T.C. Memo. 1998-47

UNITED STATES TAX COURT

WILLIAM SPENCER BACH AND BARBARA RUTH BACH, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 330-95. Filed February 5, 1998.

William S. Bach and Barbara R. Bach, pro sese.

Karen E. Chandler, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

RUWE, Judge: Respondent determined a deficiency in

petitioners' 1987 Federal income tax and additions to tax as

follows:

 Additions to Tax 

Deficiency Sec. 6651(a)(1) Sec. 6653(a)(1)(A) Sec. 6653(a)(1)(B) Sec. 6661 

 $308,201 $61,705.20 $146,064.61 50 percent of the $77,038.75

 interest due on

 $308,201
- 2 -

1Respondent concedes that: (1) $34,574 of losses disallowed

in the notice of deficiency is properly deductible; (2) there

were no unreported gains in the amount of $8,421 from the sale of

stocks; and (3) there is an unreported loss of $336 from

petitioners' sale of stock funds. 

Petitioners concede that: (1) $188,957 of losses disallowed

in the notice of deficiency is not deductible in 1987; (2)

unreported rental income of $5,133 must be included as income in

1987; (3) they failed to report interest income of $1,711, which

must be included in 1987; and (4) they received an IRA

distribution of $1,830, which they failed to report as income on

their 1987 Federal income tax return. 

2Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the taxable year in

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

After concessions,1 the issues for decision are: (1)

Whether petitioners are required to recognize and report gains

resulting from their disposition of various partnership

interests; (2) whether petitioners are entitled to bad debt

deductions for alleged loans from their wholly owned corporation

to various partnerships; (3) whether petitioners are liable for a

tax on a distribution received in 1987 from an individual

retirement plan (IRA); (4) whether petitioners are liable for tax

on their excess contributions to an IRA during 1987; (5) whether

petitioners are liable for an addition to tax pursuant to section

6651(a)(1)2 for failure to file timely their 1987 return; (6)

whether petitioners are liable for additions to tax pursuant to

section 6653(a)(1)(A) and (B); and (7) whether petitioners are

liable for an addition to tax pursuant to section 6661.
- 3 -

3Petitioners conducted their real estate business under the

name of ISI Real Estate Co. and represented on their 1987

Schedule C that Ms. Bach owned 60 percent of the business and Mr.

Bach owned 10 percent of the business. The ownership of the

remaining 30 percent of ISI Real Estate Co. is unclear from the

record.

FINDINGS OF FACT

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

The stipulation of facts is incorporated herein by this

reference. Petitioners resided in Potomac, Maryland, at the time

they filed their petition. 

During 1986, 1987, and 1988, Mr. Bach worked as a real

estate broker for a business known as ISI Real Estate Co., which

was owned in part by petitioners.3 In addition, Mr. Bach was

also the sole shareholder of Investment Syndications, Inc. (ISI),

which was incorporated in May 1981. During the same years, Ms.

Bach worked as an accountant for RMR & Associates, Inc. 

As of January 1, 1987, Mr. Bach was a general partner of

America/Bradley Limited Partnership (America/Bradley). The

principal business of America/Bradley was real estate

construction. Mr. Bach owned a 22.5-percent interest in

America/Bradley and had a deficit capital account balance of

$448,756 as of January 1, 1987. The total of all America/Bradley

partners' capital accounts decreased from a deficit of $996,674

at the beginning of 1987 to a deficit of $2,853,708 at the end of

1987. During 1987, Mr. Bach assigned his entire interest in
- 4 -

4Although the exact date that Mr. Bach assigned his interest

in America/Bradley to Mr. Goldstein is not clear from the record,

Mr. Bach received an allocable share of income, loss, deduction,

or credit from the partnership during 1987. The assignment was

treated as taking place at some point during 1987 when Mr. Bach's

deficit in his capital account was $448,756.

5Mr. Bach had a 22.916-percent profit-sharing interest and

ownership of capital interest. 

