122 T.C. No. 8

UNITED STATES TAX COURT

DELBERT L. AND MARGARET J. BAKER, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 448-02. Filed February 19, 2004.

Ps and AFVW executed a residence agreement

entitling Ps to lifetime residence at VW. VW provides

four different levels of accommodations. During the

years in issue, Ps resided in an independent living

accommodation which provides the lowest level of care

and resembles a regular residence that can be found in

any nonretirement living community. Ps paid monthly

service fees of $2,170 and $2,254 for 1997 and 1998,

respectively. Several amenities were available to Ps,

including medical services and the use of pool, spa,

and exercise facilities.

D, the vice president of finance for AFVW, the

operator of VW, calculated the portions of the monthly

service fees paid by independent living residents that

were allocable to medical care. C, an ad hoc

committee, of which P-H was a member, reviewed D’s

calculations. On the basis of certified financial

information provided by AFVW, C calculated a higher

amount allocable to medical care. Both D and C used

the percentage method to calculate the portions
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allocable to medical care. Ps claimed medical

deductions based on C’s calculations, and also claimed

additional deductions as a result of P-H’s use of the

pool, spa, and exercise facilities.

R audited Ps and issued a notice of deficiency

determining deficiencies on the basis of D’s

calculations, and also disallowing the deductions for

use of the pool, spa, and exercise facilities. R

subsequently sought the advice of an actuary and, on

the basis of the actuary’s report, now claims that the

actuarial method must be used to determine the portion

allocable to medical care. The actuary provided

calculations using both the actuarial method and the

percentage method. Ps rely on C’s calculations and a

supplemental report prepared by P-H.

Held: Ps are not required to use the actuarial

method and may use the percentage method to determine

the portions of the monthly service fees that are

allocable to medical care. 

Held, further: Sec. 7491(a), I.R.C., places the

burden of proof on R in certain situations. R concedes

that Ps have satisfied the requirements of sec.

7491(a)(2), I.R.C. Ps submitted credible evidence

under sec. 7491(a)(1), I.R.C., with regard to the

factual issue of the portions of monthly service fees

allocable to medical care. Ps did not submit credible

evidence regarding claimed deductions for use of the

pool, spa, and exercise facilities. Therefore, R bears

the burden of proof on the monthly fees issue but not

on the facilities issue.

Held, further: Sec. 213(a), I.R.C., allows

deductions for expenditures for medical care, subject

to certain limitations. Using the percentage method,

the annual amounts of monthly service fees paid by Ps

that are allocable to medical care are $7,766 and

$8,476 for 1997 and 1998, respectively. Ps are not

entitled to additional deductions for use of the pool,

spa, and exercise facilities.

Delbert L. Baker and Margaret J. Baker, pro sese.

Guy H. Glaser and Vicken Abajian, for respondent.
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1Petitioners concede that they are not entitled to claim as

a depreciation expense $595 of the $775 reported on their 1997

return. Respondent’s determination with respect to 1997 includes

a computational adjustment to petitioners’ Social Security

benefits and/or Tier I Railroad Retirement benefits based on

other changes to adjusted gross income. This adjustment will be

taken into account by the parties in the Rule 155 computation.

2Unless otherwise indicated, all 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. Dollar amounts are generally rounded to the nearest

dollar.

GOEKE, Judge: Respondent determined deficiencies in

petitioners’ Federal income taxes of $983 and $1,252 for the

taxable years 1997 and 1998, respectively. After a concession,1

the issues for decision are: (1) What portions of monthly

services fees paid by petitioners for lifetime residence at a

continuing care retirement community are allocable to medical

care under section 213;2 and (2) whether petitioners are entitled

to deduct additional amounts under section 213 for medical use of

pool, spa, and exercise facilities at the retirement community. 

We hold that the portions of the monthly service fees paid by

petitioners for medical care were $7,766 and $8,476 for 1997 and

1998, respectively. We further hold that petitioners are not

entitled to any deductions for 1997 and 1998, respectively, for

the use of the pool, spa, and exercise facilities.

FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are
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incorporated herein by this reference. Petitioners, Mr. Baker

and Mrs. Baker, resided in Riverside, California, at the time

they filed their petition.

I. Background

On December 22, 1989, petitioners and Air Force Village

West, Inc. (AFVW) executed a residence agreement entitling

petitioners to a lifetime residence at Air Force Village West

(Village West). AFVW is a nonprofit organization that was

incorporated in the State of California on September 21, 1984.

AFVW was organized to establish, maintain, endow, and operate

continuing care retirement communities (CCRCs) for officers (and

their spouses and qualified dependents) of the U.S. uniformed

services who are more than 60 years old and have been retired or

honorably separated from active duty. Village West is one of the

CCRCs owned and operated by AFVW. Village West is a gated,

guarded, perimeter-fenced, resortlike retirement community

located on 153 acres of land in Riverside, California.

A. Construction of Village West

The construction of Village West occurred in three phases. 

The first phase involved the construction of the following living

units and health care facilities: (1) Independent Living Unit

(ILU) apartments, duplexes, and cottages; (2) an Assisted Living

Unit (ALU) facility with 20 rooms; (3) a Skilled Nursing Facility

(SNF) with 59 beds; (4) a Commons building with a suite of rooms
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set aside, in part, for an outpatient medical services clinic;

(5) an F-Wing of apartment units; (6) a G-Wing of apartment

units; (7) a pool area with Jacuzzi; (8) a maintenance and

housekeeping building; (9) a mechanical building; and (10) an

outside courtyard. The first phase was substantially completed

in December 1989, and initial operation began, and the first

residents moved in, at that time.

The second phase of the construction of Village West

involved the construction of the following additional housing,

administration, and maintenance buildings: (1) A landscape

building; (2) administrative offices located at the Commons

building; and (3) additional ILU cottages. The second phase was

completed in October 1993 and started operation at that time.

The final phase of the construction of Village West involved

the expansion of the existing ALU facility and the construction

of a new Special Care Unit (SCU) facility. The final phase was

completed in June 1997 and started operation at that time.

B. Living Accommodations at Village West

Village West provides the following four different levels of

living accommodations: (1) Independent living, or ILU; (2)

assisted living, or personal care (previously referred to as

ALU); (3) special care, or SCU (Alzheimer’s/Dementia unit); and

(4) skilled nursing, or SNF. The ALU, SCU, SNF, and outpatient

medical services clinic are located in one building which also
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houses the administrative offices of AFVW, the dining room, and

apartment units. This building is known as the Village West

Health Center and is also called the Commons building. During

the years in issue, the Village West Health Center was available

for patient use by both residents of Village West (hereinafter

sometimes referred to as AFVW residents) and nonresidents of

Village West who lived in the surrounding community (hereinafter

referred to as noncontract patients). Noncontract patients were

charged higher rates for use of the Village West Health Center

and certain services were billed to them on a fee-for-service

basis.

1. Independent Living Units

The ILU apartments, duplexes, and cottages are designed for

normal, everyday independent living of AFVW residents, and

resemble regular residences that can be found in any

nonretirement living community. All ILUs are initially equipped

with miniblinds, wall-to-wall carpeting, and standard kitchen

appliances. These are paid for by AFVW.

During 1997 and 1998, several amenities were available to

AFVW residents living in the ILUs, including: (1) An emergencypull-cord system installed in each ILU; (2) complete building and

grounds maintenance; (3) weekly housekeeping services; (4) a 24-

hour front desk service; (5) access to a fitness center,

available for medical therapy, with spa and exercise areas; (6)
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an indoor/outdoor swimming pool and Jacuzzi; and (7) complete

patient access to all on-campus health services provided in the

Village West Health Center. Beginning in June 1997, AFVW

residents living in ILUs gained access as patients to the newly

opened SCU also located in the Village West Health Center.

