guaderrama with a fixed return under all circumstances

and conditions.   This is indicative of ownership, not of a

leasehold interest.    Structurally, the “lease” is very similar to

a debt financing as it contains a schedule of payments based on a

fixed interest rate.   Furthermore, the rents have no connection

with the economic value of the property, but instead they are

related to a fixed interest return on the costs of construction.

As such, the Guaderramas had little potential for economic profit

other than the fixed interest income.   Finally, the option to

acquire Severo’s at the end of the lease is, in essence, a form

of equity for Benavidez because the value to Guaderrama is really

just the present value of the future payments for 15 years at a

specified rate.

     Based on all of the factors discussed above, we conclude

that the transaction was a financing arrangement, and Benavidez

is entitled to deduct allowable depreciation and interest expense


     7
       We also note that, inconsistent with their belief that the
transaction was a lease, the Guaderramas did not claim
depreciation on Severo’s as they would have been entitled to had
they truly owned the premises and simply “leased” them to
Benavidez.
                                - 19 -

in connection with the financing arrangement, and the Guaderramas

must include interest income in connection with the financing

arrangement.

III.    Allocation of Payments Between Principal and Interest

       As an alternative argument, the Guaderramas contend that the

obligation owed by Benavidez was speculative and that they are

entitled to first recover their costs of the financing

arrangement.    The Guaderramas contend that since Benavidez had

insufficient assets to pay for the property, since his sole

source of funds was dependent on operating the new restaurant

successfully, since his liquor operation was shut down for a

period of time, and since his option to buy was nonassignable,

repayment by Benavidez was risky, and therefore they are entitled

to first recover their costs.    We disagree.

       The general rule is that “periodic payments are applied

first to interest, with any remaining amount being applied to

principal, absent any agreement of the parties to the contrary”.

Estate of O’Leary v. Commissioner, T.C. Memo. 1986-212, affd. 837

F.2d 1088 (5th Cir. 1988).    If, however, the obligation is

speculative, periodic payments may be applied to the principal

until costs are recovered.    See Underhill v. Commissioner, 45

T.C. 489, 492 (1966).    In Underhill we held that, in determining

whether a particular obligation is “speculative”, the ultimate

test is whether, at the debt’s inception, the creditor cannot be
                                - 20 -

reasonably certain of recovering the principal and a major

portion of the discount.     See id. at 495.   We are not persuaded

that the loan in the present transaction was speculative.

     The Guaderramas argue that Benavidez had insufficient assets

to exercise the option and purchase the property.     Insufficient

assets, however, is not the test of a speculative investment for

tax purposes.   In Estate of Ratliff v. Commissioner, T.C. Memo.

1995-428, we stated that “mere absence of security is not

sufficient to deem a loan speculative.”    In any event, we are not

convinced that Benavidez was unable to exercise the option to

purchase the property.     Indeed, Benavidez was approved for a loan

from the SBA in 1996 and was in a financial position where he

could have exercised the option.    Guaderrama was apparently aware

of this since Guaderrama’s attorney sent a letter to a bank

expressing interest in selling the property to Benavidez in order

to help Benavidez qualify for a loan.    Thus, the evidence in the

record suggests that Benavidez could have exercised the option.

     The Guaderramas further argue that Benavidez’ sole source of

funds was dependent on operating the new restaurant successfully,

making the likelihood of repayment speculative.     There is no

evidence, however, that Severo’s would not be successfully

operated by Benavidez.     As Guaderrama testified, he himself had

studied the transaction and decided that it would be a good

investment.   Thus, we find this argument unpersuasive.    We also
                               - 21 -

find unconvincing the Guaderramas’ argument that repayment was

risky because Benavidez had his liquor operation shut down for

some period of time.   It is unclear when Benavidez had his liquor

operation shut down.   Guaderrama testified that Benavidez’ bar

operations were shut down for a period of time, but he could not

recall when and stated that it was for “maybe a month or two”.

Such a vague recollection does not indicate to us that Guaderrama

was overly concerned with the temporary shutdown.    Furthermore,

it does not appear that Benavidez failed to make monthly payments

during any period of temporary shutdown, and the Guaderramas have

not offered any evidence to the contrary.

     Finally, we note that the loan to Benavidez was secured by

the liquor license.    The Guaderramas’ possession of such

collateral makes it difficult to argue that the loan was risky.

We therefore conclude that the obligation owed by Benavidez was

not speculative or risky, and the payments received by the

Guaderramas from Benavidez under the financing arrangement must

be allocated between principal and interest.

     To reflect the foregoing,

                                      Decisions will be entered

                                 under Rule 155.
