                        T.C. Memo. 1997-84



                      UNITED STATES TAX COURT



       JANE B. OLIVER AND ROBERT P. OLIVER, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 19840-94.                  Filed February 19, 1997.



     Jane B. Oliver and Robert P. Oliver, pro sese.

     Charles Pillitteri, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     SCOTT, Judge:   Respondent determined deficiencies in

petitioners' Federal income taxes and additions to tax for the

taxable years 1990 and 1991 as follows:
                                       -2 -




                          Additions to Tax and Accuracy-Related Penalties
Year         Deficiency          Sec. 6651(a)(1)    Sec. 6662
1990          $29,155              $7,988              $5,831
1991           55,873              11,730              11,175

           Some of the issues were conceded or settled by the parties.

The issues presented for decision are:          (1) Whether petitioners

are entitled to casualty loss deductions for the taxable year

1991 caused by heavy rain and wind damage to their home and

personal property which occurred in 1988 and for flooding which

occurred in 1991 and, if so, the amounts of the losses sustained;

(2) whether petitioners are entitled to a casualty loss carryover

deduction for the taxable year 1990 caused by the heavy rain and

wind damage which occurred in 1988; (3) whether petitioners are

entitled to a business casualty loss deduction for computer and

computer-related equipment for the taxable year 1991 caused by

the flooding which occurred in that year; (4) whether petitioners

are entitled to a casualty loss deduction for the taxable year

1991 for damage caused by broken water pipes in their kitchen;

(5) whether petitioners are entitled to relief under section

165(i)1 with respect to casualty losses suffered by them during

the taxable year 1991; (6) whether petitioners failed to report a

casualty gain for the taxable year 1991 arising from flooding in



       All section references are to the Internal Revenue Code in
       1

effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
                               -3 -

February of 1991; (7) whether petitioners are entitled to

Schedule C business expense deductions for legal and professional

expenses of $10,000 claimed for 1990 and $13,000 for 1991; (8)

whether petitioners failed to report interest income of $2,824

for 1990; (9) whether petitioners are entitled to Schedule C

business expense deductions for self-employment tax of $7,849 for

1990 and $10,246 for 1991; (10) whether the assessment of a

deficiency for the taxable year 1990 is barred by the 3-year

period of limitations provided in section 6501(a); (11) whether

petitioners are liable for the additions to tax pursuant to

section 6651(a)(1) for failure to file timely Federal income tax

returns for 1990 and 1991; and (12) whether petitioners are

liable for accuracy-related penalties pursuant to section 6662(a)

for 1990 and 1991.

                         FINDINGS OF FACT

     Some of the facts have been stipulated and are found

accordingly.   The stipulation of facts and the attached exhibits

are incorporated herein by this reference.

     At the time the petition was filed in this case, Jane B.

Oliver and Robert P. Oliver resided in Greenville, Mississippi.

Petitioners, who are cash basis taxpayers, filed their joint

Federal income tax returns for the taxable years 1990 and 1991 on

August 19, 1991, and July 20, 1992, respectively.
                                 -4 -

Claimed Casualty Loss Deductions

       A.   Rain and Wind Damage to Home and Personal Property in
1988

       In February 1988, petitioners contracted for the

construction of an addition to their home.     Because the

contractors informed petitioners that they were not bonded in

case of a loss, petitioners contacted their homeowners' insurance

agent, Eustis, Dees & Outzen, to make sure that any potential

construction-related losses were covered by their existing

homeowners' insurance policy.     Petitioners were told by their

insurance agent that any construction-related losses were covered

by their existing policy.

       In preparation for construction to the upper floor of

petitioners' home, a portion of the roof was removed during the

day on March 10, 1988, and, at the end of the work day, the open

area of the roof was covered with a protective cloth.     In either

the late evening of March 10, 1988, or the early morning of March

11, 1988, high winds blew off the protective cloth covering the

opening in the roof and rain water entered through the opening,

flooding the home.     The next day an insurance adjuster from

United States Fidelity & Guaranty Co. (USF&G), for which Eustis,

Dees & Outzen was an independent agent, appraised the damage and

advised petitioners that their existing homeowners' insurance

policy did not cover the loss.     Despite their denial of coverage,

USF&G offered petitioners $5,000, as a good-faith gesture, which

they refused.
                                -5 -

     At USF&G's request, Mrs. Oliver and her secretary prepared

and submitted to USF&G a Personal Property Inventory Booklet

listing items of personal property which petitioners claimed were

damaged by the rain water.   The booklet lists the replacement

cost and the cost to repair the damaged personal property as

$107,330.60.   Petitioners received invoices in 1987 and 1988

which show the original cost of some of their furniture was

$10,754.19.    In June and July 1988, a dry cleaning service issued

invoices to petitioners totaling $3,529.85 for cleaning some of

their personal property.

     In May 1988, petitioners obtained an estimate from John

Bernardi, an employee at a local lumber company, of the claimed

damage to their home and provided it to USF&G.   The estimate

totals $34,998.   In February 1993, petitioners obtained an

estimate from Kenny Hester, a local builder, of the claimed

damage to their home, which agrees with John Bernardi's estimate

of the cost of materials, but adds between $4,000 to $5,000 for

labor.   In August 1988, petitioners submitted a proof of loss

statement to USF&G claiming damage totaling $142,728.94.

     USF&G refused to pay the amount claimed by petitioners on

the proof of loss statement.   Fidelity and Guaranty Insurance

Underwriters, Inc. (FGIU), an affiliate of USF&G, filed a

complaint for declaratory judgment against petitioners, seeking

an adjudication that the claimed personal property damage was not

covered by the homeowners' insurance policy due to a breach of
                                -6 -

policy conditions by petitioners and tendering the full amount

owed ($12,457.62) under the dwelling portion of the policy into

the registry of the court.   The civil litigation came before

Magistrate Judge Jerry Davis, U.S. District Court for the

Northern District of Mississippi, who appointed an expert to

evaluate the damage to petitioners' personal property.    The

expert found that out of 230 disputed items of personal property,

119 items had no apparent water damage and 62 items had possible

or probable water damage.    The expert found it was impossible to

determine whether the remaining 49 items had suffered water

damage.

     In 1991, the litigation between petitioners and FGIU was

settled, with petitioners receiving a gross recovery of

$44,577.92.   After reduction for attorney's fees and expenses,

petitioners' net recovery was $32,040.37, which amount included

the $12,457.62 initially deposited into the registry of the court

by USF&G to cover the full amount owed under the dwelling portion

of the policy, and $19,582.75 representing the net amount

received by petitioners for the settlement of the dispute over

the claimed personal property damage.

     Meanwhile, the addition to petitioners' home was completed.

Before the heavy rain and wind in 1988 which caused petitioners'

claimed casualty loss, their home was approximately 3,700 square

feet.   After the addition to their home was completed, it was

approximately 9,000 square feet.
                               -7 -

     On their joint Federal income tax return for the taxable

year 1988, petitioners claimed a casualty loss deduction of

$142,729 relating to the claimed storm damage, consisting of

damage to their home in the amount of $34,998.34, damage to its

contents of $107,330.60, and cleanup costs of $400.

     Respondent sent petitioners a notice of deficiency for 1988

disallowing the claimed $142,729 casualty loss deduction because

a schedule attached by petitioners to that return showed that

they had been reimbursed by their insurance company for the full

amount of the casualty loss.   Petitioners paid the deficiency in

income tax determined by respondent for 1988.

     Respondent and petitioners agree that, pursuant to section

1.165-1(d)(2)(i), Income Tax Regs., the casualty loss deduction

in the amount of $142,729, before insurance reimbursement,

claimed by petitioners on their 1988 return is properly before

the Court for the taxable year 1991.   The amount of reimbursement

received by petitioners for the casualty loss which occurred in

1988 could not be ascertained until the civil litigation between

petitioners and FGIU was settled in 1991.

     At trial, petitioners claimed for the first time that the

amount of loss relating to the claimed storm damage in 1988 was

$193,462.16, before insurance reimbursement.

     On their Federal income tax return for the taxable year

1991, petitioners reported $32,040 received by them in settlement

of the USF&G litigation as "other income".   In the notice of
                               -8 -

deficiency respondent determined that petitioners' income for

1991 should be reduced by the $32,040.     The parties agree to the

reduction in income.   Petitioners' receipt of the $32,040 will be

considered in computing the casualty loss deduction to which

petitioners may be entitled in 1991 caused by the heavy rain and

wind which occurred in 1988.