America/Bradley to Mr. Marvin Goldstein, who assumed Mr. Bach's

capital account.4 

As of January 1, 1987, Mr. Bach was a general partner of

Jama Mobile Home Parks Limited Partnership (JAMA). The principal

business of JAMA was the rental of trailers in Jacksonville,

Florida. As of January 1, 1987, Mr. Bach owned a 21.875-percent

loss-sharing interest in JAMA and had a deficit capital account

balance of $358,312.5 Also, as of the beginning of 1987, JAMA

had outstanding a total of $931,924 in mortgages, notes, and

bonds payable in 1 year or more. 

During 1987, Mr. Bach made no capital contributions to JAMA. 

During 1987, all the property of JAMA was sold or foreclosed

upon, and the partnership filed a final U.S. Partnership Return

of Income (Form 1065). On Form 1065, JAMA reported a gain of

$644,600 on the sale of its assets. On Schedule K-1, Partner's

Share of Income, Credits, Deductions, Etc., attached to

petitioners' 1987 return, Mr. Bach's allocable share of net gain

under section 1231 was $147,717. At the time he disposed of his
- 5 -

interest in JAMA during 1987, Mr. Bach had a deficit capital

account balance for his partnership interest in JAMA of $213,535. 

As of December 31, 1986, Mr. Bach was a general partner of

the Bay Country Limited Partnership (Bay Country). The principal

business of Bay Country was real estate rental and construction. 

As of December 31, 1986, Mr. Bach owned a 23.75-percent profit,

loss, and capital-sharing interest in Bay Country and had a

deficit capital account balance of $184,802. As of the end of

1986, Mr. Bach's share of nonrecourse liabilities was $588,719.

On June 24, 1987, the partners sold their interests in Bay

Country to Rockville Central Building Corp. Number One and

Rockville Central Building Corp. Number Two for $50,000. Mr.

Bach received $5,000 on the sale of his interest in Bay Country. 

At the time he sold his interest in Bay Country, Mr. Bach had a

deficit capital account balance of $184,802. Petitioners did not

report on their 1987 Federal income tax return any gain regarding

the sale of Mr. Bach's partnership interest in Bay Country.

As of January 1, 1987, Mr. Bach was a general partner of the

Diamond Farms Limited Partnership (Diamond Farms) and had a

21.25-percent profit, loss, and ownership of capital interest in

the partnership. The principal business of Diamond Farms was the

rental of real estate. As of the beginning of 1987, Mr. Bach had

a deficit balance in his Diamond Farms capital account of

$65,072. 
- 6 -

On February 17, 1987, Mr. Bach assigned his interest in

Diamond Farms to Mr. Goldstein. On Schedule K-1 attached to

petitioners' 1987 return, Mr. Bach reported his distributive

share of loss from Diamond Farms in the amount of $1,751. 

Petitioners' Schedule K-1 also reflects capital contributed

during 1987 in the amount of $66,823, which represented Mr.

Bach's total deficit capital account assumed by Mr. Goldstein as

of the date of transfer. Petitioners did not report any gain

from the assignment of Mr. Bach's partnership interest in Diamond

Farms on their 1987 Federal income tax return. 

As of December 31, 1986, Mr. Bach was a general and limited

partner of the Wazee Street Limited Partnership (Wazee Street). 

Mr. Bach owned a 1.44-percent profit, loss, and ownership of a

capital share as a general partner and a 14.08-percent share of

profits and losses as a limited partner. 

As of December 31, 1986, Mr. Bach had a deficit balance in

his Wazee Street general and limited partner's capital accounts

of $3,661 and $35,771, respectively. Mr. Bach had allocable

general and limited partner's shares of nonrecourse partnership

debt of $14,228 and $139,120, respectively. 

During 1987, the property owned by Wazee Street was

foreclosed upon and sold. Wazee Street had outstanding debt as

of the date of foreclosure of $1,227,454. Mr. Bach's allocable

share of the partnership debt at the time of foreclosure was
- 7 -

$190,501. Wazee Street did not file a partnership return for

1987. 