The front desk is staffed 24 hours a day and is the focal

point for information, service, and assistance to residents. One

of the duties of the front desk was monitoring and responding to

the emergency-pull-cord system installed in the ILUs and other

areas of AFVW where the system is in place. The emergency-pullcord system was connected directly to the front desk and a crisis

nurse, an assistant, and a security guard would be dispatched to

the ILU if necessary.

During the years in issue, Mr. Baker used the pool, spa, and

exercise facilities at Village West. Petitioners, like other

AFVW residents, were not charged a separate fee to use these

facilities.

2. Assisted Living Units

The ALU facilities represent an intermediate step between

independent living and the need for a higher level of care; i.e.,

skilled nursing care. The ALUs are designed for two types of

individuals. They are designed for individuals who are unable to

leave a building unassisted under emergency conditions, including

but not limited to, individuals who depend on mechanical aids
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such as crutches, walkers, and wheelchairs and who are unable or

likely to be unable to respond physically or mentally to an

emergency situation such as a fire. The ALUs are also designed

for individuals who need care and supervision with the activities

of daily living, such as eating, bathing, and dressing. The ALUs

are designed to provide occupants with a comfortable, homelike

atmosphere where they are encouraged to provide their own

furniture, bedding, and linens.

During the years in issue, both AFVW residents and

noncontract patients occupied rooms as patients in the ALU

facilities. AFVW residents who became patients in the ALUs

received a 60-percent discount off the regular rate charged to

noncontract patients who occupied similar units as patients.

3. Special Care Units

The SCU at Village West is a special unit designed to

provide living accommodations to individuals with diagnosed

Alzheimer’s disease and/or similar forms of irreversible

dementia. Admission is based strictly on doctor’s orders. The

SCU is fully enclosed, can only be accessed through a securitylocked door, and is manned 24 hours per day by nursing staff

members. Patients in the SCU are provided the same services as

the individuals occupying the ALUs. Additionally, other programs

are provided which are specially geared to enhancing the dignity

and lifestyle of patients during the remainder of their lives.
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During the years in issue, both AFVW residents and

noncontract patients occupied rooms as patients in the SCU. AFVW

residents who became patients in the SCU received a 60-percent

discount off the regular rate charged to noncontract patients who

occupied similar units as patients.

4. Skilled Nursing Care

The SNF at Village West provides the highest level of care

of all the health care facilities located at Village West. 

Admission to this facility is based strictly on doctor’s orders. 

The accommodations provided in the SNF include a skilled nursing

facility bed, 24-hour nursing care, and three meals per day. In

addition, occupants of the SNF receive services such as long-term

maintenance care, necessary diagnostic care, preventative care,

therapeutic care, and rehabilitative care required by the

chronically ill.

During the years in issue, both AFVW residents and

noncontract patients occupied rooms as patients in the SNF. AFVW

residents who became patients in the SNFs received an

approximately 50-percent discount off the regular rate charged to

noncontract patients who occupied similar units as patients.

C. The Residence Agreement

Petitioners chose a 1,427-square foot, two bedroom, two

bathroom, duplex unit for their ILU accommodations. Under the

residence agreement executed on December 22, 1989, they were
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3The residence agreement does not indicate how the entrance

fee would be used by Village West. An independent auditor’s

report of AFVW provides that the entrance fees, net of the

portion that is refundable to the residents, are recorded as

deferred revenue and amortized into income. The portion of the

entrance fees that is estimated to be refundable is reflected as

a liability on the statements of financial position.

4The record does not indicate how this figure was

calculated.

required to pay certain fees in exchange for a lifetime residence

at Village West. Petitioners were required to pay: (1) A

nonrefundable processing fee of $500; (2) an entrance fee of

$130,015; and (3) an initial monthly service fee of $1,418, which

was subject to annual increases by AFVW.3 The residence

agreement states that in the case of two individual AFVW

residents, the entrance fee is considered paid one-half by each. 

Petitioners deducted $34,541 of the entrance fee as a medical

expense on their jointly filed 1989 tax return.4 Petitioners

paid monthly service fees to AFVW of $2,170 and $2,254 for 1997

and 1998, respectively.

Under the terms of the residence agreement, petitioners were

guaranteed several amenities in exchange for their payment of

monthly service fees, including: (1) The emergency-pull-cord

system; (2) 24-hour availability of a licensed nurse from the SNF

to respond to medical emergencies; (3) outpatient and other nonlife-threatening nursing services provided at the Village West

Health Center outpatient medical services clinic by their nursing
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staff; and (4) a guaranty from AFVW of a bed in the Village West

units or SNF and that the fees charged for use of the unit or the

facility would be at a reduced rate from the standard fees

charged to noncontract patients occupying such facilities. The

residence agreement is silent as to the amount of the fee

reduction for use of the units or the facility.

Under the terms of the residence agreement, AFVW could

require that petitioners be transferred to a different level of

living accommodation if certain medical conditions existed.

Additionally, the terms of the agreement provided that

petitioners were entitled to lifetime care.

II. AFVW’s Financial Information and Calculation of Deductible

Medical Expenditures

A. AFVW’s Financial Information for 1997 and 1998

In a report entitled “Air Force Village West - Health

Facility Information” (hereinafter referred to as the report or

the Health Facility Information report), Charles L. Dalton (Mr.

Dalton), vice president of finance for AFVW, certified that

financial information, allocation tables, and supplemental

accounting data contained in the report had been compiled from

the accounting records of AFVW. The report included information

for the years ended December 31, 1997, and December 31, 1998.
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The following chart represents various revenue and expense

items for 1997 listed in the report:

REVENUES

 Description Amount 

Monthly fees $7,979,906

Entrance fee revenue 2,978,303

Entrance fee terminations 551,616

Resident ALU fees 301,321

Noncontract patient ALU fees 80,156

Resident SCU fees 55,445

Noncontract patient SCU fees 3,640

Resident SNF fees 470,787

Noncontract patient SNF fees 1,207,747

Investment income 2,890,228

Gain from sale of securities 107,335

Net, direct billings 355,185

EXPENSES

 Description Amount 

Total operating expenses $16,069,104 

Total interest expense 4,797,339

Total depreciation and amortization 2,161,331

Total issue cost 98,395

Total environmental services 1,028,776

SNF expenses 3,044,041

ALU and SCU expenses 929,275
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Various SNF revenue and expenses for 1997 were listed as follows:

REVENUES

 Description Amount 

SNF room and board, private/Medicare/ $795,567

 HMO fees for residents

SNF room and board, private/Medicare/ 1,207,747

 HMO fees for noncontract patients

SNF ancillary services, Medicare/HMO 365,444

 billings for residents

SNF ancillary services, Medicare/HMO 448,462

 billings for noncontract patients

EXPENSES

 Description Amount 

Direct Expenses:

 Food service $163,348

 Payroll and benefits 1,342,771

 Departmental costs 214,727

 Patient charges 726,229

Purchased Services:

 Housekeeping and laundry 99,092

 Food service (benefits) 22,106

 Maintenance 39,316

 Landscape 29,833

 Administration 123,011

 Insurance 21,970

 Linens 8,403

 Depreciation and amortization 211,343

 Contracts 8,206

 Utilities 33,686

 Total expenses 3,044,041
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The following chart represents various revenue and expense

items for 1998 listed in the report:

REVENUES

 Description Amount

SNF room and board, private/Medicare/ $585,802

 HMO fees for residents

SNF room and board, private/Medicare/ 1,315,694

 HMO fees for noncontract patients

SNF ancillary services, Medicare/HMO 315,969

 billings for residents

SNF ancillary services, Medicare/HMO 378,905

 billings for noncontract patients

EXPENSES

 Description Amount 

Total operating expenses $17,759,058

Interest expense 4,669,121

Depreciation and amortization 2,321,300

Issue costs 107,134

Total environmental services 1,030,677

SNF expenses 3,330,031

ALU expenses 984,333

SCU expenses 796,306
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In a separate document (hereinafter referred to as the 1998

financial document) that should have been included in the Health

Facility Information report because it represents the most

accurate data, the following relevant revenue and expense items

were listed for 1998:

