                  T.C. Summary Opinion 2001-176



                     UNITED STATES TAX COURT


                   ROBERT FEDEWA, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent




     Docket No. 14639-99S.                Filed November 21, 2001.


     Lawrence P. Schweitzer, for petitioner.

     Kimberly J. Webb, for respondent.



     GOLDBERG, Special Trial Judge:   This case was heard pursuant

to the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed.   The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority.   Unless otherwise indicated,
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subsequent section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.

     In a notice of deficiency, respondent determined that

petitioner is liable for deficiencies in Federal income taxes for

the tax years 1994 and 1995 in the amounts of $3,014 and $31,949,

respectively.   Respondent also determined accuracy-related

penalties under section 6662(a) for the tax years 1994 and 1995

in the amounts of $603 and $6,343, respectively.

     After concessions made by petitioner,1 the issues for

decision are:   (1) Whether petitioner is entitled to deduct on

his 1994 Federal income tax return his pro rata share of

partnership loss attributable to a bad debt, and (2) whether

petitioner is liable for accuracy-related penalties under section

6662(a) for the tax years 1994 and 1995.

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.     At the time the petition

was filed, petitioner resided in Dewitt, Michigan.




     1
          Petitioner concedes all adjustments to income in the
notice of deficiency, except the disallowed partnership loss
deduction of $65,419 and accuracy-related penalties which are the
issues before us. There appears to be a mathematical error in
the partnership loss deduction amount; the correct amount should
be $64,559.
                                - 3 -

Background

     In 1976, petitioner and his brother, James Fedewa, and

cousin, Bernard Fedewa, formed a partnership known as BBJ

Investments (BBJ).    BBJ is a Michigan partnership in the business

of acquiring and operating residential real estate.     Initially,

the partnership was owned equally by the three partners.     On July

6, 1987, James Fedewa relinquished his one-third interest in BBJ

to petitioner.    Since 1987, petitioner has held a two-thirds

interest in BBJ.    Petitioner was also either a shareholder or

partner in Fedewa Enterprises, Fedewa Builders, Fedewa Realty

World, and Construction Redi-Mix (collectively the related

entities).   The related entities were involved in the development

and construction of residential and commercial properties through

the 1980s.

     In 1975, BBJ purchased land to build a 50-unit apartment

complex known as North Scott Villa.     In order to complete the

North Scott Villa project, Bernard E. Fedewa, James R. and Mary

Ann Fedewa, and Robert E. and Julia I. Fedewa, as the “borrower”

secured a $712,500 loan bearing 8.5-percent interest (FmHA loan),

from the Department of Agriculture Farmers Home Administration

(FmHA) in 1975.    Pursuant to the loan agreement, the borrower was

required to provide annual budgets, annual operating plans, and

maintain books and records relating to the housing project’s

financial affairs, causing such books and records to be audited
                               - 4 -

at the end of each fiscal year.   The borrower was also required

to maintain various reserve or escrow accounts (collectively

reserve accounts) so long as the loan obligation remained

unsatisfied.   In the event the borrower failed to comply with the

terms of the loan agreement, the Government could declare the

entire amount of the loan obligation immediately due and payable,

and, enforce all other available remedies.     The Government also

had an option to waive any provision of the loan agreement.

     On January 1, 1978, James Fedewa, on behalf of Fedewa

Builders, Inc., executed a promissory note for $28,056.41 to BBJ

(1978 promissory note).   The 1978 promissory note, bearing 8-

percent interest, did not state a due date.2    Fedewa Builders and

Fedewa Enterprises ceased business operations in 1987.