     Petitioners claimed a deduction of $119,435 on their joint

Federal income tax return for the taxable year 1989 as a

"casualty carry over from 1988" relating to the $142,729 casualty

loss deduction claimed by them on their 1988 return.     Respondent

sent a notice of deficiency to petitioners for 1989 disallowing

the casualty loss carryover deduction.     Petitioners filed their

petition with this Court seeking a redetermination of their

Federal income tax for 1989.   The case was settled prior to

trial.   Pursuant to the settlement, petitioners conceded that

they were not entitled to the casualty loss carryover deduction

claimed by them for 1989 in exchange for respondent's agreement

that the casualty loss deduction in the amount of $142,729

claimed by petitioners on their 1988 return was properly before

the Court for the taxable year 1991.

     Petitioners claimed a miscellaneous deduction in the amount

of $81,643 on their joint Federal income tax return for the

taxable year 1990 as a "casualty carry over from 1988-1989"

relating to the $142,729 casualty loss deduction claimed by

petitioners on their 1988 return.     In the notice of deficiency
                                 -9 -

sent to petitioners covering 1990 and 1991, respondent disallowed

the $81,643 casualty loss carryover deduction claimed by

petitioners on their 1990 return, stating that they had not

established that they were entitled to a casualty loss carryover

for that year.

       B.   Flood Damage to Home, Contents, Lawn, and Driveway in
1991

       During or after 1990, petitioners increased the size of

their home again, adding what they refer to as the "east wing".

This brought the total area of their home to 10,000 square feet.

       In February and April 1991, petitioners experienced flooding

at their home.     The February flood caused damage to their home,

its contents, their lawn, and their driveway.     The April flood

caused damage to their home and its contents.     At the time of

both floods, petitioners had flood insurance covering their home

and its contents through American Bankers Insurance Co. (ABIC).

Petitioners also had flood insurance covering their home and its

contents through the National Flood Insurance Program (NFIP).

Neither the ABIC flood insurance policy nor the NFIP flood

insurance policy covered the flood damage to petitioners' lawn

and driveway.

       Petitioners had homeowners' insurance coverage provided by

Grain Dealers Mutual Insurance Co. and National Farmers Union

Standard Insurance Co., but neither of these insurance companies

provided insurance coverage for flood damage.     They also had

homeowners' insurance coverage provided by Kemper Insurance Co.
                                -10 -

     Soon after the February flood, Rod Parker, an insurance

adjuster for ABIC, visited petitioners' home to survey the damage

and determine the insurance reimbursement to which they were

entitled.   He calculated the full cost to repair the home as

$26,168.17 and the replacement cost of the contents, less

depreciation and salvage value, as $53,779.50.   Based upon Mr.

Parker's report, petitioners received total insurance

reimbursement from ABIC of $79,978.11, consisting of $26,698.61

reimbursement for damage to the home and $53,279.50 reimbursement

for damage to its contents.

     In addition, petitioners received two checks, one for the

damage to their home and one for the damage to its contents, in

undisclosed amounts and from an undisclosed insurance company, as

reimbursement for the damage caused by the February flood.

     Petitioners claimed a casualty loss deduction in the amount

of $176,896 on Schedule A of their 1991 income tax return.    The

individual casualty losses they claimed were detailed on Form

4684 attached to the return.    Among the losses claimed was a loss

in the amount of $156,778.20, before insurance reimbursement, for

flood damage to their home on February 18, 1991.   Worksheets

prepared by petitioners in support of this loss contained

mathematical errors and duplications of the claimed losses

relating to individual items.

     At trial, petitioners reduced the amount of loss claimed for

the flood damage in February of 1991 to $105,704.87, before
                                -11 -

insurance reimbursement, consisting of a $47,502.59 loss claimed

for damage to their home, including their lawn and driveway, and

a $58,202.28 loss claimed for damage to its contents.    Of the

$47,502.59 loss claimed, $11,603.75 was attributed to damage to

their home, $8,398.84 to their lawn, and $27,500 to their

driveway.

     Petitioners calculated the $11,603.75 claimed loss to their

home by totaling the cost of repairs they claim to have made to

their home as a result of the February flood.    They received

invoices totaling $1,194 for cleaning services performed at their

home and wrote checks totaling $1,285 for repairs performed at

their home after the February flood.

     Petitioners calculated the $8,398.84 claimed loss to their

lawn by totaling the amount they claimed to have spent having

their lawn installed and the amount they claimed to have spent

having it repaired.    Petitioners received statements and an

invoice totaling $3,862.25 from lawn supply stores prior to 1991.

They wrote checks totaling $195 to lawn supply stores prior to

1991.    Petitioners received a statement totaling $1,308.07 from a

lawn supply store recording purchases made after the February

flood.    They wrote checks totaling $2,105.46 to lawn supply

stores and lawn repairmen after the February flood.

     Petitioners calculated the $27,500 claimed loss to their

driveway by totaling the estimated cost to repair multiple cracks

and gaps in their driveway caused by the February flood.    In
                               -12 -

1994, 3 years after the 1991 flood, petitioners obtained an

estimate in the amount of $27,500 to repair their driveway.    They

have not repaired any part of the damage to their driveway.

     Petitioners calculated the $58,202.28 claimed loss to the

contents of their home by totaling the claimed original cost of

each item damaged in the February flood.   Petitioners received

invoices totaling $657 for the cost to repair some of the

contents of their home after the February flood.

     Petitioners included the claimed original cost of four Tandy

computers with hard drives, one Tandy microcomputer, and three

Tandy printers, totaling $23,700, as part of the $58,202.28

claimed loss to the contents of their home.   Petitioners had four

computers at their home at the time of the February flood.    One

of the four computers was used in Mrs. Oliver's business.    The

other three computers were for the personal use of petitioners'

children, and two of them had been previously used in Mrs.

Oliver's business.

     Petitioners had been depreciating on their Federal income

tax returns two of the three computers used by their children for

personal purposes, and the one computer used in Mrs. Oliver's

business.   They claimed depreciation related to three computers,

three printers, and a hard disk drive in amounts totaling $1,240

on each of their joint Federal income tax returns for the taxable

years 1988, 1989, and 1990.   Petitioners claimed a section 179
                                 -13 -

deduction for a hard disk drive in the amount of $1,500 on their

joint Federal income tax return for the taxable year 1988.

     Among the individual casualty losses detailed by petitioners

on Form 4684 attached to their 1991 return were a loss in the

amount of $8,565 for claimed damage to a 1984 Nissan 300ZX

automobile and a loss in the amount of $11,000 for claimed damage

to a 1989 Honda Accord automobile, both caused by the February

flood.

     The N.A.D.A. Official Used Car Guide (NADA) lists an average

retail value for various automobile models depending on the

automobile's age and features.    NADA also provides a Low Mileage

Table which lists premiums to be added to the average retail

values of low mileage automobiles.       NADA lists the average

retail value of a 1984 Nissan 300ZX Coupe Turbo GL as $6,525, and

the low mileage premium to be added to a standard size car with

between 7,501 and 15,000 miles as $2,400, totaling $8,925.

     Soon after the flood in April 1991 damaged petitioners'

property, Rod Parker, an insurance adjuster for ABIC, visited

their home to survey the damage and determine the insurance

reimbursement to which they were entitled.       He calculated the

full cost to repair the home as $28,425.39 and the replacement

cost of the contents, less depreciation and salvage value, as

$12,187.   Based upon Mr. Parker's report, petitioners received

insurance reimbursement from ABIC of $39,059.91, consisting of
                              -14 -

$27,372.91 reimbursement for damage to their home and $11,687

reimbursement for damage to the contents.

     In addition, petitioners received two checks, one for the

damage to their home and one for the damage to its contents, in

undisclosed amounts and from an unidentified insurance company,

as reimbursement for the damage caused by the April flood.

     Among the individual casualty losses detailed by petitioners

on Form 4684 attached to their 1991 return was a loss in the

amount of $143,064.34, before insurance reimbursement, for damage

to their home caused by the April flood.    Worksheets prepared by

petitioners in support of this claimed loss contained numerous

duplications of individual items which they had included in their

claimed loss as a result of the February flood.

     At trial, petitioners reduced the amount of loss claimed for

flood damage to their home in April of 1991 to $99,383.28, before

insurance reimbursement, consisting of a $79,863.28 loss claimed

for damage to their home and a $19,520 loss claimed for damage to

its contents.

