T.C. Memo. 1997-280

UNITED STATES TAX COURT

ALLIE RAY McCULLEN AND SHURLEY G. McCULLEN, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 7042-95. Filed June 19, 1997.

J. Wesley Casteen, for petitioners. 

Amy Dyar Seals, for respondent. 

MEMORANDUM FINDINGS OF FACT AND OPINION

COLVIN, Judge: Respondent determined that petitioners are

liable for income tax deficiencies of $12,514 for 1990 and $7,386

for 1991. Respondent also determined that petitioners are liable

for the accuracy-related penalty for negligence under section

6662(a) of $2,503 for 1990 and $1,477 for 1991. 
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After concessions, we must decide:

1. Whether petitioner Allie Ray McCullen had a trade or

business of developing and selling real estate in 1990 and 1991. 

We hold that he did not.

2. Whether petitioners may deduct $23,067 for 1990 as

interest related to farming. We hold that they may. Respondent

contends that they may deduct $10,428 for 1990. Petitioners

deducted $20,102 in 1990, but, as discussed below, petitioners

paid more farm interest than they deducted.

3. Whether petitioners may deduct as interest related to a

trade or business the interest paid on a $100,000 loan from South

Carolina Bank that they used to buy stock in New-East Bank of

Goldsboro (New-East Bank). We hold that they may not.

4. Whether petitioners paid $8,126 in interest to First

Hanover Bank in 1990, as petitioners contend; $5,443, as

respondent contends; or some other amount. We hold that

petitioners paid $8,126 in interest to First Hanover Bank in

1990. 

5. Whether petitioners are liable for the accuracy-related

penalty for negligence under section 6662(a) for 1990 and 1991. 

We hold that they are.

Section references are to the Internal Revenue Code. Rule

references are to the Tax Court Rules of Practice and Procedure. 

References to petitioner are to Allie Ray McCullen.
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FINDINGS OF FACT

A. Petitioners

Petitioners are married and lived in Clinton, Sampson

County, North Carolina, when they filed their petition. 

Petitioners have a daughter who attended high school in 1990 and

1991. 

Petitioner has lived in Sampson County all of his life. He

has farmed since he was 13 years old. He is a college graduate

with a degree in history. He has been a licensed realtor since

1974, when he started to work in the real estate business. In

1987, he became a director of a bank. He sometimes borrowed

money from his great-aunt, Mary McCullen.

In 1990 and 1991, Mrs. McCullen was employed as a teacher

with the Clinton City Schools. She earned $29,506 in 1990 and

$31,220 in 1991. 

B. Petitioner's Real Estate Activities

1. Petitioner's Purchase of Real Estate

Petitioner bought various parcels of real estate before and

during 1990 and 1991. In 1990 and 1991, petitioner owned the

Bass Town tract, Sadie Farm, Greenview tract, and Giddonsville

Packing tract. He intended to resell the properties but did not

do so during the years in issue for various reasons. He borrowed

money from various financial institutions to buy the properties. 

Petitioners deducted interest related to these real estate
- 4 -

activities on Schedules C (Profit and Loss from Business) for

their 1990 and 1991 income tax returns. 

a. Bass Town Tract, Sadie Farm, and Greenview Tract

Bass Town tract was a farm that petitioner bought with a

loan from First American Savings and Loan. Petitioner had

difficulty selling the Bass Town tract because of changes in land

development rules in Sampson County. Petitioner sold the Bass

Town tract for a profit after 1991. 

In 1990 and 1991, petitioners owned several chicken houses

at Sadie Farm. 

Petitioner could not sell the Greenview tract for

development because of wetlands problems.

b. Giddonsville Packing Tract

At a time not stated in the record, petitioner bought a 5-

percent interest in Giddonsville Packing Co., a company that

packaged and marketed vegetables grown by its owners. Petitioner

signed a promissory note making him jointly liable for the

purchase with several other owners. 

The company made a profit the first 2 years but lost money

thereafter. Two of the persons who cosigned the note with

petitioner filed petitions in bankruptcy. Petitioner was the

only person who signed the note from whom the bank could collect. 