REVENUES

 Description Amount 

Monthly fees $8,329,241

SNF noncontract patient fees 1,301,382

ALU noncontract patient fees 104,083

SCU noncontract patient fees 110,202

EXPENSES

 Description Amount 

Total operating expenses $16,986,770

Interest expense 4,704,320

Depreciation and amortization 2,338,558

Issue costs 107,134

Total environmental services 1,020,109
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Various SNF expenses for 1998 were listed in the Health

Facility Information report as follows:

REVENUES

 Description Amount 

SNF resident fees $585,802

SNF noncontract patient fees 1,315,694

SNF Medicare/HMO billings for residents 315,969

SNF Medicare/HMO billings for 378,905

 noncontract patients

SNF other 15,696

Home care 49,578

EXPENSES

 Description Amount

Direct Expenses:

 Health services - payroll and benefits $374,008

 SNF - payroll and benefits 964,802

 Clinic - payroll and benefits 120,955

 SNF - departmental expenses 197,028

 Clinic - departmental expenses 40,446

 Patient chargeables 677,894

 Depreciation 166,303

 Insurance 32,531

 Utilities 26,073

 Contract 3,055

Purchased Services:

 Corporate administration 125,684 

 Environmental services 144,295

 Food services 381,040

 Maintenance 36,111

 Landscaping 30,306

 Linens 9,500

 Total expenses 3,330,031
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Similar charts were included detailing an allocation of expenses

to the ALU and SCU. The report states that the SNF, ALU, and SCU

expense information listed above does not include an allocation

of amortization of debt issue cost, amortization of preopening

cost, or an allocation of interest expense. Specific expenses

associated with the pool, spa, and exercise facilities at Village

West are not identified in the financial information in the

report.

In allocating expenses to the SNF, the following explanation

was provided:

 Line Item Description 

Food service Percent of total contract

Payroll and benefit Direct labor costs plus benefits

Departmental costs All expenses in specific dept., 

except payroll and benefits

Housekeeping and laundry Percent of total contract

Food service Benefits of employees directly 

allocated to cost center

Maintenance A specific employee dedicated to 

the health care facility

Landscape Based on previous time study

Administration Based on previous time study

Insurance Policies directly related to 

facility plus 10 percent of other 

policies

Linens Linens purchased directly for the 

SNF

Depreciation and Directly from the fixed asset 

 amortization program

Contracts Alarm system, copiers, fire drill, 

Medical Director, etc. (No 

ancillary contractors)

Utilities 10 percent of the total utilities 

for AFVW

Interest expense 10 percent of total interest 

expense for AFVW
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5The report does not contain a cost allocation to monitor

the system for ILUs for 1997.

6The following represents the calculations contained in the

report:

Hours required (365 days x 24 hours) 8,760

Average hourly rate 7.75

Total staff cost $67,890

Overhead of 30 percent 20,367

 Total cost to monitor $88,257

The explanation notes that allocations for ALUs and SCUs are the

same except for maintenance, landscaping, administration,

insurance, contracts, utilities, and interest, which were

allocated on the basis of two-thirds of the SNF costs.

The report contains an allocation of costs to the emergencypull-cord system for ILUs for 1998.5 The cost was determined by

developing an average hourly rate for front desk staff monitoring

the system, multiplying this by the number of hours in a year

(because the system was monitored 24 hours a day), and then

adding an overhead cost factor of 30 percent of the staff cost. 

On the basis of an average hourly rate of $7.75, the total cost

to monitor the emergency-pull-cord system for ILUs was determined

to be $88,257.6 Mr. Dalton calculated this allocation.

The report contains revenue totals for 1997 and 1998 for

monthly services fees from ILU residents. For 1997, the total

monthly service fees from ILU residents are listed as $7,979,906. 

For 1998, the report lists total monthly service fee revenue of
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7Mr. Dalton did not allocate any medical costs for the

emergency-pull-cord system for 1997 or 1998.

$8,327,083. The report also shows average census figures for the

ILUs for 1997 and 1998. The schedule reflects that for 1997

there were 372 occupied ILUs containing 574 residents. For 1998,

there were 386 occupied ILUs containing 591 residents.

B. Mr. Dalton’s Calculations

On behalf of AFVW, Mr. Dalton calculated the deductible

portion of the monthly service fees paid in 1997 and 1998 for

AFVW residents living in ILUs. Mr. Dalton informed ILU residents

of his calculations and advised them to consult their tax adviser

for possible application on their tax returns. The general

approach utilized by Mr. Dalton was to use costs associated with

the SNF in determining the medical expense attributable to ILU

residents. Some of the figures used by Mr. Dalton to calculate

the allocation percentage are different from those outlined in

the Health Facility Information report.

1. Calculation of 1997 Medical Expenses

For 1997, Mr. Dalton used a percentage method to determine

the proper allocation of monthly service fees to medical care. 

Mr. Dalton calculated the allocation percentage by determining

the total expenses associated with the SNF and subtracting from

this figure depreciation, interest expense, and Medicare and HMO

insurance reimbursements allocable to the SNF.7 He then divided
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8The evidence in the record does not contain calculations by

AFVW or Mr. Dalton using the actuarial method to determine the

deductible portion of monthly service fees paid in 1998.

this amount by the total costs, excluding total depreciation and

interest expense, of Village West. Mr. Dalton calculated that

17.78 percent of the total monthly service fees paid by residents

living in ILUs were allocable to medical care. Applying slightly

different residency and monthly service fee figures than those

contained in the Health Facility Information report, Mr. Dalton

concluded that the portion of monthly service fees for ILU

residents that was allocable to medical care was $374 per

residence per month.

2. Calculation of 1998 Medical Expenses

In 1998, AFVW switched to an actuarial method to determine

the deductible portion of monthly service fees.8 However, Mr.

Dalton still prepared a calculation for that year using the

percentage method so that AFVW residents joining the community

prior to January 1, 1998, would have information comparable to

prior years for tax return preparation. Using the same

methodology as in 1997, Mr. Dalton calculated that 19.01 percent

of the total monthly service fees paid by residents living in

ILUs were allocable to medical care. Applying slightly different

residency and monthly service fee figures than those contained in

the Health Facility Information report, Mr. Dalton concluded that
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9The information supplied included the 1998 financial

document that should have been included in the Health Facility

Information report.

the portion of monthly service fee for ILU residents that was

allocable to medical care was $416 per residence per month.

C. Ad Hoc Committee’s Calculation of Medical Expenses

In 1997, the resident council of Village West established an

ad hoc committee (hereinafter sometimes referred to as the

committee) to recalculate what portion of the monthly service

fees paid by residents living in ILUs should be allocated to

medical care. The ad hoc committee reported to the resident

council. Petitioner was a participant of the ad hoc committee. 

In February 1998, Mr. Dalton supplied the resident council with

information for purposes of determining the appropriate medical

deductions for ILU residents for 1997 and 1998.9

In a letter dated March 13, 2000, the ad hoc committee

reported to the resident council its findings regarding income

tax deductions for ILU residents for health care expenses. Using

the percentage method, the committee calculated that the portions

of monthly services fees allocable to medical care were 40.3

percent and 41.6 percent for the years 1997 and 1998,

respectively. In calculating total operating expenses, the

committee subtracted interest expense, depreciation and

amortization, issue cost, and noncontract patient expenses from

total AFVW expenses. In calculating medical expenses, the
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committee included SNF, ALU, and SCU operating expenses, and

subtracted out noncontract patient fees and depreciation and

amortization allocable to the three facilities. The committee

then made certain upward adjustments to account for the

emergency-pull-cord system, food service, environmental service,

utilities, and insurance. The adjustments for food service and

environmental expenses were based on formulas provided by the

food service contractor and the environmental service contractor. 

The adjustment for utilities was based on a square-footage method

and the adjustment for the insurance was based on a ratio- and

square-footage methodology.
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103,111,675 ÷ 7,720,496 = .403 or 40.3 percent.