     Petitioners calculated the $79,863.28 claimed loss to their

home by totaling the cost of repairs they claim to have made to

their home as a result of the April flood.   They received a

statement and invoices totaling $43,080.59 for repairs performed

at their home after the April flood.   They wrote checks totaling

$22,196.80 to various businesses for repairs performed at their

home after the April flood.
                               -15 -

     Petitioners calculated the $19,520 claimed loss to the

contents of their home by totaling the replacement cost of the

contents damaged in the April flood determined by the insurance

adjuster.   However, they erroneously arrived at this total

because the insurance adjuster actually calculated the

replacement cost of the contents of their home as $23,704.

Petitioners received an invoice totaling $231.03 for the cost to

replace some of their telephone equipment after the April flood.

     In the notice of deficiency respondent disallowed the

casualty loss deduction in the amount of $176,896 claimed by

petitioners on their 1991 return, stating that they had not

established that the lesser of the decrease in the fair market

value of their property as a result of the 1991 floods or the

adjusted basis of their property exceeded their insurance

reimbursement.   Respondent also determined that petitioners'

income for the taxable year 1991 should be increased by $14,763,

stating that the insurance reimbursement received by them because

of the February flood exceeded their sustained loss caused by

that flood by that amount.

     On Schedule C of their 1991 return, petitioners claimed a

business casualty loss in the amount of $6,880.   The total

business casualty loss claimed by them was detailed on Form 4684

attached to their 1991 return, consisting of losses in the

amounts of $3,000 for a Tandy computer, $750 for a Tandy hard

disk drive, $530 for a Tandy printer, and $2,600 for medical
                               -16 -

billing software.   Because the computer was used by petitioners

for business purposes, their ABIC insurance policy did not cover

the loss.

     Petitioners had been depreciating the Tandy computer, Tandy

printer, and Tandy hard disk drive since the taxable year 1988.

They claimed depreciation related to three computers, three

printers, and a hard disk drive in amounts totaling $1,240 on

each of their Federal income tax returns for the taxable years

1988, 1989, and 1990.   It is not clear which of the computers

petitioners had been depreciating was the one for which the

$6,880 business casualty loss was claimed.

     In the notice of deficiency respondent disallowed the

business casualty loss deduction in the amount of $6,880 claimed

by petitioners on their 1991 return, stating that they had not

established that the lesser of the decrease in the fair market

value of their computer(s) as a result of the 1991 floods or

their adjusted basis in the computer(s) exceeded their insurance

reimbursement.

     In 1991, the water pipes in petitioners' kitchen broke.

They received reimbursement in the amount of $7,744.69 from

Kemper Insurance Co. for the damage to the pipes.   Their ABIC

insurance policy did not cover the damage to the pipes in the

kitchen because they were located below the flood water line.    At

trial, petitioners claimed for the first time that they had

incurred a casualty loss of $12,566.62 in 1991, before insurance
                              -17 -

reimbursement, because of the broken pipes in their kitchen.    The

claim is separate and apart from the claimed casualty losses due

to flood damage that year.

     Petitioners calculated the $12,566.62 claimed loss to their

kitchen pipes by totaling the amount they claim to have spent

repairing the damage caused by the broken pipes.   They received

an invoice and a statement totaling $2,175.72 for repairs

performed as a result of their broken kitchen pipes.

     Washington County, Mississippi, the county in which

petitioners lived in 1991, was declared a Presidential disaster

area as a result of the floods in February and April of 1991.    At

trial, petitioners claimed that they are entitled to relief under

section 165(i) with respect to casualty losses suffered by them

during 1991.

Claimed Deductions for Legal and Professional Expenses

     On Schedule C of their Federal income tax returns for 1990

and 1991, petitioners claimed deductions for business legal

expenses of $10,000 in 1990 and $13,000 in 1991.   In respondent's

notice of deficiency the claimed business expense deductions for

legal fees were disallowed on the ground that petitioners had not

established that they constituted ordinary and necessary business

expenses.

     Beginning in 1989, Mrs. Oliver was represented by John D.

Delgado, an attorney, in a criminal case which arose out of her

activity of keeping the books of Dr. Oliver, a physician.
                                -18 -

Petitioners paid $10,370.80 for legal fees to Mr. Delgado on

September 18, 1989.

     In 1990, Dr. Oliver treated a child at his home for injuries

sustained while he was playing with petitioners' son.    As a

result, a lawsuit was filed against Dr. Oliver personally and in

his professional capacity in which the plaintiff alleged that Dr.

Oliver had acted unethically when he treated the child.    In

settlement of the lawsuit, petitioners sent a check on June 29,

1990, in the amount of $6,000 to the plaintiff's attorney.      Mr.

Gaines S. Dyer, the attorney who represented Dr. Oliver in the

case, did not charge petitioners a fee for his legal services.

     Petitioners constructed a landfill on their property in

response to the flooding they experienced in February and April

of 1991.    In January 1992, a neighbor filed a lawsuit against

them in response to their construction of the landfill.    As a

result of the lawsuit, petitioners paid damages to their neighbor

totaling $4,500 in 1992 and legal fees to their attorney totaling

$1,500 in 1992.

Interest Income

     Information returns provided to the Internal Revenue Service

for the taxable year 1990 show that petitioners received $3,401

interest income in 1990, consisting of $633 interest income from

Allstate Life Insurance Co., $368 from Sunburst Bank, $900 from

Planters Bank & Trust Co., and $1,500 from Charles Schwab and

Co., Inc.    Petitioners also received $11,339 interest income from
                                 -19 -

J. Peeples Trust and $3,212 from their J. Masters note.     Thus,

petitioners received a total of $17,952 interest income in 1990.

        On their 1990 Federal income tax return, petitioners

reported $15,1282 interest income, consisting of $345 from

Sunburst Bank, $172 from Planters Bank & Trust Co., $11,339 from

J. Peeples Trust, and $3,212 from their J. Masters note.

        In the notice of deficiency, respondent increased

petitioners' income by $2,824, stating that they received

interest income of $17,952 in the taxable year 1990, rather than

$15,128 as reported on their 1990 return.

Self-Employment Taxes

        Petitioners reported self-employment tax on their Federal

income tax returns for 1990 and 1991 in the amounts of $7,848.90

and $10,246.60, respectively.     They claimed Schedule C deductions

for self-employment tax on the returns in the amounts of

$7,848.90 and $10,246.60, respectively.

        Through adjustments made to petitioners' 1990 and 1991

returns at the Memphis Service Center, petitioners were allowed

to deduct one-half of the self-employment tax reported by them on

their 1990 and 1991 returns.


    2
       Petitioners erroneously calculated the $15,128 interest
income reported on their Federal income tax return for the
taxable year 1990. The individual items of interest income
detailed by petitioners on Schedule B attached to their 1990
return total $15,068, which is $60 less than $15,128. Thus, in
the notice of deficiency respondent determined that petitioners
failed to report interest income in the amount of $2,824, which
is $60 less than the amount of interest income petitioners failed
to disclose on Schedule B attached to their 1990 return.
                                 -20 -

     In the notice of deficiency, respondent disallowed the

deductions for self-employment tax claimed by petitioners on

their 1990 and 1991 returns in the amounts of $7,849 and $10,246,

respectively, stating that deductions are allowed for only one-

half of self-employment taxes paid and that petitioners had

previously been allowed to deduct one-half of the amounts they

paid in self-employment taxes.

Filing of Federal Income Tax Returns for 1990 and 1991

     Petitioners made estimated tax payments in the total amount

of $7,711.20 for 1990.    On or before April 15, 1991, petitioners

filed Form 4868, Application for Automatic Extension of Time to

File U.S. Individual Income Tax Return, requesting an automatic

4-month extension of the due date of their 1990 return.   No

payment of tax accompanied their extension request.   Respondent

received petitioners' 1990 return on August 19, 1991.

     Petitioners made estimated tax payments in the total amount

of $10,246.60 for 1991.   On or before April 15, 1992, petitioners

filed Form 4868, Application for Automatic Extension of Time to

File U.S. Individual Income Tax Return, requesting an automatic

4-month extension of the due date of their 1991 return.   No

payment of tax accompanied their extension request.   Respondent

received petitioners' 1991 return on July 20, 1992.

     In the notice of deficiency dated August 11, 1994,

respondent stated:

     Your income tax returns for the tax years 1990 and 1991
     were not filed within the time prescribed by law. The
                                  -21 -

         applications for automatic extensions of time to file
         are null and void. The total tax liabilities shown on
         the forms were not reasonable estimates of your correct
         liabilities. Consequently, 20 percent of the tax is
         added as provided by section 6651(a)(1) of the Internal
         Revenue Code.