Petitioner bought the interests of the other Giddonsville Packing

Co. owners so he would not be associated with a foreclosure. He

financed the purchase with unsecured short-term notes. 
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Petitioner sold his interest in the Giddonsville Packing Co.

at a loss. 

2. McCullen Real Estate and Development Co., Inc.

In 1978, petitioner incorporated McCullen Real Estate and

Development Co., Inc. (McCullen Real Estate). He is president,

sole stockholder, principal agent, and an employee of McCullen

Real Estate. 

McCullen Real Estate received commissions when its employees

sold real estate owned by third parties. It also received fees

for managing and appraising real properties. McCullen Real

Estate managed rental units for The A.F.T.E.R. Co. (described

below at par. B-4-c). McCullen Real Estate did not sell real

estate that petitioner owned. 

3. Real Estate Business

Petitioner operated a business of appraising and managing

real estate for third parties. Petitioner did not sell any real

property that he owned before or during the years in issue. He

did not advertise that any of his properties were for sale during

the years in issue.

4. Real Estate Partnerships

a. McCullen-Clifton

In 1974, petitioner formed McCullen-Clifton, a general real

estate business partnership. Petitioner's partner in McCullenClifton had experience in the real estate business. McCullen-
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Clifton was dissolved in 1978 when petitioner started his own

firm. 

b. Scott-McCullen and Godwin-McCullen

Petitioner formed a partnership with Scott (not otherwise

described in the record) to buy, subdivide, and sell real

property. Scott and petitioner bought, subdivided, and sold real 

estate over the years. They intended to have a satellite office

in Onslow County. 

In 1989, petitioner and Douglas Godwin (Godwin) formed a

partnership called Godwin-McCullen Real Estate in Dunn, North

Carolina. The record contains no other information about these

partnerships. 

c. The A.F.T.E.R. Entities

The A.F.T.E.R. Co. owned residential rental units which

McCullen Real Estate managed. Petitioner was also involved (the

record does not specify how) in A.F.T.E.R. East Associates, which

owned a multifamily housing project. 

d. Crown Farms Co.

Petitioner was involved (the record does not specify how)

with Crown Farms Co. Crown Farms bought residential lots.

C. Petitioner's Farming Activities

Before the years in issue, petitioner raised cattle,

tobacco, produce, hay, and grain crops. His largest source of

farming income in 1990 and 1991 was poultry. He built his

poultry facilities in 1968 and has operated them continuously
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since then. From 1968 to the date of trial petitioner

significantly improved his poultry facilities, which he financed

with short-term unsecured loans from financial institutions. 

Petitioner used the proceeds from his loans from New-East Bank,

Bank of Stanley, Southern National Bank, and First Citizens Bank

to finance his farm operations. Petitioner sometimes farmed on

real property that he had bought to resell but had not yet sold.

Petitioner's farming activities were profitable in 1990 and

1991. However, petitioner's farm had losses for several years

before the years in issue. He paid his farming expenses from any

of his bank accounts that had funds. He also borrowed money to

pay interest on loans. Petitioner did not keep records showing

how he used the proceeds of each loan.

Petitioner's only loan by wire transfer was from the Bank of

Stanley. Petitioner used the proceeds of that loan to pay farm

operating expenses. 

In 1990, petitioner owned three tractors, a bail wagon, and

various implements such as plows, disks, a hay bailer, and a

rake. He financed the maintenance and replacement of equipment

with short-term unsecured signature loans from financial

institutions. 

D. New-East Bank

Petitioner was a founder, original organizer, stockholder,

and director of New-East Bank. Petitioner, Godwin, and Jim Cain

(not otherwise described in the record) organized New-East Bank
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to make business contacts and to provide funds for the bank

investors' needs. Petitioner borrowed $100,000 from South

Carolina National Bank to buy New-East Bank stock around 1987. 

On their income tax returns for 1990 and 1991, petitioners

deducted the interest on that loan as a business expense. 

Petitioner borrowed money from New-East Bank to pay farm

expenses. 