As of December 31, 1986, Mr. Bach owned a 37.5-percent

interest as a general partner of 4139 Glenwood Joint Venture

(Glenwood). Also, as of December 31, 1986, Mr. Bach had a

deficit capital account balance of $4,198 and an allocable share

of nonrecourse liabilities of $47,423. 

On February 3, 1987, Mr. Bach assigned his interest in

Glenwood to Mr. Richard Segal for consideration of $10 and Mr.

Segal and Trans International Management, Inc., assigned their

interests in JAMA to Mr. Bach. Mr. Bach's deficit capital

account balance of $4,198 did not change between December 31,

1986, and the date of assignment. Petitioners did not report any

gain in relation to the disposal of Mr. Bach's interest in

Glenwood on their 1987 Federal income tax return. 

As of January 1, 1987, Mr. Bach was a general and limited

partner of Russell Street Limited Partnership (Russell Street).

Russell Street's primary business was investing in real estate. 

Mr. Bach's percentage interests in Russell Street as a general

and limited partner were 24 percent and 1 percent, respectively. 

As of the beginning of the year, Mr. Bach's capital account for

his interest as a general partner had a deficit balance of

$51,349.

Sometime in 1987, Russell Street sold all its assets and

filed its final tax return. As of the end of 1987, Mr. Bach no
- 8 -

longer held any partnership interest in Russell Street. As

reported by Russell Street on the 1987 partnership Schedules K-1,

Mr. Bach received a general and limited partner's allocable share

of net long-term capital gain of $42,156 and $1,756,

respectively, and deductions related to partnership portfolio

income of $4,990 and $208, respectively. As a result of these

distributive shares of income and deduction, Mr. Bach's general

partner capital account deficit was reduced to $14,183 and his

limited partner capital account deficit was reduced to $6,822. 

Petitioners did not report any gain in relation to the disposal

of Mr. Bach's interest in Russell Street on their 1987 Federal

income tax return. 

On that return, petitioners claimed on Schedule D, Capital

Gains and Losses and Reconciliation of Forms 1099-B, long-term

capital loss carryovers from 1985 and 1986 from partnerships, S

corporations, and fiduciaries in the amount of $175,107.81. 

Petitioners provided no substantiation to support these claimed

losses. During 1987, petitioners had a number of other

transactions, which were not reported on Schedule D, including: 

$1,889 received from the sale of petitioners' shares in the

Neuberger & Berman Government Money Fund; $1,889 received from

the sale of petitioners' shares in the Guardian Mutual Fund;

$1,780 received from the sale of petitioners' shares in the

Manhattan Fund, Inc.; and $2,864 from the sale of petitioners'

shares in the USAA Cornerstone Fund. 
- 9 -

In addition to transactions not reported on Schedule D of

petitioners' 1987 return, petitioners failed to report: Rental

income of $1,608 received from Solon Automated Services; an IRA

distribution of $1,830 received from Putnam Option Income Trust;

and interest income totaling $1,711 from various partnerships and

banks. Finally, during 1987, Ms. Bach contributed $4,000 to her

IRA held by Putnam Option Income Trust. 

Petitioners filed their 1987 Federal income tax return with

the Internal Revenue Service Center at Philadelphia,

Pennsylvania, on November 21, 1988. 

OPINION

Recognition of Gain or Loss on Disposition of Partnership

Interests

Respondent determined a deficiency for 1987 due to capital

gains not reported by petitioners on the disposition of several

partnership interests as follows:

 

 Partnership Capital Gain

 America/Bradley $448,756

 JAMA 213,535

 Bay Country 189,802

 Diamond Farms 66,823

 Wazee Street 39,432

 Glenwood 4,208

 Russell Street 21,005

 Total $983,561
- 10 -

6Sec. 741 provides: "In the case of a sale or exchange of

an interest in a partnership, gain or loss shall be recognized to

the transferor partner. Such gain or loss shall be considered as

gain or loss from the sale or exchange of a capital asset". Sec.

752(d) provides: "In the case of a sale or exchange of an

interest in a partnership, liabilities shall be treated in the

same manner as liabilities in connection with the sale or

exchange of property not associated with partnerships." See also 

Commissioner v. Tufts, 461 U.S. 300 (1983); Crane v.