The following chart prepared by the ad hoc committee

represents its calculations for 1997:

 Operating Expenses Amount 

Total expenses $16,069,104

Interest expense (4,797,339)

Depreciation and amortization (2,161,331)

Issue cost (98,395)

Noncontract patient expense (1,291,543)

 Total operating expenses 7,720,496

 Medical Expenses Amount 

SNF operating expenses $3,044,041

ALU and SCU operating expenses 929,275

Emergency pull-cord system 87,374

Food service adjustment 482,769

Environmental service adjustment 112,617

Utilities adjustment 81,146

Insurance adjustment 18,234

SNF noncontract patient fees (1,207,747)

SNF depreciation and amortization (211,343)

ALU noncontract patient fees (80,156)

SCU noncontract patient fees (3,640)

ALU and SCU depreciation and amortization (140,895)

 

 Allocable medical expenses 3,111,675

Dividing medical expenses by total operating expenses, the

committee calculated that the allocation percentage for 1997 was

40.3 percent.10
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113,459,527 ÷ 8,321,091 = .416 or 41.6 percent.

The following chart prepared by the ad hoc committee

represents its calculations for 1998:

 Operating Expenses Amount 

Total expenses $16,986,770

Interest expense (4,704,320)

Depreciation and amortization (2,338,558)

Issue cost (107,134)

Noncontract patient expense (1,515,667)

 Total operating expenses 8,321,091

 Allocable Medical Expenses Amount 

SNF operating expenses $3,330,031

ALU and SCU operating expenses 1,780,639

Emergency pull-cord system 88,257

Utilities adjustment 103,641

SNF noncontract patient fees (1,301,382)

SNF depreciation and amortization (166,303)

ALU noncontract patient fees (104,083)

SCU noncontract patient fees (110,202)

ALU and SCU depreciation and amortization (161,071)

 

 Allocable medical expenses 3,459,527

The operating expenses figures used by the committee were taken

from the 1998 financial document that should have been included

in the Health Facility Information report, not from the figures

actually contained in the report. Dividing medical expenses by

total operating expenses, the committee calculated that the

allocation percentage for 1998 was 41.6 percent.11

In a memorandum dated March 15, 2000, the resident council

reported to AFVW residents a summary of the ad hoc committee’s

findings. Attached to the memorandum was a chart showing that
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the annual deduction could be calculated by dividing total

monthly service fees for the year by 12 months to arrive at the

total average monthly service fees paid by ILU residents per

month. This amount is then divided by the number of ILU

residents shown in the census chart, resulting in the average

monthly service fee per resident. Multiplying the average

monthly service fee by the allocation percentage provides the

medical deduction per resident per month. The chart contained

the following information relevant to monthly service fees for

ILU residents for 1997 and 1998:

 Independent Living Units 

Year Number Occupied Residents Total Yearly Service Fee

1997 372 574 $7,979,906

1998 386 591 8,329,241

In a memorandum to AFVW residents dated February 1, 2002,

the resident council, in conjunction with AFVW management,

provided information to residents regarding income tax deductions

for health care expenses. The memorandum states that management

changed from the percentage method to the actuarial method in

1998 to determine the allowable deduction, and that management

planned to continue to use the actuarial method for new

residents. It is noted that the actuarial method will produce a

different deduction than the percentage method, and individual

residents are advised to analyze each method and select the one

most beneficial for his or her tax situation.
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12The amounts stated in this paragraph are before

application of the 7.5-percent floor contained in sec. 213(a).

The memorandum further states that for the years 1997, 1998,

and 1999, the ad hoc committee had coordinated and worked with

AFVW management to review and make recommendations regarding the

portion of monthly service fees allocable to medical care. In

addition, the memorandum states that certified data from the

financial records of AFVW for these years was provided to the ad

hoc committee and that data was used to determine the appropriate

allocation percentage. The allocation percentage is listed as

40.3 percent and 41.6 percent for the years 1997 and 1998,

respectively. The memorandum then states that the portion of the

monthly service fees allocable to medical care is determined per

resident. AFVW residents were advised to consult their tax

adviser for possible application of the information contained in

the memorandum, and it is stated that neither AFVW nor the

resident council is a tax adviser. The memorandum is signed by

the chairman of the resident council and the president/CEO of

AFVW. 

III. Petitioners’ Tax Returns

On their jointly filed 1997 and 1998 Forms 1040, U.S.

Individual Income Tax Return, petitioners reported medical and

dental expenses of $12,743 and $16,828, respectively.12 Of these

amounts, $6,557 and $9,891 for the years 1997 and 1998,
- 27 -

respectively, related to the portion of the monthly services fees

paid allocable to medical care. These amounts are primarily

derived from the ad hoc committee’s calculations. The amounts of

$3,461 and $3,596 for the years 1997 and 1998, respectively,

related to Mr. Baker’s use of the pool, spa, and exercise

facilities at Village West. The remainder of the reported

amounts was for various other items.

Petitioners’ claimed entitlement to deductions for Mr.

Baker’s use of the pool, spa, and exercise facilities is based in

part on a letter dated July 29, 1991, from Elaine K. Jones, M.D.,

which states that her evaluation confirms Mr. Baker’s previous

diagnoses of hypertension, valvular heart disease,

hyperlipidemia, and degenerative arthritis. The letter states

that to treat the above medical conditions it is imperative that

Mr. Baker continue his exercise program, including the exercise

room, swimming pool, and whirlpool at least three times a week. 

The letter also states that the exercise program will help

alleviate the symptoms of Mr. Baker’s chronic illnesses.

IV. Respondent’s Determination

The examination in this case commenced after July 22, 1998. 

On September 28, 2001, respondent issued a notice of deficiency

to petitioners for their 1997 and 1998 taxable years. In the

notice, respondent determined that the portion of the monthly

service fees attributable to medical care was limited to $4,488
- 28 -

13The amounts stated in this paragraph are before

application of the 7.5-percent floor contained in sec. 213(a).

14$374 x 12 months = $4,488.

15($2,254 x 12 months) x 19.01 percent = $5,142.

16Respondent’s determinations based on the percentage method

are inconsistent because for 1997 he determined the amount

allocable to medical care based on the weighted average of

monthly service fees paid by ILU residents but for 1998 he

determined the amount allocable based on the actual monthly

service fees paid by petitioners. 

and $5,142 for the years 1997 and 1998, respectively.13

Respondent’s determination for 1997 was based on Mr. Dalton’s

determination that $374 of the monthly service fees per residence

in an ILU was allocable to medical care.14 The determination for

1998 was calculated by multiplying the 19.01-percent allocation

figure determined by Mr. Dalton by petitioners’ total monthly

service fees paid to AFVW.15 These determinations are based on

the percentage method, not the actuarial method.16 Respondent

completely disallowed petitioners’ claimed deductions for both

years relating to Mr. Baker’s use of the pool, spa, and exercise

facilities at Village West. The remaining claimed medical

deductions were allowed.

Respondent subsequently sought the advice of Alwyn V. Powell

(Mr. Powell), an actuary, for the purpose of determining the

portion of the monthly services fees allocable to medical care. 

On the basis of Mr. Powell’s expert report, respondent now

asserts that $4,584 and $5,304 are the correct amounts allocable
- 29 -

17On brief, respondent expressly states that use of the

alternative actuarial method is not being advocated in this case.

18Respondent does not argue that we should use any of the

figures used by Mr. Dalton in his calculations under the

percentage method, which figures were the basis of the

determination in the notice of deficiency.

to medical care for petitioners for the years 1997 and 1998,

respectively. In his report, Mr. Powell calculated the amounts

allocable to medical care for petitioners using the actuarial

method, an alternative actuarial method,17 and the percentage

method. Mr. Powell relied on the financial information contained

in the Health Facility Information report for purposes of

applying the above three methods.