Petitioner sold his New-East Bank stock for a loss of 

$30,000 to $40,000 in 1994 or 1995. 

E. Loans From Other Banks

In 1990 and 1991, petitioner paid interest on many loans. 

The loans on which interest was paid, the deductibility of which

remains in issue after concessions, are listed in par. A-1 of the

opinion.

Petitioner used one of the two First American Bank loans in

dispute to buy the Bass Town tract. He used the other First

American Bank loan as a second mortgage on his satellite office

in Onslow County. 

F. Petitioners' Finances and Bank Accounts

Mrs. McCullen had a personal checking bank account into

which she deposited her salary. Petitioner had a separate

personal bank account. He also had two farm bank accounts and

one account for his real estate business. His corporation had

one account. Petitioner used money from whichever account had

enough money to pay other business expenses. For example, he
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sometimes used funds from the real estate business account to

finance farm operations. 

Banks made short-term unsecured loans to petitioner. They

did not require petitioners to identify the purpose of the loans. 

In his records, petitioner charged the interest to the

account that he used to pay the interest. He kept no records of

how he used his funds. 

Petitioners concede that petitioner's corporation paid the

following interest that petitioners deducted on their income tax

returns for 1990: (1) $1,620 to New-East Bank; (2) $1,177 to

Southern National Bank; (3) $527 to Standard Bank and Trust; (4)

$1,168 to United Carolina Bank; and (5) $570 to Mary McCullen. 

Petitioners also concede that petitioner's corporation paid the

following interest that petitioners deducted on their income tax

returns for 1991: (1) $3,590 to New-East Bank; (2) $956 to Mary

McCullen; (3) $1,796 to South Carolina National Bank; (4) $1,432

to Barclay's America; and (5) $594 to First Citizens Bank. 

Petitioner's corporation also deducted this interest for 1990 and

1991. 

Petitioner used his checkbooks to create ledgers for his

farm and other business accounts. Petitioner did not have a

formal balance sheet or income statement for his businesses. He

gave an informal annual financial statement to banks when he

needed a loan. 
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Petitioner paid $8,126 of interest to First Hanover Bank in

1990. 

G. Petitioners' Income Tax Returns

Johnson Sheffield (Sheffield), a certified public

accountant, prepared petitioners' income tax returns from 1981

through the years in issue. Petitioner prepared and gave

Sheffield a summary of petitioners' income and expenses for 1990

and 1991. Sheffield prepared petitioners' returns based on

petitioner's summary. In his summary, petitioner treated

interest paid from each account as if it were an expense of that

account. Sheffield did not know that petitioner moved assets and

money between his real estate and farming operations.

Sheffield did not prepare McCullen Real Estate's income tax

returns (Forms 1120) for 1990 and 1991. Petitioners concede that

they and McCullen Real Estate deducted some of the same interest

items.

On their income tax returns, petitioners reported wages and

salaries of $61,991 in 1990 and $31,220 in 1991, and farm income

of $12,959 in 1990 and $26,151 in 1991. On their Schedules C,

they reported having gross receipts of $14,675 in 1990 and $9,921

in 1991 from appraisals. They reported no income or advertising

expenses relating to the sale of real property in the years in

issue. Petitioners did not report that they had any inventory on

Schedule C of their returns for the years in issue.
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On Form 4797 (Sales of Business Property) attached to their

1991 return, petitioners reported that they bought a packing shed

(not otherwise described in the record) on March 11, 1989, having

an original basis of $35,104, reduced by depreciation of $1,820,

and sold it for $20,000, producing a $13,284 loss. 

Petitioners deducted interest of $38,049 for 1990 and

$33,571 for 1991 on their Schedules C. Petitioners deducted

interest of $20,102 for 1990 and $16,289 for 1991 on their

Schedules F (Farm Income and Expenses). 