Accuracy-Related Penalties

         In respondent's notice of deficiency, it was determined that

all underpayments of tax for the taxable years 1990 and 1991 were

due to negligence or disregard of rules or regulations, and that

petitioners had not shown that the underpayments were due to

reasonable cause.

                                 OPINION

         Most of the issues in this case are factual and involve

deductions claimed by petitioners.        The burden of proof is on

petitioners, and respondent's determinations of the income tax

deficiencies, additions to tax, and accuracy-related penalties

are presumptively correct.      Rule 142(a); Welch v. Helvering, 290

U.S. 111 (1933).      Deductions are a matter of legislative grace,

and petitioners bear the burden of proving entitlement to any

claimed deductions.      Rule 142(a); INDOPCO, Inc. v. Commissioner,

503 U.S. 79, 84 (1992).

I.   Issues 1 Through 6.     Claimed Casualty Loss Deductions

Section 165(a)3 allows as a deduction any loss sustained during

     3
      SEC. 165.    LOSSES.

              (a) General Rule.--There shall be allowed as a
         deduction any loss sustained during the taxable year
         and not compensated for by insurance or otherwise.

                                                           (continued...)
                                   -22 -

the taxable year and not compensated for by insurance or

otherwise.     Section 165(c) limits the allowance of losses in the

case of individuals.       Section 165(c)(3) allows as a deduction to

an individual certain losses commonly referred to as casualty

losses.     A casualty loss is allowable to an individual for a loss

of property not connected with a trade or business or with a

transaction entered into for profit, if the loss results from

"fire, storm, shipwreck, or other casualty", subject to

limitations set forth in section 165(h).

        Section 165(h)(1) provides that any loss of an individual

described in section 165(c)(3) is allowed only to the extent that

the amount of the loss arising from each casualty exceeds $100.

Section 165(h)(2) provides that if the personal casualty losses

for a taxable year exceed the personal casualty gains for the

year, the losses are allowable only to the extent of the sum of


    3
     (...continued)
                  *    *      *    *       *   *   *

             (c) Limitation on Losses of Individuals.--In the
        case of an individual, the deduction under subsection
        (a) shall be limited to--

                  (1) losses incurred in a trade or business;

                  *    *      *    *       *   *   *

                  (3) except as provided in subsection
             (h), losses of property not connected with a
             trade or business or a transaction entered
             into for profit, if such losses arise from
             fire, storm, shipwreck, or other casualty, or
             from theft.
                               -23 -

the personal casualty gains for that taxable year plus so much of

the excess as exceeds 10 percent of adjusted gross income for

that taxable year.   Thus, where there are no personal casualty

gains for a taxable year, personal casualty losses (in excess of

$100 per casualty) are allowable to the extent that they exceed

10 percent of adjusted gross income for that taxable year.

     The method of valuation to be used in determining a casualty

loss is prescribed in section 1.165-7(a)(2), Income Tax Regs.,

which provides as follows:

     (i) In determining the amount of loss deductible under
     * * * [section 165], the fair market value of the
     property immediately before and immediately after the
     casualty shall generally be ascertained by competent
     appraisal. This appraisal must recognize the effects
     of any general market decline affecting undamaged as
     well as damaged property which may occur simultaneously
     with the casualty, in order that any deduction under
     * * * [section 165] shall be limited to the actual loss
     resulting from damage to the property.

     (ii) The cost of repairs to the property damaged is
     acceptable as evidence of the loss of value if the
     taxpayer shows that (a) the repairs are necessary to
     restore the property to its condition immediately
     before the casualty, (b) the amount spent for such
     repairs is not excessive, (c) the repairs do not care
     for more than the damage suffered, and (d) the value of
     the property after the repairs does not as a result of
     the repairs exceed the value of the property
     immediately before the casualty.

     The amount deductible is governed by section 1.165-7(b)(1),

Income Tax Regs., which provides that the amount of the loss to

be taken into account for purposes of section 165(a) shall be the

lesser of:   (1) The amount which is equal to the fair market

value of the property immediately before the casualty reduced by
                                 -24 -

the fair market value of the property immediately after the

casualty, or (2) the amount of the adjusted basis for determining

the loss from the sale or other disposition of the property

involved.

       A.   Rain and Wind Damage to Home and Personal Property in
1988

       The parties agree that the heavy rain and wind which caused

damage to petitioners' home and its contents in 1988 was a

casualty within the meaning of section 165(c)(3).     They also

agree that any loss resulting from the casualty was sustained in

1991 when the litigation between petitioners and FGIU was settled

with petitioners receiving a total recovery of $44,577.92, or a

net of $32,040 after payment of attorney's fees and expenses.

The dispute pertains primarily to the deductible amounts of the

claimed casualty losses in excess of the insurance recovery.

Petitioners claimed a casualty loss of $142,729 on their 1988

Federal income tax return.     The claimed amount was revised to

$193,462, before insurance reimbursement, at the time of trial.

       Petitioners contend that the evidence they submitted

supports their claimed losses.     To the contrary, respondent

contends that petitioners have failed to prove they actually

sustained the claimed losses to their home and to many of the

items of personal property, but, if so, they failed to establish

the amounts of the losses.

       We do not find persuasive the estimates of John Bernardi and

Kenny Hester regarding the extent of damage to petitioners' home.
                                -25 -

Neither testified or qualified as an expert.   Mrs. Oliver offered

only her uncorroborated testimony that Mr. Bernardi often does

such estimates.   Petitioners obtained Mr. Hester's estimate in

1993, several years after the claimed damage occurred, and thus

we seriously doubt whether it was an accurate estimate of the

cost to repair damage that occurred in 1988.

     The estimates made by Mr. Bernardi and Mr. Hester do not

show the decrease in fair market value of the home caused by the

1988 storm.   Petitioners have presented no reliable evidence of

the repairs made to the home as a result of the storm.   An

estimate of the cost to repair damage caused by a casualty

ordinarily does not establish the amount of the casualty loss, as

contemplated by section 1.165-7(a)(2)(i) and (ii), Income Tax

Regs., unless the repairs are actually made.   Lamphere v.

Commissioner, 70 T.C. 391, 396 (1978).

     Furthermore, even if the repairs detailed in the estimates

were made, petitioners have not shown that the amount of repairs

was no greater than necessary to restore the home to its

condition prior to the storm, as required by section 1.165-

7(a)(2)(ii), Income Tax Regs.   Indeed, their home underwent a

major renovation which increased its size from 3,700 square feet

before the storm to approximately 9,000 square feet after the

storm.

     Likewise, petitioners' Personal Property Inventory Booklet

is not persuasive to show that they sustained losses to their
                               -26 -

personal property.   The booklet merely lists items of personal

property that Mrs. Oliver and her secretary claim were damaged

because of the heavy rain and wind in 1988.     We do not find a dry

cleaning invoice convincing as to whether the items cleaned had

been damaged by the heavy rain and wind.     In addition, the

independent, court-appointed expert concluded that out of 230

disputed items, 119 had no apparent water damage; 62 items had

possible or probable water damage; and it was impossible to

determine whether the remaining 49 items suffered any water

damage.

     Petitioners argue that we should apply the rule in Cohan v.

Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930), and

approximate the amounts of the losses sustained by them as a

result of the 1988 storm.   Respondent argues that the

approximation rule described in the Cohan case is inapplicable

here.   We agree with respondent because petitioners have failed

to prove that they sustained casualty losses in excess of their

insurance reimbursement and because their inexactitude in

substantiating such casualty losses is of their own making.

     Based on the facts and circumstances contained in this

record, we hold that petitioners did not sustain a casualty loss

with respect to the 1988 rain and wind storm in excess of their

recovered insurance reimbursement.     Therefore, they are not

entitled to a casualty loss deduction for the damage that

resulted from that storm.
                                     -27 -

       B.     Claimed Casualty Loss Carryover Deduction for 1990

       On line 26 of Schedule A of their Federal income tax return

for the taxable year 1990, petitioners claimed a miscellaneous

deduction in the amount of $81,643.          The explanation given for

the deduction was "casualty carry over from 1988 - 1989."          This

deduction relates to the $142,729 claimed casualty loss for the

claimed storm damage in 1988, which petitioners originally

claimed on their Federal income tax return for the taxable year

1988.       The claimed casualty loss is properly before the Court for

the taxable year 1991.       Consequently, petitioners are not

entitled to the $81,643 claimed miscellaneous deduction for the

taxable year 1990.