Respondent’s current position is that the actuarial method

is the correct way to calculate the deductible portion of

petitioners’ monthly service fees. In the event that the

percentage method must be used, respondent generally argues that

the percentage method calculations performed by Mr. Powell are

the correct calculations to use.18

OPINION

During the years in issue, petitioners lived in an ILU,

which, as stated above, is a residential unit designed for

normal, everyday independent living of AFVW residents, and

resembles a regular residential accommodation that can be found

in any nonretirement living community. The primary issue in this

case is the amount of the monthly service fees paid while
- 30 -

19The portion of fees paid by residents in higher levels of

care, such as ALUs, SCUs, or the SNF, that is allocable to

medical care is not at issue in this case. For further

discussion of the treatment of costs incurred while residing in a

retirement home, see Levine v. Commissioner, 695 F.2d 57, 59-60

(2d Cir. 1982), affg. T.C. Memo. 1981-437, Estate of Smith v.

Commissioner, 79 T.C. 313, 319 (1982), and sec. 1.213-1(e)(1)(v),

Income Tax Regs.

petitioners resided in an ILU that is allocable to medical

care.19 Resolution of this issue depends in part on whether we

apply the percentage method or the actuarial method. 

Additionally, we must decide whether petitioners are entitled to

medical deductions for amounts they claim are attributable to Mr.

Baker’s use of the pool, spa, and exercise facilities at AFVW.

Section 213(a) allows as a deduction any expenses that are

paid during the taxable year for the medical care of the

taxpayer, his spouse, and dependents and that are not compensated

for by insurance or otherwise. Estate of Smith v. Commissioner,

79 T.C. 313, 318 (1982). The deduction is allowed only to the

extent the amount exceeds 7.5 percent of adjusted gross income. 

Sec. 213(a); sec. 1.213-1(a)(3), Income Tax Regs. The term

“medical care” includes amounts paid “for the diagnosis, cure,

mitigation, treatment or prevention of disease, or for the

purpose of affecting any structure or function of the body”. 

Sec. 213(d)(1)(A); Estate of Smith v. Commissioner, supra at 318-

319.
- 31 -

Petitioners claim that they are entitled to a medical

deduction related to the monthly service fees paid using the

percentage method and applying an allocation percentage of

approximately 41 percent. Petitioners also claim that they are

entitled to additional medical deductions as a result of Mr.

Baker’s use of the pool and spa facilities at AFVW. 

Respondent agrees that petitioners are entitled to deduct

under section 213 a portion of the monthly service fees paid to

AFVW. However, respondent argues that the actuarial method

should be used to calculate the amount allocable to medical care. 

Respondent contends that petitioners are not entitled to any

deductions for Mr. Baker’s use of the pool, spa, and exercise

facilities at Village West because petitioners have not

substantiated how the claimed amounts were calculated or that the

expenditures were paid for the primary purpose of and are

directly related to the medical care of the taxpayers.

I. The Allocation Methods

The primary disagreement between the parties with respect to

the monthly service fees issue is the appropriate method to use

to calculate the portion of the fees allocable to medical care. 

Petitioners, relying on published guidance by the Commissioner,

argue that they are entitled to use the percentage method. 

Respondent, relying on the expert report of Mr. Powell, argues

that the actuarial method should be used.
- 32 -

A. The Percentage Method 

The percentage method assumes that the medical care portion

of entrance fees and monthly service fees is the same portion or

percentage as the CCRC’s medical expenses to total costs because

the sum of the fees over the resident’s lifetime is expected to

cover the costs of care for residents in a CCRC. Thus, the

percentage method generally involves analyzing each expense

category to determine what portion of each category’s total costs

is for medical purposes. In his report, Mr. Powell explained

that this allocation process is fairly straightforward for CCRCs

that provide medical care through stand alone detached units with

budgets separate from the nonmedical center or that purchase

medical services from a third party. However, most CCRCs that

Mr. Powell was familiar with (including Village West) do not make

this distinction in their budgets and operate on a blended basis

for the entire facility.

Under the percentage method, once total medical expenses are

determined, this amount is divided by the CCRC’s costs to

determine the medical expense allocation percentage. This

percentage is then multiplied by the total monthly fees collected

from ILU residents for the year to find the total medical costs

allocable to monthly fees revenue. This total is then divided by

the number of ILU residents to determine the portion of the fees

that is allocable to medical care.
- 33 -

20Mr. Powell is the chairman and CEO of A.V. Powell &

Associates, LLC, a firm of consulting actuaries and accountants.

Mr. Powell has an undergraduate degree in major statistics from

Harvard and a master’s degree in actuarial science from Georgia

State University. Mr. Powell was recognized by the Court as an

expert in actuarial science.

B. The Actuarial Method

According to respondent’s expert, Mr. Powell,20 the

actuarial method is a procedure based on actuarial projections of

longevity and health care utilization for estimating the

deductible portion of fees paid by a taxpayer to a CCRC. Like

the percentage method, the actuarial method initially requires

that expenses be allocated between medical care and nonmedical

care. The following is a simplified description of the actuarial

method used by Mr. Powell and relied on by respondent. On brief,

respondent acknowledges that this description does not detail

much of the complexity in actually applying the method. 

The first step in applying the actuarial method is to

determine operating expenses and capital expenses for the use of

fixed assets. The second step is to estimate the length of time

a resident will spend in each level of care. Although this is

normally accomplished using actuarial tables, CCRCs present a

complicating factor because survivorship possibilities and the

corresponding life expectancies need to be refined by the level

of care (e.g., independent living versus assisted living versus

skilled nursing care). The third step is to combine the
- 34 -

assumptions about costs of services with the longevity projection

to determine the lifetime total costs of care and the lifetime

total medical care costs. By applying the lifetime medical care

costs, the fourth step uses the contract provision about monthly

service fees paid to determine the prepaid medical care costs. 

The amount of medical care that is funded before transfer to

assisted living or nursing care is the difference between

lifetime medical care costs and the sum of monthly service fees

paid. This difference is referred to as the prepaid medical care

costs and should be considered deductible under section 213(a). 

The calculation of the portion of the prepaid medical care costs

that can be claimed for the entrance fee and the portion that can

be claimed for the total monthly service fees for the year is at

the discretion of the taxpayer with the limitation that the

actuarial present value sum of all deductions does not exceed the

prepaid medical care costs.

C. Appropriate Allocation Method

The threshold dispute is over which method to use to

determine the portion of the monthly service fees that is

allocable to medical care. As explained in detail below, the

percentage method preferred by petitioners has been accepted by

respondent and generally relied upon since at least 1967. 

Properly applied, the percentage method provides a reasonable and

straightforward approach for determining the portion of monthly
- 35 -

21We are aware that revenue rulings are not binding on this

Court or other Federal courts. Rauenhorst v. Commissioner, 119

T.C. 157, 171 (2002); Frazier v. Commissioner, 111 T.C. 243, 248

(1998). However, the public has a right to rely on positions

taken by the Commissioner in published guidance. Alumax, Inc. v.

Commissioner, 109 T.C. 133, 163 n.12 (1997), affd. 165 F.3d 822

(11th Cir. 1999); Am. Campaign Acad. v. Commissioner, 92 T.C.

1053, 1070 (1989); Nissho Iwai Am. Corp. v. Commissioner, 89 T.C.

765, 778 (1987); see also Rev. Proc. 89-14, sec. 7.01(5), 1989-1

C.B. 814 (taxpayers may rely on published revenue rulings in

determining the tax treatment of their own transactions). 

service fees that is allocable to medical care. The method

provides a direct link between the actual fees paid by the

residents and the medical costs incurred by the CCRC during the

taxable year. Despite this, respondent asserts that the

actuarial method is more precise and accurate. Respondent freely

admits that the actuarial method is more complex, indeed, so

complex as to defy full explanation in testimony and on brief.

Both methods involve subjective judgments, so neither is immune

from differences of opinion. We hold under these circumstances

that petitioners are not compelled to adopt a new method, and we

decline respondent’s suggestion that the percentage method be

usurped by the actuarial method.