     In 1979, Touche Ross & Co., BBJ’s certified public

accountants, conducted an audit of BBJ’s books and records.       On

its books and records appeared an asset account of $109,540 for

notes receivable due from two related entities.3    Despite the

related party transaction, Touche Ross & Co. gave BBJ a “clean”

financial opinion.   However, beginning in 1982 and through 1988,

BBJ failed to obtain “clean” financial opinions and received



     2
          We note that the photocopy of the 1978 promissory note
is illegible and testimony by petitioner’s sole witness, Michael
A. Comito, did not provide such information.
     3
          It is unclear which two related entities generated the
notes receivable referenced in the Touche Ross & Co. audit.
                                - 5 -

“disclaimer” opinions.   FmHA raised concerns about BBJ’s failure

to maintain the reserve accounts required under the FmHA loan

agreement.   FmHA refused to waive BBJ’s noncompliance under the

loan agreement.   In 1989, FmHA began foreclosure proceedings

against BBJ for its failure to maintain adequate reserve

accounts.

     In 1994, Yeo and Yeo, P.C., certified public accountants,

audited the North Scott Villa Apartments project for years 1992

and 1993.    Yeo and Yeo provided a disclaimed opinion based on the

following:

     As discussed in Note 6 to the financial statements,
     North Scott Villa Apartments is in violation of certain
     covenants of its loan agreements with the United States
     Department of Agriculture Farmers Home Administration.
     The lender has the option to demand immediate payment
     of the mortgage note. On January 9, 1989, the owners
     of North Scott Villa Apartments were notified by the
     Untied [sic] States Department of Agriculture Farmers
     Home Administration of the acceleration of the mortgage
     note and immediate payment of the mortgage note. * * *
     The financial statements do not include any adjustment
     relating to the recoverability and classification of
     recorded assets and liability amounts that might be
     necessary should North Scott Villa Apartments be unable
     to continue in existence.

     Petitioner timely filed his 1994 Federal income tax return

wherein he reported $64,559 reflecting his pro rata share of

partnership loss attributable to a business bad debt.   Petitioner

claims that the bad debt deduction is attributable to uncollected

accounts receivable due from the following entities:
                                - 6 -

          Fedewa Enterprises                 $20,638
          Fedewa Realty World                    435
          Construction Redi-Mix                3,229
          Fedewa Builders                     72,371
          FCC                                    165
            Total                            $96,838[1]

     1 Petitioner’s pro rata share of the accounts receivable is
$64,559 based upon his two-thirds interest in BBJ. (2/3 X
$96,838 = $64,559)

The following is a schedule of BBJ’s notes receivable ledger from

1976 through 1988:

          Year        Notes Receivable Principal

          1976                   $5,008.92
          1977                   32,956.41
          1978                   55,022.53
          1979                  109,540.00
          1980                  105,495.00
          1981                   91,794.00
          1982                   87,942.00
          1983                   87,895.00
          1984                   96,588.00
          1985                   96,838.00
          1986                   96,838.00
          1987                   96,838.00
          1988                   96,838.00

No payments of interest or principal were received after 1984.

Petitioner could not explain the origin of the initial $5,008.92

note receivable in 1976.   The 1978 note receivable is reflected

in the 1977 year-end amount listed above.       Besides the 1978 note

receivable, there is no documentation memorializing any additions

to principal or income and/or principal paid.        Moreover, the

record does not provide a description of the surrounding

circumstances or the purpose for the increases in the notes

receivable account.
                               - 7 -

     In the notice of deficiency, respondent disallowed for

taxable year 1994 petitioner’s partnership loss deduction of

$64,559 attributable to his pro rata share of a business bad

debt.4   Respondent also determined for taxable years 1994 and

1995 accuracy-related penalties on the business bad debt and

other issues petitioner has conceded.

Discussion

     Section 166(a) generally allows a deduction for bona fide

debts that become wholly or partially worthless within the

taxable year.   A business bad debt is fully deductible from

ordinary income.   Sec. 166(d)(1).   A bona fide debt “arises from

a debtor-creditor relationship based upon a valid and enforceable

obligation to pay a fixed or determinable sum of money.”     Sec.

1.166-1(c), Income Tax Regs.   Whether the parties actually

intended the transactions to be loans depends on whether the

advances were made “with a reasonable expectation, belief and

intention that they would be repaid.”    Goldstein v. Commissioner,

T.C. Memo. 1980-273.