       C.     Flood Damage to Home, Contents, Lawn, and Driveway in
1991

       It is clear that the flooding of petitioners' property in

February and April 1991 was so severe as to constitute two

separate casualties within the meaning of section 165(c)(3).

               1.   February Flood

       With respect to the February flood damage to petitioners'

home and its contents, an insurance adjuster for ABIC determined,

and ABIC paid to petitioners, insurance reimbursement of

$79,978.11, consisting of $26,698.61 for damage to the home (not

including their lawn and driveway) and $53,279.50 for damage to

its contents.       On their 1991 Federal income tax return

petitioners claimed a loss of $156,778 for the damage caused by

the February flood.       At trial, they reduced the amount of the
                               -28 -

claimed loss to $105,704.87, before insurance reimbursement,

consisting of $47,502.59 for damage to their home and $58,202.28

for damage to its contents.   Of the $47,502.59, the amount of

$11,603.75 was attributed to damage to their home, $8,398.84 to

their lawn, and $27,500 to their driveway.

     Respondent contends that petitioners have failed to

establish that the amount of the February flood loss is either

the amount claimed on their 1991 return or the reduced amount

claimed at trial.

     Petitioners failed to establish by competent appraisal the

fair market value of their home and its contents before and after

the February flood.   It is petitioners' position that the cost to

repair their home is the measure of its decrease in fair market

value as a result of the damage caused by the February flood.

     Petitioners calculated the $47,502.59 claimed loss to their

home, including their lawn and driveway, by totaling the amount

they claim to have spent repairing their home as a result of the

February flood.   Their evidence does not substantiate the amount

claimed.   The total amount of the invoices and canceled checks

submitted by them does not approach $47,502.59.   Furthermore, the

estimate of the cost to repair their driveway is not persuasive

unless the repairs were actually made.   Lamphere v. Commissioner,

supra at 396.   The estimate was made 3 years after the February

flood and no repairs have been made to the driveway.
                               -29 -

     In addition, petitioners presented no evidence, as required

by section 1.165-7(a)(2)(ii), Income Tax Regs., that the amount

they claim as the cost to repair their home is not greater than

necessary to restore the home to its condition before the

February flood.   Petitioners testified that during or after 1990,

the size of their home was increased to 10,000 square feet.   We

therefore think it is improbable that the amounts spent by them

to repair their home after February 1991 restored their home to

its condition before the casualty.

     Petitioners calculated the $58,202.28 claimed loss to the

contents of their home by totaling the claimed original cost of

the contents.   They presented no evidence which substantiates the

claimed original cost.

     Petitioners erred by calculating the claimed loss to the

contents of their home based on the claimed original cost of the

contents.   Section 1.165-7(b)(1), Income Tax Regs., provides that

the proper measure of the amount of a casualty loss is the lesser

of the decrease in the fair market value of the property as a

result of the casualty or the adjusted basis for determining the

loss from the sale or other disposition of the property involved.

Section 1.165-7(a)(2)(i) and (ii), Income Tax Regs., provides

that the cost to repair property damaged by a casualty may be

used to determine its decrease in fair market value as a result

of the casualty when a competent appraisal has not been obtained.
                              -30 -

     Petitioners apparently contend that their cost basis in the

contents of their home is less than the decrease in the fair

market value of the contents as a result of the casualty.

However, this seems illogical because personal property generally

declines in value from the time it is first used.   Thus, even if

petitioners had shown the fair market value of the contents was

zero after the casualty, their adjusted basis in the property

might be greater than the decrease in fair market value of the

property because of the casualty.

     This is particularly true in the case of computer equipment,

which has a tendency to become obsolete and declines in value.

Petitioners included the claimed original cost of four Tandy

computers with hard drives, one Tandy micro-computer, and three

Tandy printers, totaling $23,700, as part of the $58,202.28

claimed loss to the contents of their home.   Insofar as disclosed

by the record, the original cost basis of the computer equipment

would not be less than the decrease in fair market value of the

equipment as a result of the casualty, even if petitioners had

shown that the equipment was ruined in the flood.

     Furthermore, petitioners claimed depreciation related to

three computers, three printers, and a hard disk drive in amounts

totaling $1,240 on each of their joint Federal income tax returns

for the taxable years 1988, 1989, and 1990, and they claimed a

section 179 deduction for a hard disk drive in the amount of

$1,500 on their joint Federal income tax return for the taxable
                                -31 -

year 1988.   Thus, their claimed cost basis ($23,700) in this

computer equipment should have been reduced by the claimed

depreciation and section 179 expense by $2,740, which results in

a $20,960 adjusted basis.   Sec. 1016(a)(2)(A).

     Even if petitioners had included the proper adjusted basis

of their computer equipment in their $58,202.28 total claimed

cost basis, however, they have failed to prove that they were

entitled to calculate their claimed casualty loss based on the

original cost of the contents of their home, rather than using

the decrease in the fair market value of the contents of the

residence as the appropriate measure of their sustained casualty

loss.

     We are not persuaded by petitioners' evidence that the loss

to the contents of their home is $58,202.28 as a result of the

February flood.   The total amount of the invoices submitted by

them does not approach $58,202.28.

     Petitioners also presented no evidence that the amount they

claim as the cost to repair the contents of their home is not

greater than necessary to restore the contents to their condition

prior to casualty.   Such evidence is required by section 1.165-

7(a)(2)(ii), Income Tax Regs.

     We have found it difficult to determine with reasonable

accuracy the amount of the loss sustained by petitioners in the

February flood.   Again, petitioners contend that we should

approximate the loss sustained by them as a result of the
                               -32 -

casualty based on Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d

Cir. 1930).   To the contrary, respondent contends that the Cohan

approximation rule is inapplicable because petitioners have not

shown they had casualty losses in excess of their insurance

reimbursement and because their inexactitude in substantiating

their claimed casualty losses is of their own making.   We agree

with respondent and decline to apply the Cohan rule in these

circumstances.

     It is impossible to determine the total amount of insurance

reimbursement received by petitioners as a result of the February

flood.   We know they received reimbursement from ABIC for the

damage to their home and its contents in the amounts of

$26,698.61 and $53,279.50, respectively, as a result of the

February flood.   But, in addition, they received two checks, one

for the damage to their home and one for the damage to its

contents, in undisclosed amounts and from an undisclosed

insurance company, as reimbursement for the damage caused by the

February flood.   However, they apparently received no insurance

reimbursement for the damage to their lawn and driveway.   As to

the lawn, the loss claimed by petitioners was determined by

totaling the amounts they spent on the lawn before the flood,

and, of course, that proved neither the fair market value of the

lawn before the flood nor its fair market value after the flood.

And, with respect to the driveway, as previously indicated, no

repairs were made.
                                 -33 -

     Petitioners received $53,279.50 insurance reimbursement for

the damage to the contents of their home, based on the insurance

adjuster's worksheet, which estimated the cost to replace their

personal property, less depreciation and salvage value.

Petitioners have not proven that they sustained a loss of any

greater amount.

     In sum, based on the evidence in this record, we hold that

petitioners failed to prove that the damage to their home and

personal property exceeded the amount of insurance reimbursement

they received from ABIC as a result of the February flood.

     2.     Casualty Gain From February Flood

     Respondent argues that petitioners received insurance

reimbursement in excess of their sustained loss in the February

flood, and thus improperly failed to report a casualty gain for

1991.     Petitioners offered no evidence to prove that the amount

of their casualty loss was not exceeded by the amount of

insurance reimbursement received by them as a result of the

February flood.     Respondent, on the other hand, established that

petitioners received insurance reimbursement, in excess of the

$79,458.11 disclosed by them, in an undisclosed amount from an

undisclosed insurance company as reimbursement for the damage

caused by the February flood.     Respondent determined in the

notice of deficiency that the insurance reimbursement exceeded

petitioners' sustained loss from the February flood by at least
                                 -34 -

$14,763.    Petitioners have failed to prove otherwise.   Therefore,

we sustain respondent's determination on this issue.

     3.    Claimed Casualty Loss Deduction on Automobiles

     Petitioners claimed additional casualty losses on their 1991

return for damage to a 1984 Nissan 300ZX automobile and a 1989

Honda Accord automobile in the amounts of $8,565 and $11,000,

respectively.

     Respondent contends that petitioners failed to prove that

they sustained a loss to either automobile as a result of the

February flood.

     In support of the claimed casualty losses to the two

automobiles, petitioners testified that both automobiles were

damaged by the February flood.    However, they presented no

evidence showing that they owned either automobile and no

evidence, other than their uncorroborated testimony, showing that

the automobiles were damaged by the February flood.    Thus, we

agree with respondent that petitioners failed to prove that they

sustained losses on the two automobiles.

