                         T.C. Memo. 2006-70



                      UNITED STATES TAX COURT



                  MELVIN D. LEE, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 21038-03.            Filed April 11, 2006.



     Melvin D. Lee, pro se.

     Michael E. Melone and Catherine G. Chang, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     SWIFT, Judge:   Respondent determined a deficiency in

petitioner’s Federal income tax for 1997, an addition to tax, and

a penalty, as follows:

                Addition to Tax     Accuracy-Related Penalty
Deficiency    Under Sec. 6651(a)       Under Sec. 6662(a)
 $67,822            $16,956                  $13,564
                              - 2 -
     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

     After settlement or concession of some issues, the two

primary issues for decision are (1) whether petitioner has

substantiated increased itemized deductions for State and local

income taxes, a $25,990 net operating loss (NOL) carryforward

from 1996, a $206,881 long-term capital loss carryforward from

1996, $35,289 in suspended passive activity losses in 1992

through 1996 relating to real estate which petitioner sold in

1997, and $40,466 in legal fees relating to an investment in a

limited partnership, and (2) whether a nonbusiness loan made by

petitioner to a friend became worthless in 1997.


                        FINDINGS OF FACT

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

     At the time the petition was filed, petitioner resided in

San Francisco, California.

     Petitioner provides consulting services to developers and

contractors seeking building permits.   Petitioner has invested in

various construction projects in the San Francisco Bay area.
                               - 3 -
Belmont Gardens

     In approximately 1994 or 1995, petitioner and Ike Guillory

(Guillory), a business associate, formed Belmont Gardens, L.P.,

as a limited partnership (BG Partnership).     The BG Partnership

agreement designated Guillory as the general partner and

petitioner as the limited partner.     Petitioner and Guillory

formed the partnership in order to develop a 20-unit senior-

living residential complex in Belmont, California (Belmont

Gardens).   I.P.G. Builders, Inc. (I.P.G. Builders), which

Guillory owned, was to serve as the general contractor for

construction of Belmont Gardens.

     Construction of Belmont Gardens began prior to 1997.     At

some point during construction, petitioner became dissatisfied

with the work performed on Belmont Gardens by I.P.G. Builders.

Construction was behind schedule, and the construction quality

was substandard.   Extensive water damage to many of the units

occurred because of leaks in the roof.

     Petitioner eventually took legal action against I.P.G.

Builders and Guillory to remedy the construction defects and to

assume control over construction of Belmont Gardens.     On April

25, 1997, petitioner filed a complaint in State court against

I.P.G. Builders and Guillory for breach of contract.
                                - 4 -
Peach Tree Property

     Beginning in 1991, petitioner rented out real property he

owned in Penryn, California (Peach Tree Property).    In 1997

petitioner sold the Peach Tree Property for $235,000.


Dejanu Loan

     In mid-1994, petitioner made two loans to a friend of his by

the name of Peter Dejanu (Dejanu), which loans totaled $15,000.

The loans were to be repaid by Dejanu with interest 30 days from

the date each loan was made.    Dejanu did not repay the loans.

Petitioner attempted to obtain repayment of the loans from Dejanu

on approximately a weekly or biweekly basis from the due date in

1994 until some time in 1997.

     In 1997, petitioner discovered that Dejanu was essentially

insolvent and was seeking funds from other individuals.    After

discovery of Dejanu’s desperate financial situation, and his

unsuccessful collection efforts and the length of time his loans

to Dejanu had been in default, petitioner concluded that the

Dejanu loans were uncollectible, and petitioner ceased collection

activities.   Petitioner did not recover any principal or interest

on the Dejanu loans.


Tax Return and Respondent’s Audit

     On June 20, 1999, petitioner untimely filed with respondent

his 1997 individual Federal income tax return, on which
                                       - 5 -
petitioner claimed various deductions relating to State and local

income taxes, an NOL carryover, a long-term capital loss

carryover, suspended passive activity losses relating to the

Peach Tree Property, legal fees relating to Belmont Gardens, and

the worthlessness of the Dejanu loan.