As noted above, use of the percentage method has been

sanctioned by respondent for over 35 years. In Rev. Rul. 67-185,

1967-1 C.B. 70, Rev. Rul. 75-302, 1975-2 C.B. 86, and Rev. Rul.

76-481, 1976-2 C.B. 82,21 the Commissioner addressed similar

situations involving the issue of whether the portion of a

monthly fee paid by individuals in connection with their
- 36 -

residence at a retirement home under a lifetime care contract was

deductible by the individuals as an expense for medical care

under section 213, subject to the limitations of the statute. In

the rulings, the taxpayers had entered into agreements with a

retirement home under which they became entitled to live in the

home and to receive lifetime care that included specified

residential accommodations, meals, and medical care. In exchange

for the promise of the lifetime care, the taxpayers paid a

monthly fee to the homes.

In Rev. Rul. 67-185, supra at 70, the taxpayers proved that

on the basis of the retirement home’s experience, a portion of

the monthly fee was for costs of providing medical care,

medicine, and hospitalization. The ruling cited the holding in

Rev. Rul. 54-457, 1954-2 C.B. 100, that where a university

charges a student a lump-sum fee which includes his education,

board, medical care, etc., the portion of the charge which was

allocable to medical care is considered a proper medical expenses

deduction if there is a breakdown showing the amount of the fee

allocable to medical care, or such information was readily

available to the university. Id. at 71. Rev. Rul. 67-185,

supra, then stated that the principle in Rev. Rev. 54-457, supra,

relating to allocation of the fee, was equally applicable to its

situation. Rev. Rul. 67-185, supra at 71, concluded:
- 37 -

22See also Rev. Rul. 68-525, 1968-2 C.B. 112 (relying on the

statement in Rev. Rul. 67-185, 1967-1 C.B. 70).

Accordingly, where the taxpayers, a husband and

his wife, pay a monthly life-care fee to a retirement

home, and prove that a specific portion of the fee

covers the costs of providing medical care for them,

that portion of the fee is deductible by the taxpayers

as an expense for medical care in the year paid,

subject to the limitations prescribed in section 213 of

the Code.[22]

In Rev. Rul. 75-302, supra, the taxpayer, pursuant to a

lifetime care contract with a retirement home, was required to

pay a lump-sum fee. The Commissioner ruled that the portion of

the lump-sum fee that was properly allocable to the taxpayer’s

medical care was deductible as an expense for medical care in the

year paid, subject to the limitations in section 213.

The facts involved in Rev. Rul. 76-481, supra, are similar

to those in Rev. Rul. 67-185, supra. Rev. Rul. 76-481, supra at

82, noted that the fees were calculated without reference to any

similar contract with other patients at the institution and was

not medical insurance. Additionally, because the home had not

been in operation for a sufficient length of time to demonstrate

from its own financial experience what portion of the fees was

allocable to medical care of the residents, the home used longterm financial information from a comparable retirement home. 

Id. at 83. The home determined that 15 percent of the monthly

fee would be used to discharge the home’s obligations to provide

medical care to its residents. Id.
- 38 -

23In other rulings, taxpayers have been allowed to deduct

specific portions of entrance fees paid to retirement homes,

subject to the limitations of sec. 213. See Rev. Rul. 76-481,

1976-2 C.B. 82 (10 percent of entrance fee allocable to medical

care); Rev. Rul. 75-302, 1975-2 C.B. 86 (30 percent of entrance

fee allocable to medical care). In Estate of Smith v.

Commissioner, 79 T.C. 313, 321-322 (1982), we held that 7 percent

of an entrance fee paid to a retirement home was allocable to

medical care because this percentage was determined to be the

cost of providing free days of standard care in a convalescent

center for the residents’ lifetimes. The Commissioner acquiesced

in our decision in Estate of Smith at 1984-2 C.B. 1. 

The ruling first examined previous rulings discussing the

deductible portion of fees paid by taxpayers for lifetime care

from retirement homes. Id. The ruling cited the statement in

Rev. Rul. 67-185, supra, quoted above. The ruling then addressed

the monthly fee issue and stated: 

In addition, the portion of the monthly fee (15

percent * * *) paid by the taxpayers that is properly

allocable to medical care is also deductible as an

expense for medical care in the year paid, subject to

the limitations prescribed in section 213 of the Code.

[Id.]

The ruling also discussed the deductibility of portions of an

entrance fee paid by the taxpayers.23 Id. 
- 39 -

24Although Rev. Rul. 76-481, supra, was clarified by Rev.

Rul. 93-72, 1993-2 C.B. 77, the clarification does not affect the

issue in the instant case. It is unclear whether the

Commissioner has considered the issue of the deductibility of

monthly service fees since 1993. See Rev. Proc. 93-43, 1993-2

C.B. 544 (stating that no further rulings will be issued on the

issue of whether amounts paid for medical care extending

substantially beyond the taxable year may be deducted under

section 213); see also Rev. Proc. 99-3, 1999-1 C.B. 103

(designating the issue stated in Rev. Proc. 93-43, supra as an

area under extensive study in which rulings or determination

letters will not be issued until the Service resolves the issue

through publication of a revenue ruling, revenue procedure,

regulations, or otherwise). We note that the monthly service

fees in this case relate to current medical care.

25See, e.g., Priv. Ltr. Rul. 86-51-028 (Sept. 19, 1986);

Priv. Ltr. Rul. 86-41-037 (July 11, 1986); Priv. Ltr. Rul. 86-30-

005 (Apr. 4, 1986); Priv. Ltr. Rul. 82-13-102 (Dec. 30, 1981). 

Private letter rulings are not regarded as precedent in this

Court and may not be relied on by the public. Sec. 6110(j)(3);

Alumax, Inc. v. Commissioner, 109 T.C. at 163 n.12. However,

private letter rulings may be cited to show the practice of the

Commissioner. Rowan Cos., Inc. v. United States, 452 U.S. 247,

261 n.17 (1981); Hanover Bank v. Commissioner, 369 U.S. 672, 686-

687 (1962); Rauenhorst v. Commissioner, 119 T.C. at 170 n.8;

Estate of Cristofani v. Commissioner, 97 T.C. 74, 84 n.5 (1991).

None of the above rulings have been revoked or modified,24

and the Commissioner has relied on these rulings in issuing

private letter rulings regarding the deductible portion of

monthly service fees.25 Indeed, the Commissioner in private

letter rulings has cited the above revenue rulings and sanctioned

use of the percentage method. See, e.g., Priv. Ltr. Rul. 86-30-

005 (Apr. 4, 1986), which states in relevant part:

The proper allocation of medical to total fees may

be determined by dividing all directly related medical

expenses by total expenses. To the extent that they

can be substantiated and are allocable to medical care

facilities, medically related expenses may include,
- 40 -

among other items, salaries of nurses, nurses’ aides,

orderlies and incidental medication and supplies, as

well as expenses allocable to the facility, such as,

housekeeping, maintenance and utilities, a

proportionate share of interest on indebtedness, real

estate taxes, insurance, and depreciation.

* * * * * * *

(5) Medical expenses for purposes of the

computation of the ratio of medical to total expenses

include, but are not limited to, salaries of the

Medical Center staff, incidental medication and

supplies, the proportionate amount attributable to the

provision of medical care of housekeeping, maintenance,

utilities, administrative and marketing costs, interest

on indebtedness, real estate taxes and depreciation of

the nursing facility.

There is no requirement in the revenue rulings that

taxpayers engage in an actuarial analysis to factor in life

expectancy and health care level expectancy on the basis of the

residency population of a CCRC to determine estimated lifetime

medical care costs and total costs. The rulings focus on the

amount of fees paid by residents to the CCRC during the taxable

year that are properly allocable to medical care in the year

paid, and imply that the percentage method is an appropriate

method for taxpayers to use. The actuarial method used by

respondent’s expert requires estimating total lifetime costs of

services and lifetime medical care costs, steps that are not

anticipated or required by the revenue rulings. Additionally,

the longstanding practice of the Commissioner has been to allow

use of the percentage method. The Commissioner’s guidance
- 41 -

26Sec. 7491 is effective with respect to court proceedings

arising in connection with examinations commencing after July 22,

(continued...)

provides further justification for our holding that petitioners

are not required to use the actuarial method.