OPINION

A. Parties' Contentions and Background

1. Interest Petitioners Deducted as a Trade or Business

Expense

Respondent contends that the following amounts of interest

paid by petitioners in the years in issue are investment interest

and not related to petitioner's trade or business: 

 1990

 Lender Amount

First American Savings Bank $4,223

Mary S. McCullen 2,936

South Carolina National Bank 9,773

 1991

 Lender Amount

First American Savings Bank $4,964

Mary S. McCullen 2,711

South Carolina National Bank 5,823

Petitioners contend that they may deduct these amounts as

interest because the loans related to petitioner's trade or
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1 Sec. 163(h) provides in pertinent part:

(continued...)

business of selling real estate. Respondent contends that

petitioners may not deduct interest related to developing and

selling real estate as a trade or business expense because that

activity was not a trade or business. Respondent contends that

petitioners may deduct the interest as investment interest.

2. Interest That Petitioners Deducted as Farm Interest

Respondent contends that petitioners have proven only that

they paid $10,428 in interest for their farming activity for

1990. Respondent contends that the following interest paid by

petitioners and deducted as farm interest is personal interest:

 1990

 Lender Amount

New-East Bank (#8501000163,

#8501001047, and #7501000074) $5,394

First Hanover Bank 8,126

Southern National Bank

(#274-114025 and #273-018600) 2,074

Bank of Stanley 1,826

United Carolina Bank #0174 567

First Citizens Bank 3,345

Total $21,332

Petitioners contend that they may deduct these amounts as

trade or business interest because petitioner used the proceeds

from the loans for farming. 

3. Background

Generally, a taxpayer other than a corporation may not

deduct personal interest. Sec. 163(h)(1).1 Investment interest,
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1(...continued)

SEC. 163(h) Disallowance of Deductions for Personal

Interest.--

(1) In General.--In the case of a taxpayer other

than a corporation, no deduction shall be allowed

under this chapter for personal interest paid or

accrued during the taxable year.

(2) Personal Interest.--For purposes of this

subsection, the term “personal interest” means any

interest allowable as a deduction under this

chapter other than--

(A) interest paid or accrued on indebtedness

properly allocable to a trade or business

(other than the trade or business of

performing services as an employee),

(B) any investment interest (within the

meaning of subsection (d)) * * *

interest allocable to a trade or business (other than the trade

or business of performing services as an employee), and qualified

residence interest are not personal interest. Sec. 163(h)(2). 

A taxpayer may deduct 10 percent of personal interest he or

she paid in 1990. Sec. 163(h)(5), (d)(6)(B). A taxpayer may

deduct interest on property held for investment up to the net

investment income of the taxpayer for the taxable year. Sec.

163(d)(1). Net investment income is the amount by which

investment income exceeds investment expenses. Sec.

163(d)(4)(A). 
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B. Whether Petitioners May Deduct Interest on Their Schedules C

1. Whether Petitioner Was in the Trade or Business of

Buying and Selling Real Estate

To be engaged in a trade or business, the taxpayer must be

involved in the activity with continuity and regularity and the

taxpayer's primary purpose for engaging in the activity must be

for profit. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). 

Whether a taxpayer's activities are a trade or business is a

question of fact that must be decided based on the circumstances

of each case. Higgins v. Commissioner, 312 U.S. 212, 217 (1941). 

Courts have considered several factors in deciding whether a

taxpayer was in the trade or business of buying and selling real

estate, including: (a) The nature and purpose of buying the

property; (b) the length of time the taxpayer owned the property;

(c) the continuity of sales activity over a period of time; (d)

the number and frequency of sales; (e) the extent to which the

taxpayer developed the property, solicited customers, and

advertised; and (f) the ratio of sales to other sources of

income. United States v. Winthrop, 417 F.2d 905, 910 (5th Cir.

1969); Polakis v. Commissioner, 91 T.C. 660, 669-670 (1988);

Hoover v. Commissioner, 32 T.C. 618, 625 (1959); Dressen v.

Commissioner, 17 T.C. 1443, 1447 (1952); Thrift v. Commissioner,

15 T.C. 366, 369 (1950).

Petitioners contend that they bought their property for

resale, but the objective facts show otherwise. Petitioner had
- 15 -

no sales before or during the years in issue. There is no

persuasive evidence that petitioners tried to develop or sell

their property, solicit buyers, or advertise before or during the

years in issue. Petitioners contend that the properties were

available for sale. However, there is no evidence that they did

anything to make this fact known to prospective buyers.

