                        T.C. Memo. 1998-439



                      UNITED STATES TAX COURT



            IMRE AND GIZELLA CZIRAKI, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 18878-96.                Filed December 15, 1998.



     Jeffrey R. Matsen and Arlin P. Neser, for petitioners.

     Ian Russell and Michael H. Salama, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   Respondent, by means of a statutory notice

of deficiency, determined a deficiency in petitioners’ 1992

income tax of $63,874 and a section 6662(a)1 penalty of $12,775.


     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year under
consideration, and all Rule references are to this Court's Rules
of Practice and Procedure.
                                -2-

After concessions, the following issues remain for our

consideration:   (1) Whether petitioners are entitled to a

casualty loss deduction in the amount of $220,000 for the 1992

taxable year, and (2) whether any underpayment of tax is due to

either negligence or intentional disregard of rules or

regulations.

                         FINDINGS OF FACT2

     Petitioners Imre and Gizella Cziraki are husband and wife

and resided in Huntington Beach, California, at the time of the

filing of their petition.   In 1975, petitioners purchased two

parcels of property covering 80 acres in the county of San Diego

for $70,000.   For simplicity, hereinafter the 80 acres of

property shall be referred to as “property A”.   In 1983,

petitioners purchased 38 acres adjacent to property A for

$150,000.   Hereinafter, the 38 acres of property shall be

referred to as “property B”.

     Petitioners utilized properties A and B for their wholly

owned farming business, the Rainbow Hills Nursery.   The Rainbow

Hills Nursery grows protea flowers, macadamia trees, aloe vera

plants, and palm trees for sale.   At the time petitioners

purchased property A, there existed a road, partially of asphalt,

that traversed a portion of property A, but which did not



     2
        The stipulation of facts and the attached exhibits are
incorporated by this reference.
                                 -3-

traverse any portion of property B.    At the time petitioners

purchased property B, there was no road on property B.

     Sometime during 1978 and 1979, petitioner husband Imre

Cziraki (Mr. Cziraki) extended the preexisting road on property

A.   In 1983, Mr. Cziraki further extended the road on property A

to traverse a portion of property B.    Each of these extensions of

the road was constructed by Mr. Cziraki, using his own labor and

equipment, in order to access the crops, greenhouses, and shade

houses utilized by the Rainbow Hills Nursery.    The extensions of

the road were variously composed of dirt and/or gravel; no

portion of the extensions constructed by Mr. Cziraki was paved

with asphalt.    The only road construction performed by outside

contractors was an asphalt extension that was constructed on or

about June 1984.    Petitioners' cost basis in this road extension,

for purposes of depreciation, was $10,364.    The adjusted basis of

the road extension, after adjustment for depreciation, was

$6,844, as reflected on petitioners' 1992 return.

     In the later part of 1992 and the early part of 1993, the

area in which properties A and B are located experienced severe

rain storms.    The storms occurred during the period of October

1992 through March 1993.    A portion of the asphalt road and much

of the dirt/gravel road were damaged as a result of these storms.

The 1984 extension was also damaged by these storms.    The area in

which properties A and B are situated was declared a Federal

disaster area for the period January 5 through March 20, 1993.
                                  -4-

     On May 26, 1993, petitioners filed an application with the

U.S. Small Business Administration (SBA) for disaster relief.     On

June 3, 1993, in conjunction with petitioners' SBA loan

application, an agent from the SBA visited petitioners' property

for the purpose of evaluating the damage from the storms and

preparing a written appraisal of the damage.   The SBA report

describes the damage to the property as a “washed out surface

roadway.”   The SBA report estimates repair cost to the road at

$208,000.

     On their 1992 Federal income tax return, petitioners claimed

a casualty loss of $220,000.    Petitioners’ return was prepared by

their accountant.   This amount is equivalent to petitioners’

total adjusted basis in properties A and B, exclusive of the

$6,844 attributable to the cost of the road extension constructed

in 1984.    The claimed casualty loss derived from damages to the

road from the storms.   In the notice of deficiency, respondent

disallowed the casualty loss.