II. Burden of Proof

We must now determine which party bears the burden of proof

as to the factual issues in this case. Generally, the taxpayer

bears the burden of establishing the entitlement to any deduction

claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992);

New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). 

However, in certain circumstances, if the taxpayer introduces

credible evidence with respect to any factual issue relevant to

ascertaining the proper tax liability, section 7491 places the

burden of proof on the Commissioner. Sec. 7491(a)(1). Credible

evidence is “‘the quality of evidence which, after critical

analysis, the court would find sufficient upon which to base a

decision on the issue if no contrary evidence were submitted’”. 

Higbee v. Commissioner, 116 T.C. 438, 442 (2001) (quoting H.

Conf. Rept. 105-599, at 240 (1998), 1998-3 C.B. 755, 994). 

Section 7491(a)(1) applies only if an individual taxpayer

complies with substantiation requirements, maintains all required

records, and cooperates with reasonable requests by the

Commissioner for witnesses, information, documents, meetings, and

interviews. Sec. 7491(a)(2).26 
- 42 -

26(...continued)

1998. Internal Revenue Service Restructuring and Reform Act of

1998, Pub. L. 105-206, sec. 3001(c), 112 Stat. 727. Respondent

has conceded that the examination in this case commenced after

July 22, 1998.

Whether an expense is for medical care is primarily a

question of fact. Levine v. Commissioner, 695 F.2d 57, 59 (2d

Cir. 1982), affg. T.C. Memo. 1981-437; Counts v. Commissioner, 42

T.C. 755, 764 (1964); Estate of Smith v. Commissioner, 79 T.C. at

319; sec. 1.213-1(e)(1)(v), Income Tax Regs. For purposes of

this case, the factual issues involved are: (1) The portions of

the monthly service fees allocable to medical care under the

percentage method; and (2) the amounts, if any, that petitioners

are entitled to deduct for Mr. Baker’s use of the pool, spa, and

exercise facilities.

On brief, respondent argues that petitioners have failed to

present credible evidence that they are entitled to the amounts

of the medical deductions claimed on their returns for the years

in issue and that they did not comply with the substantiation,

recordkeeping, and cooperation requirements of section

7491(a)(2). However, at trial, respondent specifically stated

that petitioners had cooperated and maintained records. 

Respondent represented to the Court that the only issue under

section 7491(a) was whether petitioners had presented credible

evidence. We treat respondent’s representation at trial as a
- 43 -

concession that petitioners have satisfied the requirements of

section 7491(a)(2).

The stipulated joint exhibits and petitioners’ exhibits

contain detailed financial information, including total revenue

and expenses figures for Village West for the years in issue. 

Petitioners rely primarily on the findings of the ad hoc

committee, of which Mr. Baker was a member, with certain

adjustments. AFVW management informed its AFVW residents that

certified data from the financial records of AFVW for the years

in issue was provided to the ad hoc committee and that the

committee coordinated and worked with management to review and

make recommendations regarding the allowable deductions for

medical expense. This financial information and the ad hoc

committee’s report are detailed and contain the revenue and

expense figures necessary to calculate petitioners’ medical

deductions for the years in issue. After discussing this issue

with the parties at trial and examining their briefs, we

interpret petitioners’ position to be that both the ad hoc

committee’s findings and the findings resulting from petitioners’

subsequent adjustments are appropriate methods of calculating the

appropriate allocation percentage and determining petitioners’

medical deductions.

After thorough review and critical analysis of the

stipulated joint exhibits and petitioners’ exhibits, we find that
- 44 -

27See Forste v. Commissioner, T.C. Memo. 2003-103 (holding

that taxpayers produced credible evidence in the form of draft

proposal offers and final settlement agreement that was

sufficient to show that a payment was made in settlement of tort

or tort-type claim for personal injury).

28On brief, petitioners argue that respondent’s reliance on

Mr. Powell’s report and use of the actuarial method constitutes a

new matter. Petitioners may be correct, especially in light of

the fact that any appeal in this case would normally lie to the

Court of Appeals for the Ninth Circuit. See, e.g., Estate of

Harper v. Commissioner, T.C. Memo. 2002-121 (discussing recent

decisions by the Court of Appeals for the Ninth Circuit regarding

burden of proof). However, because we have already held that

respondent has the burden of proof, we need not reach this issue.

petitioners have submitted credible evidence; i.e., evidence

which, after critical analysis, is sufficient on which to base a

decision sustaining the ad hoc committee’s calculations regarding

the portion of the monthly service fees that is allocable to

medical care under the percentage method.27 Accordingly, we hold

that respondent bears the burden of proof regarding the portions

of the monthly service fees paid by petitioners in 1997 and 1998

that are allocable to medical care under the percentage method.28

However, with respect to the claimed deductions for medical

use of the pool, spa, and exercise facilities, we find that

petitioners have not submitted credible evidence. The financial

information discussed above, as further explained below, does not

contain specific figures or calculations by Mr. Dalton or AFVW

relating to expenditures for the facilities that are sufficient
- 45 -

29Petitioners do not argue that respondent raised a new

matter with respect to the disallowance of the claimed deductions

for Mr. Baker’s use of the pool, spa, and exercise facilities.

for us to base our decision. Therefore, we conclude that the

burden of proof does not shift to respondent on this issue.29

III. Portion of Monthly Services Fees Allocable to Medical Care 

Under the Percentage Method

The parties’ positions regarding the application of the

percentage method are based primarily on the ad hoc committee’s

report and the portion of Mr. Powell’s report discussing this

method. Respondent argues that Mr. Powell’s application of the

method and the resulting conclusion should be followed if the

percentage method is applied. Petitioners rely primarily on the

ad hoc committee’s findings with certain adjustments contained in

a supplemental calculation. After discussing this issue with the

parties at trial and examining their briefs, we interpret

petitioners’ position to be that both the ad hoc committee’s

findings and the findings resulting from petitioners’ subsequent

adjustments are appropriate methods of determining the

appropriate allocation percentage. Petitioners ultimately argue

that, based on either calculation, the appropriate allocation is

approximately 41 percent.

A. Petitioners’ Calculations

Petitioners generally agree with the approach and financial

figures used by the ad hoc committee, of which Mr. Baker was a
- 46 -

member. They also presented a supplemental report prepared by

Mr. Baker as another means of establishing the appropriate

allocation percentage. As previously mentioned, we interpret

their position to be that the allocation percentage is

approximately 41 percent under either the ad hoc committee’s

calculations or Mr. Baker’s supplemental report.

In order to complete its calculations regarding the

appropriate allocation percentage, the ad hoc committee relied on

certified data from the financial records of AFVW. The committee

coordinated and worked with AFVW’s management in reaching its

calculations. Petitioners have adequately demonstrated to the

Court how the ad hoc committee used the information provided by

AFVW management to arrive at its conclusions regarding the

appropriate allocation percentage.

The ad hoc committee calculated an allocation percentage by

dividing medical expenses by total operating costs, with specific

item adjustments to both figures. In calculating total operating

costs, the committee subtracted interest expense, depreciation

and amortization, issue cost, and noncontract patient expenses

from total costs. In calculating medical expenses, the committee

included SNF, ALU, and SCU operating expenses, and subtracted out

noncontract patient fees and depreciation and amortization

allocable to the three facilities. The committee then made

certain upward adjustments to account for the emergency-pull-cord
- 47 -

system, food service, environmental service, utilities, and

insurance. The adjustments for food service and environmental

expenses were based on formulas provided by the food service

contractor and the environmental service contractor. The

adjustment for utilities was based on a square-footage method and

the adjustment for insurance was based on a ratio- and squarefootage methodology.