     Respondent also contends that, even if petitioners had shown

that they sustained losses on the automobiles, they failed to

prove the amounts of such losses.

     Petitioners calculated the amount of their claimed losses to

the automobiles by subtracting the amount they determined to be

the fair market value of the automobiles after the February flood

from the amount they determined to be the fair market value of
                               -35 -

the automobiles before the February flood.    Petitioners used the

amounts they claimed to have received as salvage value and trade-

in value for the automobiles after the February flood as the fair

market value of the automobiles after the February flood.    They

used NADA's list of average retail values of automobiles to

determine the fair market value of the automobiles before the

February flood.

     Petitioners claimed to have received $335 in salvage value

for the 1984 Nissan 300ZX and $2,000 in trade-in value for the

1989 Honda Accord.   NADA lists the average retail value of a 1984

Nissan 300ZX Coupe Turbo GL as $6,525, and the low mileage

premium to be added to a standard size car with 7,501 to 15,000

miles as $2,400, or a total of $8,925.   The average retail value

of a 1989 Honda Accord Sedan LXi and its applicable low mileage

premium, which petitioners used to determine the retail value of

the 1989 Honda Accord, are illegible in the photocopied NADA

pages submitted by petitioners.

     Petitioners, however, presented no evidence, other than

their uncorroborated testimony, showing how much they received in

salvage or trade-in value for the two automobiles.   And they

presented no evidence proving the model, features, or mileage of

either car.   Thus, we agree with respondent that petitioners

failed to prove the amounts of such losses.   Consequently, they

are not entitled to deduct a casualty loss on their 1991 return

for damage to the two automobiles.
                                 -36 -

     4.   April Flood

     With respect to the April flood damage to petitioners' home

and its contents, an insurance adjuster for ABIC determined, and

ABIC paid to petitioners, insurance reimbursement of $39,059.91,

consisting of $27,372.91 for damage to the home and $11,687

reimbursement for damage to its contents.     On their 1991 Federal

income tax return petitioners claimed a loss of $143,064.34,

before insurance reimbursement, for damage to their home caused

by the April flood.     At trial, they reduced the claimed loss to

$99,383.28, before insurance reimbursement, consisting of a

$79,863.28 loss claimed for damage to their home and a $19,520

loss claimed for damage to its contents.

     Respondent contends that petitioners have failed to

establish that the amount of the April flood loss is either the

amount claimed on their 1991 return or the reduced amount claimed

at trial.

     Petitioners failed to establish by competent appraisal the

fair market value of their home and personal property before and

after the April flood.    It is petitioners' position that the cost

to repair their home is the measure of its decrease in fair

market value as a result of the damage caused by the April flood.

     Petitioners calculated the $79,863.28 claimed loss to their

home by totaling the amount they claim to have spent repairing

their home as a result of the April flood.     Their evidence does

not substantiate the amount claimed.     The total amount of a
                                -37 -

statement, invoices, and canceled checks submitted by petitioners

falls far short of the amount claimed.   By contrast, the

insurance adjuster's worksheet, which we find convincing, allowed

only $28,425.39 to repair the home.

     Moreover, petitioners presented no evidence that the amount

they claim as the cost to repair their home is not greater than

necessary to restore their home to its condition prior to the

April flood.   Such evidence is required by section 1.165-

7(a)(2)(ii), Income Tax Regs.   Petitioners testified that during

or after 1990, the size of their home was increased to 10,000

square feet.   We think it is improbable that the amounts spent by

petitioners to repair their home after the April flood merely

restored their home to its condition before the casualty.

     Petitioners erred by calculating their claimed loss of

$19,520 to the contents of their home based on the insurance

adjuster's estimate of the replacement cost of the contents.

Section 1.165-7(a)(2)(ii), Income Tax Regs., provides that the

cost of repairs may be used to measure a casualty loss, but only

if the value of the property after the repairs does not as a

result of the repairs exceed the value of the property

immediately before the casualty.    To use replacement cost as the

cost of repairs may violate this requirement since the fair

market value of the replacement property will be greater than the

fair market value of the replaced property immediately before the

casualty.   Hernandez v. Commissioner, 72 T.C. 1234, 1240-1241
                                -38 -

(1979).     Furthermore, an estimate of the cost of repairs to the

property damaged because of a casualty is not evidence of the

actual cost of repairs unless the repairs are actually made.

Lamphere v. Commissioner, 70 T.C. at 396.

     We are not persuaded by petitioners' evidence that the loss

to the contents of their home is $19,520 as a result of the April

flood.    The total amount of the invoices and canceled checks

submitted by petitioners does not approach $19,520.    In addition,

petitioners presented no evidence that the amount they claim as

the cost to repair the contents of their home is not greater than

necessary to restore the contents to their condition prior to the

casualty, as required by section 1.165-7(a)(2)(ii), Income Tax

Regs.

     Here again, we find it difficult to determine with

reasonable accuracy the amount of loss sustained by petitioners

in the April flood.    We decline to apply the Cohan rule in these

circumstances.    There is no sound basis for making an

approximation because petitioners have not shown they had

casualty losses in excess of their insurance reimbursement and

because of their inexactitude in substantiating their claimed

losses.

     It is impossible to determine the total amount of insurance

reimbursement received by petitioners as a result of the April

flood.    We know they received reimbursement from ABIC for the

damage to their home and its contents in the amounts of
                               -39 -

$27,372.91 and $11,687, respectively.   But, in addition,

petitioners received two checks, one for the damage to their

home, and one for the damage to its contents, in undisclosed

amounts and from an undisclosed insurance company, as

reimbursement for the damage caused by the April flood.

     Accordingly, based on the evidence contained in this record,

we conclude that petitioners failed to prove that the damage to

their home and personal property exceeded the amount of insurance

reimbursement they received from ABIC as a result of the April

flood.   Petitioners therefore are not entitled to deduct a

casualty loss on their 1991 return for damage caused by that

flood.

     5. Claimed Business Casualty Loss Deduction for Computers
and Equipment

     Petitioners deducted a business casualty loss of $6,880 on

Schedule C of their 1991 return for damage to computer equipment

located at their home at the time of the 1991 floods.   The

equipment consisted of one computer, one hard disk drive, one

printer, and software.

     Respondent contends that the business casualty loss claimed

by petitioners for damage to computer equipment was duplicated in

the casualty loss deduction arising from the February flood.    We

agree, and thus sustain respondent's determination that

petitioners are not entitled to a business casualty loss

deduction for the computers and equipment in 1991.
                               -40 -

     6.   Claimed Casualty Loss Deduction for Broken Kitchen Water
Pipes

     Petitioners contend that damage to their home resulting from

broken kitchen water pipes is either part of the casualty loss

arising from the floods in 1991 or a separate casualty loss

deduction for 1991.   Respondent contends that the broken kitchen

water pipes do not constitute a casualty within the meaning of

section 165(c)(3).

     A "casualty" is an event due to some sudden, unexpected, or

unusual cause, such as a fire, storm, or shipwreck.      Durden v.

Commissioner, 3 T.C. 1, 3 (1944).      The progressive deterioration

of property through a steadily operating cause is not a casualty.

Fay v. Commissioner, 120 F.2d 253 (2d Cir. 1941), affg. 42 B.T.A.

206 (1940).

     Petitioners offered no evidence which establishes that their

kitchen water pipes broke as a result of the 1991 floods.     Their

flood insurance provider refused to cover the damage resulting

from the broken water pipes because they were located below the

flood water line, which indicates that the floods did not cause

the pipes to break.   Therefore, we hold that the broken kitchen

water pipes were not part of the casualty loss caused by the 1991

floods.   In the absence of proof that the water pipes broke as a

result of the floods, the logical conclusion is that they broke

as a result of progressive deterioration.     Consequently, no

casualty loss may be deducted by petitioners for 1991 as a result

of the broken water pipes.
                                -41 -

      7.   Claimed Section 165(i) Relief

      Section 165(i)(1) provides that any loss attributable to a

disaster occurring in an area subsequently determined by the

President of the United States to warrant assistance by the

Federal Government under the Disaster Relief and Emergency

Assistance Act may, at the election of the taxpayer, be taken

into account for the taxable year immediately preceding the

taxable year in which the disaster occurred.    If such an election

is made, the casualty resulting in the loss is treated as having

occurred in the taxable year for which the deduction is claimed.

Sec. 165(i)(2).