Petitioners contend that petitioner did not need to advertise

because his corporation did and he already had considerable name

recognition. We disagree; his being well known was not a

substitute for soliciting buyers, which is relevant to

establishing his purpose in holding property. 

The record does not show when petitioners bought the Bass

Town and Giddonsville tracts. Petitioner sold them after 1991. 

A sporadic activity is not a trade or business. Commissioner v.

Groetzinger, supra at 35; Polakis v. Commissioner, supra at 670-

671; Christian v. Commissioner, T.C. Memo. 1995-12. 

2. Petitioners' Other Contentions

Petitioners contend that the fact that they farmed their

land does not show that they were not trying to sell it. We

agree. We did not consider the fact that they farmed some of the

land in deciding whether they had a trade or business of selling

real estate.

Petitioners contend that the factors stated in Polakis v.

Commissioner, supra, and Christian v. Commissioner, supra, do not

apply here because the facts in those cases differ. We disagree. 
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2 We need not decide respondent's alternate contention that

petitioners may not deduct the interest at issue because

petitioner commingled his real estate and farm accounts.

The legal principles and factors stated in those cases apply to

whether a taxpayer had a trade or business of selling real

estate. The factual differences between this case and those

cases are immaterial.

Petitioners contend that the fact that they had only a few

parcels of real estate does not show that they were not trying to

sell them. We agree. We did not consider the number of parcels

of real estate that petitioners owned in deciding whether they

had a trade or business of selling real estate. 

Petitioners point out that petitioner's primary occupation

was appraising, managing, developing, and selling real estate. 

That does not establish that he had a trade or business of

selling real estate. 

3. Conclusion

We conclude that petitioner did not have a trade or business

of selling real estate in 1990 or 1991.2 The interest

petitioners paid to Mary McCullen, First American Savings Bank,

and South Carolina National Bank is investment interest which

petitioners may deduct under section 163(h)(2)(B) for 1990 and

1991 to the extent of their investment income.
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C. Whether Petitioners May Deduct the Interest That They

Claimed on Their Schedules F as Farm-Related Interest

1. Whether the Interest Was Related to Farming

Respondent points out that petitioners commingled funds and

did not keep accurate records. Respondent contends that

petitioners have not shown that the interest that they deducted

on their Schedules F for 1990 related to farming. We disagree. 

Petitioner credibly testified that he used his loans from

New-East Bank, Bank of Stanley, Southern National Bank, and First

Citizens Bank for his farm operations. Thus, we hold that

petitioners properly deducted the interest remaining at issue

that they paid to those banks for farm interest. Petitioners may

not deduct as farm interest the interest they paid to First

Hanover Bank because petitioners have not shown that they used

the loans from First Hanover Bank for farming. Thus, that

interest is personal interest.

Respondent contends that we should not rely on petitioner's

testimony because it is self-serving. We disagree. We decide

whether a witness is credible based on objective facts, the

reasonableness of the testimony, the consistency of statements

made by the witness, and the demeanor of the witness. Quock Ting

v. United States, 140 U.S. 417, 420-421 (1891); Wood v.

Commissioner, 338 F.2d 602, 605 (9th Cir. 1964), affg. 41 T.C.

593 (1964); Pinder v. United States, 330 F.2d 119, 124-125 (5th

Cir. 1964); Concord Consumers Hous. Coop. v. Commissioner, 89
- 18 -

T.C. 105, 124 n.21 (1987). We may discount testimony which we

find to be unworthy of belief, Tokarski v. Commissioner, 87 T.C.

74, 77 (1986), but we may not arbitrarily disregard testimony

that is competent, relevant, and uncontradicted, Conti v.