Commissioner, 331 U.S. 1 (1947). Sec. 752(b) provides: "Any

decrease in a partner's share of the liabilities of a

partnership, or any decrease in a partner's individual

liabilities by reason of the assumption by the partnership of

such individual liabilities, shall be considered as a

distribution of money to the partner by the partnership."

Respondent argues that gain should be recognized in the amount of

liabilities petitioners were relieved of when Mr. Bach disposed

of his interests in the partnerships.6 These amounts correspond

to the deficit balances in Mr. Bach’s capital accounts in the

partnerships before the disposition of each partnership interest. 

At trial and on brief, petitioners did not contest the propriety

of respondent's determination that those amounts should be

considered proceeds from the dispositions of Mr. Bach's

partnership interests for purposes of determining his capital

gains.

Petitioners argue that certain transactions involving ISI

and the partnerships should be factored into our overall

determination of their 1987 tax liability. 

Petitioners argue that they are entitled to "set off" gains

determined by respondent by bad debt deductions which were not
- 11 -

7Sec. 166(a) provides that there shall be allowed as a

deduction any debt which becomes worthless during the taxable

year. Petitioners bear the burden to establish: (1) The

existence of a bona fide debt; (2) the amount of the debt; (3)

that the debt was incurred in or was created or acquired in

connection with Mr. Bach's trade or business; and (4) that the

debt became worthless at least in part during the taxable year. 

Sec. 166(a), (d)(2); Rule 142(a); secs. 1.166-1(a), (c), 1.166-

5(b), Income Tax Regs.

claimed on their return.7 Petitioners contend that various debts

of the partnerships arose when loans were made by petitioners to

ISI which, in turn, made loans to each of the various

partnerships in which both ISI and Mr. Bach held interests. 

Further, petitioners contend that the loans receivable from the

partnerships recorded on ISI's books would be reduced at the end

of the year and a corresponding increase in salary or officer's

compensation expense would be made on the books which represented

payment to Mr. Bach by the same amount. Petitioners also contend

that each of the alleged payments made to them was recorded as

income on their income tax return for each year. Petitioners

ultimately contend that through this process, they were in

essence making the loans to the various partnerships and that

these loans were never paid back nor credited to petitioners'

capital accounts.

Mr. Bach testified that no written loan agreements ever

existed between ISI and any partnership or between petitioners

and any of the partnerships. On brief, petitioners attached

documents which purport to summarize loans totaling $1,042,809.42
- 12 -

8The "Officer Loan Payable" account shows a number of

"loans" from Mr. Bach to ISI and shows payments either to Mr.

Bach or to other vendors on behalf of Mr. Bach. The beginning

balance of the Officer Loan Payable account is zero, and the

balance at the end of the year is $12,070.15. We also note that

many of the cash payments, which reduce ISI's payable to Mr. Bach

during 1986, were listed as payments for, among other things,

country club dues, a yacht, petitioners' Jaguar automobile, and

the automobiles of petitioners' daughters. 

from ISI to the various partnerships. These documents were not

admitted as evidence. However, even if we were to accept these

documents as proof of partnership debts to ISI, petitioners have

not offered any documentation which would confirm that ISI owed

petitioners a similar amount. In an attempt to prove that such a

debt existed, petitioners offered ISI's general ledger as of

December 31, 1986, which reflects that payments were made from

ISI to petitioners and from petitioners to ISI. However, as of

the end of 1986, the general ledger shows total officer loans

payable of $12,070.15.8 Such a small debt to petitioners during

1986 does not support their claims that there was in excess of $1

million in loans that became worthless in 1987. 

With regard to the $1,042,809.42 allegedly lent by

petitioners to the various partnerships via ISI, we find that

petitioners have not met their burden of proving that a bona fide

debt existed. The only evidence in support of petitioners'

argument is Mr. Bach's own self-serving testimony. No notes were

executed, no due date or interest rate was established, and no

security was offered or taken. Therefore, we deny all of
- 13 -

petitioners' claimed bad debt deductions. See Williams v.