                                OPINION

     At issue is the proper computation of petitioners’ 1992

casualty loss deduction.3   Petitioners claimed a $220,000

casualty loss because of purported damages to their road from

     3
        Although the loss at issue occurred in 1993, sec.
165(i)(1) permits any loss attributable to a casualty in an area
subsequently declared a Federal disaster area, at the election of
the taxpayer, to be taken into account for the taxable year
immediately preceding the taxable year in which the disaster
occurred.
                                 -5-

heavy rains and flooding.   Both parties agree that the damage to

the road from the storms would qualify as a casualty loss under

section 165.   The parties also agree that the property at issue

was used in a trade or business or held for the production of

income, and therefore any loss realized would be subject to the

limitations contained in section 1.165-7(b), Income Tax Regs.

     Section 165(a) allows a deduction for “any loss sustained

during the taxable year and not compensated for by insurance or

otherwise.”    In the case of a casualty loss, if property used in

a trade or business or held for the production of income is

damaged, the amount of the loss taken into account for the

purposes of section 165(a) is the lesser of:   (1) The amount

equal to the fair market value of the property immediately before

the casualty reduced by the fair market value immediately after

the casualty; or (2) the amount of the adjusted basis of the

property.   Sec. 1.165-7(b)(1), Income Tax Regs.   The reason for

this limitation is clear.   Where the taxpayer suffers a loss from

a destruction of market value greater than the cost of the

property to him, that excess in value destroyed represents

unrealized appreciation, and he may not claim a deduction for

such loss because he never recognized or paid a tax on the gain.

Keefer v. Commissioner, 63 T.C. 596, 600 (1975).

     There is an additional limitation on the recognition of loss

with respect to property used in a trade or business or in any

transaction entered into for profit.   The loss must be determined
                                  -6-

by reference to the single, identifiable property damaged or

destroyed.     Id.; Trinity Meadows Raceway Inc. v. Commissioner,

T.C. Memo. 1998-79; sec. 1.165-7(b)(2)(i), Income Tax Regs.     “A

taxpayer may not borrow basis from his unharmed property in order

to increase the amount of his loss deduction for an injury to his

other property.”    Rosenthal v. Commissioner, 416 F.2d 491, 497-

498 (2d Cir. 1969), affg. 48 T.C. 515 (1967).

     In the case of land with improvements, the regulations

require that a separate basis be assigned to each depreciable

improvement to distinguish it from the land, which is not

depreciable.     Keefer v. Commissioner, supra at 599.   This

distinction is also a valid reason for differentiating business

and nonbusiness property.    See also United States v. Koshland,

208 F.2d 636, 639-640 (9th Cir. 1953), where the following is

noted:

          The most obvious reason for this tax treatment of
     business realty is that a building is an exhaustible
     asset and therefore subject to depreciation under the
     income tax laws, while land is not. * * * Thus the
     necessity arises of allocating a part of the cost of a
     parcel of land with a building upon it to the building
     in order to fix its basis for computing depreciation.
     * * * The result is that there is no single “adjusted
     basis” for the land and building as a unit. The
     depreciation allowed or allowable on the building
     reduces the basis of the building only. No
     depreciation is allowed on the land, and the original
     basis of the land therefore remains unaffected. The
     adjusted basis of the building and the basis of the
     land cannot be combined into a single “adjusted basis”
     for the property as a whole, for to do so would in
     effect be reducing the basis of the whole by
     depreciation allowed or allowable only as against the
     building, a part. [Citations omitted.]
                                 -7-


      The parties disagree over the proper basis to be used to

determine the section 1.165-7(b)(1), Income Tax Regs.,

limitation.    Petitioners argue that the road at issue is not a

separate object, but is part of the real property that surrounds

it.   Therefore, petitioners assert that the basis limitation

should be $220,000, petitioners’ total combined basis in

properties A and B (exclusive of the road extension constructed

in 1984).   Respondent contends that the road should be viewed as

a separate object with its own basis and value.    Respondent also

contends that because petitioners did not present any evidence

about a separate basis in the dirt/gravel road, petitioners’

casualty loss is limited to their claimed cost basis in the 1984

extension, $6,844.    We agree with respondent.