Commissioner, 39 F.3d 658, 664 (6th Cir. 1994), affg. 99 T.C. 370

(1992) and T.C. Memo. 1992-616; Demkowicz v. Commissioner, 551

F.2d 929, 931-932 (3d Cir. 1977), revg. T.C. Memo. 1975-278;

Banks v. Commissioner, 322 F.2d 530, 537 (8th Cir. 1963), affg.

in part and remanding in part T.C. Memo. 1961-237; Loesch & Green

Constr. Co. v. Commissioner, 211 F.2d 210, 212 (6th Cir. 1954),

revg. and remanding a Memorandum Opinion of this Court dated

December 11, 1952. Respondent offered no evidence to contradict

petitioner's testimony. Petitioner's testimony was plausible,

and, we believe, truthful. 

Respondent contends that petitioners have not proven how

much farm interest they paid because petitioner and his

corporation paid interest. We disagree. Petitioners have

conceded that they may not deduct interest that the corporation

paid. We accept petitioner's testimony that he paid the interest

at issue and that he used these loans for farming. 

2. Conclusion

We conclude that, in addition to the $10,428 for 1990 which

respondent concedes, petitioners may deduct the following as farm

interest:
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 1990

 Lender Amount

New-East Bank (#8501000163,

#8501001047, and #7501000074) $5,394

Southern National Bank

(#274-114025 and #273-018600) 2,074

Bank of Stanley 1,826

First Citizens Bank 3,345

Total $12,639

Thus, petitioners may deduct total farm interest of $23,067 in 

1990.

D. Whether Petitioners May Deduct as Trade or Business Interest

the Interest They Paid on the $100,000 Loan From South

Carolina National Bank

Petitioner borrowed $100,000 from South Carolina National

Bank to buy stock of New-East Bank. Petitioners contend that the

interest they paid on the South Carolina National Bank loan was

related to petitioner's trade or business, making the interest

deductible under section 163(h)(2)(A). We disagree.

Petitioner's purchase of New-East Bank stock was not a trade

or business. Petitioner was not continuously and regularly

involved in buying stock. Commissioner v. Groetzinger, 480 U.S.

at 35. Petitioners contend that petitioner bought the New-East

Bank stock to help him make business contacts and to provide a

source of funds for his business. Even if this were true, the

interest on the loan to buy New-East Bank stock would not be

deductible under section 163(h)(2)(A). We are not convinced that

the amount of interest petitioner paid to buy the stock bears any
- 20 -

3 We did not consider sec. 163(h) in Miller v. Commissioner,

70 T.C. 448 (1978), and Schanhofer v. Commissioner, T.C. Memo.

1986-166, because it had not yet been enacted. We decided

(continued...)

reasonable relationship to the benefit petitioner got from owning

stock in New-East Bank. 

Petitioners contend that petitioner's purchase of the stock

was not the purchase of a capital asset because he had no

investment motive when he bought the stock. We disagree. Stock

is generally a capital asset. Arkansas Best Corp. v.

Commissioner, 485 U.S. 212, 216-217, 219, 222-223 (1988). Buying

stock is not ordinarily an activity of a trade or business. 

Higgins v. Commissioner, 312 U.S. at 216 (managing securities

investments and collecting income therefrom generally is not a

trade or business, regardless of the amount invested, continuity

of effort, or amount of time devoted to the activity). 

Petitioners rely on Schanhofer v. Commissioner, T.C. Memo.

1986-166, where we held that the investment interest limitations

of section 163(d) did not apply to interest paid by a taxpayer

who borrowed money to buy stock in the company for which he

worked. That case is distinguishable. In Schanhofer, the

taxpayer paid a substantial premium for stock that was not

marketable. The stock in Schanhofer had minimal growth

potential. In contrast, petitioner bought unrestricted New-East

Bank stock and did not show that he paid more than fair market

value for the stock or that it had no growth potential.3 This
- 21 -

3(...continued)

whether the interest at issue was limited by sec. 163(d) in those

cases.

4 The ledger sheets show that petitioner paid First Hanover

Bank interest of $5,485.19. 

case is more like Miller v. Commissioner, 70 T.C. 448 (1978),

where we held that a taxpayer who borrowed money to buy a

controlling interest in the stock of a bank so that he could

become the bank's president held the stock as an investment.