     The objective indicia of a bona fide debt includes whether a

note or other evidence of indebtedness existed and whether

interest was charged.   Clark v. Commissioner, 18 T.C. 780, 783

(1952), affd. 205 F.2d 353 (2d Cir. 1953).   We also consider the

existence of security or collateral, the demand for repayment or



     4
           See supra note 1.
                                 - 8 -

a fixed schedule for repayment, records that may reflect the

transaction as a loan, and the borrower’s solvency at the time of

the loan.   Id. at 783-784.    The key factor is whether the parties

actually intended and regarded the transaction as a loan.     Estate

of Van Anda v. Commissioner, 12 T.C. 1158, 1162 (1949), affd. per

curiam 192 F.2d 391 (2d Cir. 1951).

     Respondent contends that petitioner failed to substantiate

the amount of the purported business bad debt and to demonstrate

that such debt was bona fide.    Petitioner asserts that the notes

receivable were substantiated by the 1987 promissory note, the

1980 Touche Ross & Co. audit report, and the 1994 Yeo and Yeo

audit report.   We disagree.

     At trial petitioner produced the $28,056.41 promissory note

signed by James Fedewa on January 1, 1978.    Although the 1978

promissory note bore interest of 8 percent, the note did not

provide a discernable due date; thus, we find the enforcement or

demand of repayment on this note highly suspect.    Furthermore,

petitioner failed to provide any credible evidence to establish

the origin of the $5,008.92 note receivable in 1976, to which

principal the 1978 promissory note added, or the subsequent

increases from 1978 through 1984.    Although the origin of the

notes receivable is unclear, petitioner does not dispute that the

purported debt in issue arose from related party transactions.

The record is devoid of any helpful information as to the
                               - 9 -

creation, purpose, or payment on the notes receivable principal

balance from 1976 through 1985.

     We also find petitioner’s reliance on the audit reports of

Touche Ross & Co. and Yeo and Yeo misplaced.   These reports cover

a span of over a decade and clearly state that the auditors

relied on information provided by, and exclusively in the control

of the owners.   There is no information in the auditing firm’s

reports that they made an independent verification of the notes

receivable account.

     Likewise, FmHA’s recognition of the notes receivable debt is

inapposite to the primary issue of substantiation.    The FmHA loan

is not the subject of the bad debt for which petitioner is

claiming a partnership loss deduction in this case.   Pursuant to

the loan agreement, the borrower must maintain certain reserve

accounts while the loan obligation remained outstanding.

According to FmHA, petitioner and the other borrowers failed to

maintain these accounts.   Although FmHA began foreclosure

proceedings for the failure to maintain adequate reserve

accounts, FmHA did not attempt collection on the notes

receivable.   FmHA was not a party to any of the transactions that

gave rise to the underlying debt in issue.   FmHA’s interest

focused on the funding of the reserve accounts, from whatever

source.

     Based upon the above, we find that the balance in the notes
                                - 10 -

receivable accounts was not verified and further does not

constitute a bona fide debt.     Accordingly, petitioner is not

entitled to the partnership loss deduction during the years in

issue.    Respondent is sustained on this issue.

Accuracy-Related Penalty

     Section 6662(a) imposes an accuracy-related penalty of 20

percent of the portion of the underpayment which is attributable

to negligence or disregard of rules or regulations.      Sec.

6662(b)(1).    Negligence is the lack of due care or failure to do

what a reasonable and ordinarily prudent person would do under

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

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

intentional disregard.     Sec. 6662(c).   No penalty shall be

imposed if it is shown that there was reasonable cause for the

underpayment and the taxpayer acted in good faith with respect to

the underpayment.    Sec. 6664(c).

     On the basis of the record, we find that petitioner has

failed to demonstrate that he was not negligent and did not

disregard rules or regulations.      We hold that petitioner is

liable for the accuracy-related penalty under section 6662(a) for

each year in issue.

     We have considered all arguments by the parties, and, to the

extent not discussed above, conclude that they are irrelevant or

without merit.
                            - 11 -

    Reviewed and adopted as the report of the Small Tax Case

Division.

                                       Decision will be entered

                                  under Rule 155.