      For purposes of section 1.165-7(b)(2)(i), Income Tax Regs.,

a road is a single, identifiable piece of property.    See Trinity

Meadows Raceway, Inc. v. Commissioner, supra (horse racing track

is a separate, identifiable piece of property for purposes of

sec. 1.165-7(b)(2)(i), Income Tax Regs.).    The road at issue was

an improvement on petitioners’ property that required significant

time and effort to construct.    The fact that Mr. Cziraki

personally constructed most of the road does not alter the

principle that the road is still a separate, identifiable piece

of property.   Moreover, we note that petitioners were

depreciating the 1984 road extension up until the year at issue,
                                -8-

an act contrary to their argument that the road is a part of the

real property that surrounds it.

     The regulations require that petitioners identify each

separate piece of property damaged and isolate the basis in that

asset.   Petitioners have failed to identify what portion, if any,

of the original purchase price should be allocated to the road

that existed on the property at the time of purchase.   In

addition, we note that petitioners have not alleged or shown that

any amounts spent by Mr. Cziraki in personally constructing

dirt/gravel extensions of the road were capitalized or added to

petitioners' basis in the property.   Petitioners are not entitled

to apply their entire cost basis in the two properties to the

road damage because of the limitation of section 1.165-7(b)(1),

Income Tax Regs., and petitioners' zero basis in the personally

constructed road.   Accordingly, petitioners’ casualty loss is

limited to $6,844, their cost basis in the 1984 road extension

less allowable depreciation.

     The next issue for our consideration is whether petitioners

are liable for an accuracy-related penalty pursuant to section

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

20 percent on any portion of an underpayment of tax that is

attributable to items set forth in section 6222(b).   Respondent

contends that petitioners were negligent with respect to their

understatement of tax under section 6662(b)(1).
                                -9-

     Negligence includes any careless, reckless, or intentional

disregard of rules and regulations, any failure to make a

reasonable attempt to comply with the provisions of the law, and

any failure to exercise ordinary and reasonable care in the

preparation of a tax return.   Zmuda v. Commissioner, 731 F.2d

1417, 1422 (9th Cir. 1984), affg. 79 T.C. 714 (1982).    To prevail

on the issue of negligence, petitioners must prove that their

actions in connection with this transaction were reasonable in

light of their experience and business sophistication.     Hoffpauir

v. Commissioner, T.C. Memo. 1996-41; Avellini v. Commissioner,

T.C. Memo. 1995-489.   If a taxpayer acts in good faith and with

reasonable cause, he or she will not be liable for the addition

to tax for negligence.   Sec. 6664(c); see Collins v.

Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988), affg. Dister

v. Commissioner, T.C. Memo. 1987-217.

     Respondent asserted accuracy-related penalties based on all

the adjustments made in the notice of deficiency.    Petitioners

have conceded the penalty as to all adjustments, with the

exception of the adjustment to the casualty loss.4    Petitioners

have no tax or accounting backgrounds.   We also note that

petitioners' property did sustain extensive damage.     Petitioners’

return was prepared by their accountant, upon whom they relied.

     4
        Since petitioners have failed to address the accuracy-
related penalty with respect to the other adjustments, we treat
this as a concession by petitioners and find for respondent.
Theodore v. Commissioner, 38 T.C. 1011, 1041 (1962).
                                 -10-

In sustaining respondent's determination regarding the casualty

loss, this case turned on the somewhat technical concept that the

road constituted a separate, identifiable piece of property,

rather than a part of the real property that surrounds it, for

purposes of section 1.165-7(b)(2)(i), Income Tax Regs.      Although

we have not ruled in favor of petitioners on this issue, their

failure to comply with the regulations was due to their

reasonable belief that their cost could be allocated to the

damage to the road.   Consequently, petitioners are not liable for

an accuracy-related penalty with respect to the claimed casualty

loss.

     To reflect the foregoing,

                                             Decision will be entered

                                        under Rule 155.