      Section 1.165-11(e), Income Tax Regs., provides that an

election under section 165(i) must be made on or before the later

of:   (1) The due date for filing the income tax return

(determined without regard to any extension of time for filing

the return) for the taxable year in which the disaster actually

occurred, or (2) the due date for filing the income tax return

(determined with regard to any extension of time for filing the

return) for the taxable year immediately preceding the taxable

year in which the disaster actually occurred.

      Petitioners contended for the first time at trial that they

are entitled to relief under section 165(i) for their claimed

casualty losses resulting from the floods in 1991.   Petitioners

did not address this issue in their brief.
                               -42 -

     Respondent does not question that Washington County,

Mississippi, was officially determined a disaster area to which

section 165(i) applies because of the floods which occurred in

February and April of 1991.   However, it is asserted that

petitioners did not timely elect under section 165(i) for that

provision to apply to the 1991 floods.

     The due date for filing petitioners' 1991 return (determined

without regard to any extension of time for filing the return)

was April 15, 1992.   The due date for filing their 1990 return

(determined with regard to any extension of time for filing the

return) was April 15, 1991.   The later of these two dates is

April 15, 1992.   Because petitioners did not attempt to elect

section 165(i) treatment until October 1995, the date of the

trial of this case, petitioners did not make a timely election.

Therefore, section 165(i) does not apply to treat the floods

which occurred in 1991 as having occurred in 1990.

II. Issue 7.   Claimed Deductions for Legal and Professional
Expenses

     Section 162(a) allows a deduction for all ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business.     Legal expenses are deductible

under section 162(a) as ordinary and necessary business expenses

if the litigation is directly connected with, or proximately

related to, the taxpayer's business.     Bingham Trust v.

Commissioner, 325 U.S. 365, 373-374 (1945); Rafter v.

Commissioner, 60 T.C. 1, 8 (1973), affd. without published
                              -43 -

opinion 489 F.2d 752 (2d Cir 1974).   Section 262 provides that no

deduction shall be allowed for personal expenses.

     First, petitioners contend that they are entitled to a

deduction for 1990 of a $10,370.80 legal fee paid to an attorney

in 1989 for representing Mrs. Oliver in a criminal case which

arose out of her bookkeeping business.

     Respondent does not question that the legal fee is a

properly deductible business expense under section 162(a).    See

Commissioner v. Tellier, 383 U.S. 687 (1966), which allowed a

deduction under section 162(a) for amounts the taxpayer spent in

defense of criminal charges which arose out of his business.

Respondent contends, however, that because petitioners are cash

method taxpayers, the amount was deductible only in 1989 when it

was paid.

     Section 461(a) provides that deductions shall be taken for

the taxable year which is the proper taxable year under the

method of accounting used in computing taxable income.   Section

1.461-1(a)(1), Income Tax Regs., provides that under the cash

method of accounting, amounts representing allowable deductions

shall generally be deducted in the taxable year in which such

amounts are paid.

     Petitioners argue that, even though the legal expenses were

paid in 1989, they were not incurred until 1990, which is the

year in which the legal services were performed, and thus they

should be allowed a deduction in 1990.   They offered no evidence
                                -44 -

showing that the legal services were performed in 1990.

Consequently, we hold that the attorney's fee was not deductible

in 1990.

     Second, petitioners claim that they are entitled to deduct

as a business expense a $6,000 payment made in 1990 in settlement

of a lawsuit against Dr. Oliver.    The lawsuit, in which the

plaintiff alleged that Dr. Oliver acted unethically when he

treated a child at his home for injuries the child suffered while

playing with his son, was filed against Dr. Oliver personally and

in his professional capacity as a physician.

     Respondent argues that because the $6,000 payment

represented a payment in settlement of litigation and was not a

legal fee, it is not deductible under section 162(a).

Alternatively, respondent argues that the expense was personal in

nature.

     It is well established that settlement payments made to

avoid litigation are deductible under section 162(a) as ordinary

and necessary business expenses when they have a business origin.

Anchor Coupling Co. v. United States, 427 F.2d 429, 433 (7th Cir.

1970); Eisler v. Commissioner, 59 T.C. 634 (1973).    Here we find

that petitioners are not barred from deducting payments made in

settlement of the litigation.

     To determine whether a payment made in settlement of

litigation is directly connected with, or proximately related to,

the taxpayer's business, the controlling criteria are the origin
                               -45 -

and character of the controversy, rather than the potential

consequences of the failure to prosecute or defend the

litigation.   United States v. Gilmore, 372 U.S. 39, 44-51 (1963);

Anchor Coupling Co. v. United States, supra at 433.

     In Freedman v. Commissioner, 301 F.2d 359 (5th Cir. 1962),

affg. 35 T.C. 1179 (1961), the Court of Appeals held that the

cost of settling a personal injury suit arising out of an

accident which occurred while the taxpayer was en route from one

place of employment to another was a nondeductible personal

expense because the taxpayer was not engaged in his vocation at

the time of the accident.   Similarly, after applying the "origin

of claim" test in Marcello v. Commissioner, 380 F.2d 499, 504-505

(5th Cir. 1967), affg. in part 43 T.C. 168 (1964), the deduction

for attorney's fees was denied because the controversy did not

originate out of a business activity.

     Here, by contrast, the origin of the controversy was Dr.

Oliver's medical treatment, as a physician, of a child for

injuries at his home.   Unlike the taxpayers in the Freedman and

Marcello cases, Dr. Oliver was acting in his professional

capacity when the controversy arose, and therefore the payment in

settlement of the lawsuit was a business, rather than personal,

expense.   Consequently, we hold that petitioners are entitled to

deduct the $6,000 paid in 1990 in settlement of litigation as an

ordinary and necessary business expense.   See Musgrave v.

Commissioner, T.C. Memo. 1997-19.
                               -46 -

     Third, petitioners contend that they are entitled to a

deduction in 1991 for damages of $4,500 and legal fees of $1,500,

which resulted from a lawsuit filed by a neighbor against them

after they constructed a landfill on their property.

     Respondent argues that the amounts paid as damages and legal

fees are not deductible because they are personal expenses.

Petitioners argue that they were business expenses because

petitioners maintained an office at their home which was

protected from flood damage by the landfill.

     We agree with respondent that the amounts petitioners paid

as damages and legal fees as a result of the construction of a

landfill on their property were personal expenses and thus

nondeductible.   Applying the "origin of claim" test, we conclude

that the controversy did not originate in petitioners' business

activity, but rather originated in their effort to protect their

home from flooding.   United States v. Gilmore, supra at 44-51.

The connection between the construction of the landfill and

petitioners' business activities is far too attenuated for us to

conclude that the expenses were not personal.   In any event,

petitioners, as cash method taxpayers, are not entitled to deduct

the damages and legal fees because they apparently were not paid

by them until 1992, a year that is not before the Court in this

case.
                                  -47 -

III.    Issue 8.    Interest Income

       Section 61(a) provides that gross income means all income

from whatever source derived.      Section 61(a)(4) provides that

gross income includes interest.

       Respondent contends that petitioners failed to report

interest income of $2,824 on their Federal income tax return.

Information returns provided to respondent show that petitioners

received $17,952 in interest income in 1990.        Petitioners

reported only $15,128 as interest income on their 1990 return.

       Petitioners contend that $633 of the unreported interest

income paid by Allstate Life Insurance Co. (Allstate) was not

taxable.    They submitted a letter from Allstate, which they claim

explained that the interest was not taxable.        The letter does not

support their contention.

       Petitioners have offered no evidence as to the remaining

amount of unreported interest income determined by respondent.

However, respondent presented testimony and documentary evidence

showing that petitioners received $2,824 in interest income which

was not reported on their 1990 return.        Therefore, respondent is

sustained on this issue.

IV.    Issue 9.    Claimed Deductions for Self-Employment Taxes

       Section 275(a)(1) provides that no deduction shall be

allowed for Federal income taxes.         However, section 275 does not

apply to disallow a deduction for taxes to the extent such a

deduction is allowable under section 164(f), which provides that
                                  -48 -

one-half of the self-employment tax for the taxable year is

allowed as a deduction.

      Through adjustments made to petitioners' 1990 and 1991

income tax returns at the Memphis Service Center, petitioners

were allowed to deduct one-half of the self-employment tax

reported by them on those returns.

      Petitioners contend that they are entitled to a deduction

for the full amount of self-employment tax paid by them in 1990

and 1991 in the amounts of $7,849 and $10,246, respectively.

However, petitioners offer no support for this contention.