      On audit, respondent disallowed the claimed deductions

primarily on the grounds of lack of substantiation, as set forth

below:


                                                         Amount         Amount
                                                       Claimed by     Allowed by
Nature of Deduction Claimed                            Petitioner     Respondent
State and local income taxes                            $ 17,385        $3,532
NOL carryforward from 1996                                25,990             0
Long-term capital loss carryforward1                     206,881             0
Suspended passive activity losses                         35,289             0
Legal fees relating to Belmont Gardens                    40,466             0
Worthless Dejanu loan2                                    15,000             0

      1
       From prior years, petitioner claimed a long-term capital loss carryforward
into 1997 of $206,881, of which $88,430 was used to offset in full a net long-term
capital gain for 1997, $3,000 was claimed as a long-term capital loss for 1997, and
the $115,451 balance was reported as a long-term capital loss carryforward to 1998.
      2
       On his 1997 individual Federal income tax return, petitioner claimed a
business bad debt relating to the Dejanu loan on schedule C, Profit or Loss From
Business. Petitioner now concedes that the loan should be treated as a nonbusiness
bad debt and reported as a short-term capital loss in 1997, the alleged year of
worthlessness.



      Respondent disallowed the deduction for the Dejanu loan

because respondent determined that the loan became worthless in

1995, not 1997.

      Respondent also determined that petitioner was liable under

section 6651(a) for an addition to tax for failure to timely file
                               - 6 -
his 1997 individual Federal income tax return and an accuracy-

related penalty under section 6662 on the full amount of the tax

deficiency determined by respondent.


                              OPINION

     Taxpayers are expected to keep adequate books and records

reflecting their income and expenses.   Sec. 6001.

     Generally, under section 7491(a), the burden of proof

on factual issues relating to a taxpayer’s tax liability may

shift from the taxpayer to respondent where the taxpayer has

credible evidence to substantiate the item in question, has

maintained appropriate records relating thereto, and has

cooperated with reasonable requests for information relating to

the item in question.   Sec. 7491(a)(1) and (2); Rule 142(a).

     Petitioner has not produced credible evidence to

substantiate any of the items at issue, nor has petitioner

maintained appropriate records relating to the deductions at

issue.   Therefore, the burden of proof as to each of the issues

in this case remains on petitioner.


State and Local Income Taxes -- $13,853

     In general, a taxpayer is allowed an itemized deduction for

State and local taxes paid within a year.   Sec. 164(a).

     Petitioner has not introduced any credible evidence to

substantiate that during 1997 he paid the $13,853 in State and
                                - 7 -
local income taxes.    Petitioner is not entitled to deduct the

claimed $13,853 in State and local income taxes in excess of the

$3,532 allowed by respondent.


Net Operating Loss Carryforward -- $25,990

     Section 172 allows an NOL deduction to a taxpayer equal to

the total of the NOL carryforwards and carrybacks to the year.

Sec. 172(a).   Absent an election to the contrary, NOLs are to be

carried back to the 3 prior years, and then, if not fully

absorbed, are to be carried forward to subsequent years up to a

maximum of 15 years.    Sec. 172(b)(1)(A), (2), and (3).1

     Taxpayers bear the burden of establishing both the existence

and amount of NOL carrybacks and carryforwards.      Rule 142(a);

Keith v. Commissioner, 115 T.C. 605, 621 (2000); Jones v.

Commissioner, 25 T.C. 1100, 1104 (1956), revd. and remanded on

other grounds 259 F.2d 300 (5th Cir. 1958).

     We may consider facts relating to years not in issue that

are relevant to the claimed NOLs.    Sec. 6214(b).

     The only evidence petitioner has presented with regard to

the $25,990 claimed 1996 NOL carryforward is his 1996 individual

Federal income tax return.




     1
      For tax years beginning on or after Aug. 5, 1997, net
operating losses are to be carried back 2 years and then carried
forward up to a maximum of 20 years. Taxpayer Relief Act of
1997, Pub. L. 105-34, sec. 1082(a)(1), 111 Stat. 950.
                               - 8 -
     In this case, petitioner’s 1996 tax return is insufficient

to substantiate that petitioner incurred an NOL in 1996.