Commissioner, T.C. Memo. 1994-560.

It is not clear whether petitioners are also making an

argument that money advanced to the partnerships by ISI should be

viewed as increasing Mr. Bach's basis in the partnerships for

purposes of determining the amount of gain. Any such argument

must be rejected for the same reason we reject petitioners'

argument that they are entitled to an offsetting loss.

Early Distribution From Petitioners' IRA During 1987

Petitioners concede they received an IRA distribution in the

amount of $1,830 from Putnam Option Income Trust during 1987. 

Amounts paid or distributed out of an IRA must be included in

gross income "in the manner provided under section 72." Sec.

408(d)(1). A 10-percent tax on "early distributions" generally

applies where a taxpayer receives a distribution from a qualified

retirement plan which is includable in his gross income. Sec.

72(t)(1). Although section 72(t)(2) sets forth certain

exceptions to the 10-percent tax on early distributions,

petitioners have presented no evidence to suggest they fit within

any of these exceptions. Therefore, we find that petitioners are

liable for the 10-percent additional tax under section 72(t). 

See Chiu v. Commissioner, T.C. Memo. 1997-199.

Excess Contributions to Petitioners' IRA During 1987
- 14 -

Petitioner Barbara Bach made contributions totaling $4,000

to her IRA during 1987. Under section 4973(a), a 6-percent tax

is imposed on excess contributions to an IRA. An excess

contribution is defined as an amount contributed to an IRA less

any qualified rollovers and less the amount allowable as a

deduction under section 219. Sec. 4973(b)(1). Section 219(b)

allows a maximum deduction of $2,000 for a contribution to Ms.

Bach's IRA. Because Ms. Bach made an excess contribution of

$2,000 to her IRA, none of which constituted a qualified

rollover, she is subject to this tax.

Addition to Tax for Failure To File a Timely Return

Respondent determined that petitioners are liable for an

addition to tax under section 6651(a)(1). Petitioners filed

their 1987 Federal income tax return on November 21, 1988. 

Petitioners bear the burden of proof on this issue. Abramo v.

Commissioner, 78 T.C. 154, 163 (1982). Petitioners did not

address this issue on brief, nor is there any evidence in the

record that would lead us to conclude that they had a reasonable

excuse for not filing their 1987 return until November 21, 1988. 

See sec. 6651(a)(1). Thus, we sustain respondent's

determination.

Additions to Tax for Negligence
- 15 -

Respondent also determined that petitioners are liable for

additions to tax under section 6653(a)(1)(A) and (B). This Court

has defined negligence as a lack of due care or failure to do

what a reasonable and ordinarily prudent person would do under

the circumstances. McGee v. Commissioner, 979 F.2d 66, 71 (5th

Cir. 1992), affg. T.C. Memo. 1991-510; Neely v. Commissioner, 85

T.C. 934, 947 (1985). Respondent made numerous adjustments to

petitioners' income and deductions for 1987. Petitioners have

not presented any evidence either at trial or on brief to

convince us that their omissions from gross income and excess

deductions were not the result of negligence. Therefore, we

sustain respondent's determination.

Additions to Tax for Substantial Understatement of Income Tax

The final issue for decision is whether petitioners are

liable for additions to tax under section 6661. Section 6661(a)

provides for an addition to tax equal to 25 percent of the amount

of any underpayment attributable to a substantial understatement

of income tax. Pallottini v. Commissioner, 90 T.C. 498, 503

(1988). An understatement is substantial if it exceeds the

greater of 10 percent of the tax required to be shown on the

return or $5,000. Sec. 6661(b)(1)(A). However, the amount of

the understatement may be reduced under section 6661(b)(2)(B) for

amounts adequately disclosed or supported by substantial

authority. Petitioners have not addressed this issue on brief,
- 16 -

nor have they presented any evidence that would bring them within

the safe harbor provisions of section 6661(b)(2)(B). 

Accordingly, we sustain respondent's determination.

Decision will be entered

under Rule 155.