Respondent counters with the assertion that the deductions

claimed by petitioners on their returns for 1990 and 1991 for the

full amount of self-employment tax paid by them should be

disallowed.      Because petitioners were previously allowed a

deduction for one-half of the self-employment tax reported by

them on their returns for 1990 and 1991, as provided in section

164(f), we agree with respondent that the full amount of the

deductions claimed by them on their returns for 1990 and 1991

should be disallowed.      We so hold.

V.   Issue 10.    Statute of Limitations on Assessment for 1990

      Petitioners contend that respondent's notice of deficiency

for 1990 was issued after the statutory period for the assessment

of a tax deficiency had expired.      This issue was raised for the

first time in petitioners' brief.
                                  -49 -

      Respondent contends that petitioners should not be allowed

to raise this issue for the first time in their brief because it

was not pleaded by petitioners as an affirmative defense in their

petition or at the trial.

      We agree with respondent.    Rule 39 requires that the statute

of limitations be pleaded as an affirmative defense.        Where a

taxpayer fails to plead the expiration of the statutory period of

limitations as an affirmative defense in his petition, that issue

is not properly before the Court.         United Bus. Corp. of Am. v.

Commissioner, 19 B.T.A. 809, 831-832 (1930), affd. 62 F.2d 754

(2d Cir. 1933).     Moreover, petitioners' contention lacks merit

because the notice of deficiency covering 1990 was sent to

petitioners on August 11, 1994, which was within 3 years after

their 1990 return was filed on August 19, 1991.        Sec. 6501(a).

VI.   Issue 11.   Section 6651(a)(1) Additions to Tax

      Section 6651(a)(1) provides for an addition to tax for

failure to file a Federal income tax return by its due date,

determined with regard to any extension of time for filing,

unless such failure was due to reasonable cause.        In this case

petitioners applied for automatic 4-month extensions of time

within which to file their 1990 and 1991 returns.        If the

requests for extensions were effective, their 1990 and 1991

returns were due on August 15, 1991, and August 15, 1992,

respectively.     Sec. 1.6081-4, Income Tax Regs.     Petitioners' 1990
                               -50 -

return was received by respondent on August 19, 1991, and their

1991 return was received by respondent on July 20, 1992.

     Respondent takes the position that the applications for

automatic extensions were invalid because petitioners did not

comply with regulations for obtaining such extensions, and,

therefore, the applications for automatic extensions were null

and void.   Section 1.6081-4(a)(4), Income Tax Regs., provides

that the application for extension must show the full amount

properly estimated as tax for the taxpayer for the taxable year,

and that the application must be accompanied by

the full remittance of the amount properly estimated as tax which

is unpaid as of the date prescribed for filing the return.     An

extension of time to file a return does not extend the time for

payment of tax due on the return.      Sec. 1.6081-4(b), Income Tax

Regs.

     Petitioners made no payment of tax with their extension

requests for 1990 or 1991, although they made estimated tax

payments of $7,711.20 for 1990 and $10,246.60 for 1991.

Petitioners underestimated their 1990 estimated tax liability by

approximately $25,000 and their 1991 tax liability by

approximately $50,000.

     In Crocker v. Commissioner, 92 T.C. 899, 908 (1989), this

Court held that a taxpayer should be treated as having "properly

estimated" his tax liability when he makes a bona fide and

reasonable estimate of his tax liability based on the information
                                 -51 -

available to him at the time he makes his request for extension,

and that a taxpayer must make a bona fide and reasonable attempt

to locate, gather, and consult information which will enable him

to make a proper estimate of his tax liability.    An extension of

time to file a return is invalid when the taxpayer fails to make

a proper estimation of his tax liability, even if the taxpayer

receives no notice of the termination of the extension request.

Crocker v. Commissioner, supra at 910-912.

     In the instant case petitioners' estimate of their tax

liability for each year, based on the information available to

them at the time of their extension request, was not reasonable.

Petitioners concluded that they owed zero tax in addition to the

estimated tax payments they had already made for the years 1990

and 1991 based, among other things, on their contentions that

they incurred deductible casualty losses in excess of insurance

reimbursements, and that they were entitled to deductions for the

full amounts of self-employment taxes paid by them in 1990 and

1991.    However, we have found that these positions are without

merit.    As a matter of law, petitioners are entitled to a

deduction for only one-half of the self-employment tax paid by

them.    Sec. 164(f).   And they failed to produce evidence showing

that they were entitled to casualty loss deductions for 1990 and

1991 in amounts in excess of their insurance reimbursements.

     Since petitioners failed to "properly estimate" their tax

liabilities, the Forms 4868 on which they requested extensions of
                              -52 -

time within which to file their 1990 and 1991 Federal income tax

returns were invalid.

     If the Commissioner voids an automatic extension for failure

of a taxpayer to properly estimate, the taxpayer is liable for an

addition to tax under section 6651(a)(1), unless he can establish

that the failure to file a return by the date prescribed by law

is due to reasonable cause and not due to willful neglect.

Crocker v. Commissioner, supra at 912.   The term "willful

neglect" implies a conscious, intentional failure to file or

reckless indifference to the obligation to file.   United States

v. Boyle, 469 U.S. 241, 245 (1985).   A failure to file is due to

"reasonable cause" if the taxpayer exercised ordinary business

care and prudence and was, nevertheless, unable to file his

return within the date prescribed by law.   Sec. 301.6651-1(c)(1),

Proced. & Admin. Regs.

     Petitioners argue that their failure to file timely their

1990 return was due to reasonable cause and not willful neglect

because in February and April of 1991, the months in which

information needed to be gathered and the 1990 return prepared,

they experienced flooding at their home which was so severe that

Washington County was declared a Presidential disaster area.

They assert that because of the floods necessary documents were

destroyed and they were too preoccupied with the damage to their

home to file their Federal income tax return on time.
                                -53 -

Petitioners offer no explanation of their failure to file their

1991 return timely.

     Petitioners' allegation as to the unavailability of records

does not establish reasonable cause for failure to file timely

returns.    Electric & Neon, Inc. v. Commissioner, 56 T.C. 1324,

1342-1344 (1971), affd. without published opinion sub nom.

Jiminez v. Commissioner, 496 F.2d 876 (5th Cir. 1974).    A

taxpayer is required to file a timely return based on the best

information available and to file an amended return thereafter if

necessary.    Estate of Vriniotis v. Commissioner, 79 T.C. 298, 311

(1982).    In addition, a taxpayer is not excused from timely

filing his income tax return merely because he is overworked.

Crocker v. Commissioner, supra at 913;    Dustin v. Commissioner,

53 T.C. 491, 507 (1969), affd. 467 F.2d 47 (9th Cir. 1972).

Consequently, we hold that petitioners have not established that

the failure to file timely 1990 and 1991 returns was due to

reasonable cause, and that they are liable for the additions to

tax under section 6651(a)(1).

VII. Issue 12.    Section 6662(a) Accuracy-Related Negligence
Penalties

     Finally, respondent determined that petitioners are liable

for accuracy-related penalties under section 6662(a) for 1990 and

1991.

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

portion of an underpayment attributable to a taxpayer's
                                -54 -

negligence or disregard of rules or regulations.     Sec. 6662(a)

and (b)(1).   The term "negligence" includes any failure to do

what a reasonable and ordinarily prudent person would do under

the same circumstances.    Neely v. Commissioner, 85 T.C. 934, 947

(1985).   The term "disregard" includes any careless, reckless, or

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

to any portion of an underpayment for which there was reasonable

cause and with respect to which the taxpayer acted in good faith.

Sec. 6664(c)(1).

     Petitioners failed to prove that they were not negligent.

They failed to report taxable interest income received by them in

1990.   They claimed deductions for self-employment tax on their

returns for 1990 and 1991 even though they are not, as a matter

of law, entitled to such deductions.      They claimed casualty loss

deductions in 1991 to which they were not entitled.     Worksheets

prepared by them in support of their claimed casualty loss caused

by the February flood contained duplications of the claimed

losses relating to individual items.      Worksheets prepared by them

in support of their claimed casualty loss caused by the April

flood contained numerous duplications of individual items which

petitioners had included in their claimed loss as a result of the

February flood.

     Accordingly, except for the $6,000 business expense

deduction allowed for the litigation settlement, we hold that

petitioners are liable for the accuracy-related penalties for
                              -55 -

negligence with respect to underpayments relating to all other

issues.

     To reflect conceded and settled issues and our conclusions

with respect to the disputed issues,



                                           Decision will be entered

                                      under Rule 155.