Petitioner’s tax return only sets forth petitioner’s claimed NOL

and does not establish petitioner’s entitlement thereto.     Roberts

v. Commissioner, 62 T.C. 834, 837 (1974).

     Also, even if petitioner had substantiated that he incurred

in 1996 an NOL, petitioner did not file an election to forgo the

carryback thereof to prior years.    Petitioner was required to

carryback any 1996 NOL to 1993, 1994, and 1995 before carrying it

forward to 1997.   If petitioner had carried back the $25,990

claimed 1996 NOL into 1993, 1994, and 1995, the entire NOL would

have been absorbed, and no carryforward into 1997 would be

available.


Capital Loss Carryover -- $206,881

     Generally, a taxpayer’s capital losses and capital gains in

a year offset each other, and any excess capital losses, up to

$3,000 are allowed as a capital loss deduction in the current

year.   Any excess may be carried forward to succeeding years.

Sec. 1212(b)(1)(A) and (B); sec. 1211(b).

     Petitioner did not introduce any evidence to indicate, let

alone to substantiate, the year in which the claimed $206,881

capital loss carryover originated, the circumstances which

produced the claimed capital loss, or the amount of the capital

loss.   Petitioner’s only effort to substantiate the claimed
                                 - 9 -
capital loss was to introduce Federal income tax returns from

prior years on which capital loss carryovers were claimed.

     As explained earlier, income tax returns merely reflect

taxpayers’ claims.    They do not establish the facts reflected

therein.    Without additional evidence of the original claimed

capital loss, petitioner’s tax returns are insufficient to

substantiate his entitlement to the claimed $206,881 capital loss

carryover to 1997.

     Petitioner argues that respondent’s acceptance without

adjustment of his prior year income tax returns on which

petitioner claimed a carryforward of the capital loss now estops

respondent from contesting that the underlying capital loss

occurred.    We disagree.   Respondent is not bound in any given

year to allow the same treatment or the same deductions not

disallowed in prior years.     See Lerch v. Commissioner, 877 F.2d

624, 627 n.6 (7th Cir. 1989); Pekar V. Commissioner, 113 T.C. 158

(1999).

     Petitioner’s claimed $206,881 capital loss carryforward to

1997 is denied.


Peach Tree Property Suspended Losses -- $35,289

     In general, no deduction is allowed in a year for an

individual taxpayer’s passive activity losses in excess of

passive activity income, but the excess losses may be carried

forward to subsequent years to offset subsequent passive activity
                                - 10 -
income.   Sec. 469(a), (b), (d).   If, however, a taxpayer sells

his entire interest in a passive activity, an excess loss

relating to the activity for the year the sale occurred

(including suspended losses relating to the activity carried

forward into the year of the sale) over the total income for the

current year from all passive activities is treated as a loss

from a nonpassive activity and is not subject to the above

limitation of section 469(a).    Sec. 469(g).

     Other than the claims made on his 1992 through 1996 Federal

income tax returns, petitioner has not offered any evidence to

substantiate that he incurred disallowed passive activity losses

in 1992 through 1996 in relation to the Peach Tree Property.      As

discussed previously, claims made on petitioner’s tax returns do

not substantiate the items in issue.     Petitioner is not entitled

to deduct in 1997 the claimed $35,289 in suspended passive

activity losses relating to the Peach Tree Property.


Belmont Gardens Legal Fees -- $40,466

     Petitioner has not substantiated that he paid $40,466 in

legal fees in relation to the construction of Belmont Gardens.

Petitioner introduced into evidence certain checks made to three

different law firms; however, these checks totaled only $9,500.

At trial, petitioner did not call to testify the attorneys who

allegedly represented him in the Belmont Gardens litigation,

notwithstanding the Court’s suggestion to do so.    See Wichita
                               - 11 -

Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946),

affd. 162 F.2d 513 (10th Cir. 1947).    Petitioner’s claimed legal

fees are disallowed.2


Dejanu Loan -- $15,000

     A taxpayer is allowed to deduct as a short-term capital loss

nonbusiness debts that become worthless within the year.    Sec.