We conclude that petitioners bought and held the New-East

Bank stock as an investment, and that the interest on the loans

was not properly allocable to a trade or business. Thus, the

interest on the $100,000 loan from South Carolina National Bank

is investment interest and is not trade or business interest

under section 163(h)(2)(A). 

E. Amount of Interest Paid to First Hanover Bank

Respondent contends that petitioners paid $5,443 in interest

to First Hanover Bank in 1990 because that is the amount shown in

petitioner's ledgers.4 Petitioners contend they paid $8,126

because that is the amount First Hanover Bank reported in the

Form 1098, Mortgage Interest Statement, it sent to petitioners

for 1990. We agree with petitioners because we think the Form

1098 issued by First Hanover Bank is more reliable than

petitioner's ledger sheets.

Respondent points out that petitioner testified that either

he or his corporation paid the interest to First Hanover Bank and
- 22 -

5 This is personal interest for reasons discussed above at

par. C-1.

that petitioner's corporation paid other interest that

petitioners erroneously deducted on their income tax returns for

1990 and 1991. Respondent contends that petitioner's corporation

may have paid some of the interest. We disagree. The Form 1098

bears petitioner's Social Security number, and it was addressed

to petitioner, not his corporation. We conclude that petitioner

paid $8,126 to First Hanover Bank in 1990.5 

F. Whether Petitioners Are Liable for the Accuracy-Related

Penalty Under Section 6662(a)

Petitioners contend that they are not liable for the

accuracy-related penalty for negligence for 1990 and 1991 under

section 6662(a) and (c). They contend that they acted reasonably

under the circumstances. We disagree.

Taxpayers are liable for a penalty equal to 20 percent of

the portion of the underpayment to which section 6662 applies. 

Sec. 6662(a). For purposes of section 6662(a), negligence

includes any failure to make a reasonable attempt to comply with

the provisions of the Internal Revenue Code. Sec. 6662(c). The

accuracy-related penalty under section 6662(a) does not apply to

any part of an underpayment if the taxpayer shows that there was

reasonable cause for that part of the underpayment and that the

taxpayer acted in good faith. Sec. 6664(c)(1).
- 23 -

Negligence is a lack of due care or failure to do what a

reasonable and ordinarily prudent person would do under the

circumstances. Zmuda v. Commissioner, 731 F.2d 1417, 1422 (9th

Cir. 1984), affg. 79 T.C. 714 (1982); Neely v. Commissioner, 85

T.C. 934, 947 (1985). Failure to keep adequate records is

evidence of negligence. Marcello v. Commissioner, 380 F.2d 499,

506-507 (5th Cir. 1967), affg. in part and remanding in part 43

T.C. 168 (1964) and T.C. Memo. 1964-299; Magnon v. Commissioner,

73 T.C. 980 (1980). A taxpayer is required to maintain records

sufficient to correctly prepare his or her tax return. Sec.

1.6001-1(a), Income Tax Regs. Petitioners bear the burden of

proving that they are not liable for the accuracy-related

penalty. Rule 142(a).

Petitioners concede that they should not have deducted

interest paid by the corporation for each year in issue. They

also concede that they commingled funds, had inadequate records,

and made accounting errors. Petitioner did not coordinate

petitioners' and the corporation's returns to avoid deducting the

same items twice. Petitioner gave Sheffield summary sheets from

which Sheffield prepared petitioners' tax returns. Sheffield did

not have books and records from petitioner's businesses. 

Petitioner used a different return preparer to prepare the

corporate income tax returns. Petitioner did not ensure that the

two preparers handled various items consistently. 
- 24 -

Petitioners contend that they should not be held liable for

the accuracy-related penalty because they readily conceded their

errors. We disagree. Conceding errors does not excuse the

underlying negligence. 

Petitioners also contend that they should not be held liable

for the accuracy-related penalty because petitioner believed that

he needed to pay expenses from whatever accounts had funds. We

disagree. Petitioner could have recorded those payments

properly. 

We conclude that petitioners are liable for the

accuracy-related penalty for negligence for 1990 and 1991 under

section 6662(a) and (c).

To reflect concessions and the foregoing,

Decision will be

entered under Rule 155.