166(d); sec. 1.166-5(a)(2), Income Tax Regs.

     Whether a nonbusiness debt is to be treated as worthless in

a particular year is a question of fact to be resolved by an

examination of the circumstances and events.    Aston v.

Commissioner, 109 T.C. 400, 415 (1997); Crown v. Commissioner, 77

T.C. 582, 598 (1981).    Relevant considerations include the

solvency of the debtor and efforts to collect the debt from the

debtor.   Crown v. Commissioner, supra.

     On the facts of this case, petitioner has provided

sufficient evidence to establish that the $15,000 Dejanu

nonbusiness loan became worthless in 1997, not in 1995 as

     2
      We note further that even if petitioner had substantiated
the legal fees in question, respondent contends that any
deductions relating to the legal fees would be limited by the
passive activity loss limitation of sec. 469(a). Petitioner
contends that under State law he became a general partner in
Belmont Gardens L.P. due to his level of activity in the
business, and therefore that sec. 469(a) should not apply to him.
A taxpayer, however, is considered to hold a limited partnership
interest without regard to State law if, in the partnership
agreement, the taxpayer is designated as having a limited
partnership interest. Sec. 1.469-5T(e)(3)(A), Temporary Income
Tax Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988).
                              - 12 -

respondent contends.   Even though the loan first became

delinquent in 1994 and even though petitioner in 1995 began to

lose hope that it would eventually be repaid, petitioner’s

continued collection efforts after 1995 and into 1997 indicate

that the loan did not become worthless in 1995 or 1996.    The

length of time in which the loan was in default, in conjunction

with Dejanu’s desperate financial condition indicate that this

loan became worthless in 1997, not in 1995.


Accuracy-Related Penalty

     Under section 6662, a 20-percent accuracy-related penalty is

to be added to that portion of an underpayment of tax

attributable to, among other things, a substantial understatement

of income tax.3   Sec. 6662(a) and (b)(2).

     A substantial understatement of income tax is defined as a

tax understatement constituting the greater of 10 percent of the

tax required to be shown on a Federal income tax return or

$5,000. Sec. 6662(d)(1)(A).   An understatement of tax for

purposes of determining the accuracy-related penalty may be

reduced by that portion of the understatement attributable to




     3
      Respondent also argues that petitioner is liable for the
accuracy-related penalty for negligence or disregard of rules and
regulations under sec. 6662(b)(1). We do not address whether
petitioner is liable for the accuracy-related penalty under
respondent’s alternative theory.
                               - 13 -

reasonable cause and good faith.    Secs. 6662(d)(2)(B),

6664(c)(1).

     Under section 7491(c), respondent has the burden of

production with respect to a section 6662 accuracy-related

penalty.    Once respondent meets that burden of production,

however, the taxpayer continues to have the burden of proof with

regard to whether respondent’s determination of the penalty is

correct.    Rule 142(a); Higbee v. Commissioner, 116 T.C. 438, 446

(2001).

     As a result of our holdings herein, petitioner, on his 1997

individual Federal income tax return, understated his tax by more

than $5,000 and also by more than 10 percent of the tax required

to be shown.    Respondent has met his burden of production with

respect to the accuracy-related penalty.4

     Petitioner argues that the understatement of tax on his 1997

individual Federal income tax return was due to reasonable cause

and was made in good faith because of his reliance on his

accountant.    We disagree.

     The only alleged erroneous advice petitioner’s accountant

gave to petitioner related to the carryforward of the claimed

1996 NOL to 1997 instead of a carryback thereof to 1993, 1994,

and 1995.    That advice, however, has no bearing on our holding



     4
      The actual amount to which the sec. 6662 accuracy-related
penalty applies is subject to the Rule 155 computation.
                             - 14 -

because our disallowance of the claimed NOL deduction is due to

petitioner’s failure to substantiate the NOL, for which

petitioner has offered no excuse.

     Petitioner is liable for the accuracy-related penalty on the

full amount of the understatement of tax on his 1997 individual

Federal income tax return as determined herein.

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