The committee ultimately concluded that the allocation

percentages were 40.3 percent and 41.6 percent for the years 1997

and 1998, respectively. The resident council reported to AFVW

residents a summary of the ad hoc committee’s findings. The

resident council explained how the allocation percentage was to

be applied, provided the same census figures used in the Health

Facility Information report, and stated what the medical

deduction was per resident.

Mr. Baker testified that the calculations in the

supplemental report he prepared were similar to the ad hoc

committee’s calculations. He testified that his calculations

assumed that the fee charged for a medical service approximated

the cost of Village West’s providing that service. Mr. Baker did

not explain in detail the adjustments contained in his

supplemental report, and we are unable to satisfactorily connect

his figures to the financial information contained in the record. 

As a result, we find the supplemental report to not be helpful,
- 48 -

and we choose not to rely on it in our analysis. Accordingly, we

will examine respondent’s position to determine whether he has

shown that the allocation percentages and portions of the monthly

service fees allocable to medical care are different from those

calculated by the ad hoc committee.

B. Mr. Powell’s Calculations

Respondent relies on the percentage method as applied by Mr.

Powell. Although Mr. Powell did not believe that the percentage

method should be used, he developed a procedure for generating a

percentage for use with the percentage method. Mr. Powell stated

that the basic formula would examine the relationship between

total costs and amounts allocated to medical care, with

adjustments for specific items. In his report, Mr. Powell stated

that because the sum of entrance fees and monthly service fees

over the resident’s lifetime is expected to cover the costs of

care for residents in a CCRC, it is reasonable to assume that the

costs of medical care in the fee structure represent the same

proportion or percentage in the total costs. Mr. Powell relied

on the financial figures in AFVW’s Health Facility Information

report. He did not rely on the 1998 financial document.

Mr. Powell stated that total costs would include

departmental cash expenses plus depreciation and interest

expense. Subtractions would be made for issuance costs

associated with debt financing, room and board revenues and
- 49 -

30The SCU was completed in June 1997 and began operation at

that time. Mr. Powell did not allocate any medical expenses to

the SCU for 1997.

Medicare and HMO billings for noncontract patients in the SNF,

and ancillary services associated with the SNF. He stated that

it is reasonable to subtract medical expenses not associated with

the residents from both the numerator and denominator of the

formula. Additionally, the ancillary fees that are paid on a

fee-for-service basis and expected reimbursements from Medicare

and HMO insurance should also be subtracted from both the

numerator and denominator because these expenses are not expected

to be covered by entrance fees or monthly service fees.

Similar to the ad hoc committee, Mr. Powell believed that

the expenses for medical care would include expenses allocated to

the ALU, SCU,30 and SNF, plus a portion of the interest expense

allocable to these facilities. The same debt finance costs, SNF

room and board revenues, and ancillary services and Medicare and

HMO billings subtracted from the total costs would also be

subtracted from the medical expense. In addition, ancillary

services, Medicare, and HMO billings for residents should be

subtracted; however, Mr. Powell stated that he could not obtain

an accurate amount due to a difference between the accrual and

cash bases for those revenues.
- 50 -

The following chart prepared by Mr. Powell reflects his

calculations for 1997:

 Operating Expenses Source for Amount 

$16,069,104 Total operating expenses for AFVW, 

including depreciation and interest 

expense

 (93,395) Issuance costs associated with debt 

financing

 (1,207,747) SNF room and board revenues for 

noncontract patients

 (448,462) SNF ancillary services, Medicare, and 

HMO billings for noncontract patients

 14,319,500 Total for denominator

 Medical Expenses Source for Amount 

$3,044,014 Operating expenses allocated to SNF

 929,275 Operating expenses allocated to ALU

 479,734 10 percent of interest expenses to SNF

 319,823 6.67 percent of interest expenses to ALU

(1,207,747) SNF room and board revenues for 

noncontract patients

 (448,462) SNF ancillary services, Medicare, and 

HMO billings for noncontract patients

 (0) Ancillary services, Medicare, and HMO 

billings for residents; not included

 

 13,116,664 Total for numerator

For 1997, the percentage is 21.8 percent ($3,116,664 ÷ 

$14,319,500).2

1We note that the total of the medical expenses is $3,116,637,

not $3,116,664 as listed in Mr. Powell’s report.

2We note that application of the corrected medical expense

figure still produces a percentage of 21.8 percent.
- 51 -

The following chart prepared by Mr. Powell reflects his

calculations for 1998:

 Operating Expenses Source for Amount 

$17,759,058 Total operating expenses for AFVW, 

including depreciation and interest 

expense

 (107,134) Issuance costs associated with debt 

financing

 (1,315,694) SNF room and board revenues for 

noncontract patients

 (378,905) SNF ancillary services, Medicare, and 

HMO billings for noncontract patients

 15,957,325 Total for denominator

 Medical Expenses Source for Amount 

$3,330,031 Operating expenses allocated to SNF

 984,333 Operating expenses allocated to ALU

 796,306 Operating expenses allocated to SCU

 466,912 10 percent of interest expenses to SNF

 311,275 6.67 percent of interest expenses to ALU

 311,275 6.67 percent of interest expenses to SCU

(1,315,694) SNF room and board revenues for 

noncontract patients

 (378,905) SNF ancillary services, Medicare, and 

HMO billings for noncontract patients

 (0) Ancillary services, Medicare, and HMO 

billings for residents; not included

 4,505,533 Total for numerator

For 1998, the percentage is 28.2 percent ($4,505,533 ÷ 

$15,957,325).

To complete his procedure, Mr. Powell chose to apply the

percentages to the total monthly service fees that petitioners

paid to Village West. As previously mentioned, petitioners’

monthly service fees were $2,170 and $2,254 for 1997 and 1998,

respectively. Thus, Mr. Powell calculated that petitioners were
- 52 -

31Calculated as 21.8 percent of 12 x $2,170.

32Calculated as 28.2 percent of 12 x $2,254.

33We note that to the extent respondent has not challenged

certain assumptions by the ad hoc committee, we treat these as

concessions by respondent and express no opinion as to the

validity or accuracy of the assumptions.

entitled to deductions (before application of the 7.5-percent

floor) of $5,67731 and $7,628.32

C. Analysis of Parties’ Positions

Our approach in this case is to examine the ad hoc

committee’s calculations regarding the appropriate allocation

percentage in light of respondent’s allegations of error, which

are primarily based on Mr. Powell’s calculations, his testimony,

and the testimony of Mr. Dalton.33 In order to accomplish this

task, we will address the portions of the committee’s

calculations that respondent claims are inaccurate. Because

respondent relies on Mr. Powell’s application of the percentage

method, we generally compare this approach with that used by the

ad hoc committee.

The ad hoc committee computed the denominator by starting

with total costs and subtracting total interest expense, total

depreciation and amortization, total issue cost, and total

noncontract patient expense. Mr. Powell did not subtract total

interest expense and total depreciation and amortization. 
- 53 -

34In the Health Facility Information report, expenses

related to depreciation are included in the medical expenses

allocable to the SNF, ALU, and SCU. Allocations for amortization

of debt issue cost, amortization of preopening cost, and interest

expense are not included.

However, Mr. Powell did subtract SNF ancillary services,

Medicare, and HMO billings for noncontract patients.

The ad hoc committee calculated medical expenses by first

calculating the sum of SNF, ALU, and SCU operating expenses,

expenses related to the emergency-pull-cord system, and certain

adjustments related to food service, environmental service,

utilities, and insurance. It then subtracted noncontract patient

fees for the SNF, ALU, and SCU, and depreciation and amortization

allocable to the SNF, ALU, and SCU.34 In addition to including

operating expenses of the SNF, ALU, and SCU, Mr. Powell included

interest expense allocable to the SNF and ALU. He did not

include an expense for the emergency-pull-cord system or

adjustments for food service, environmental service, utilities,

or insurance. Mr. Powell did not subtract either noncontract

patient fees for the ALU and SCU or depreciation and amortization

of the SNF, ALU, and SCU. However, he did subtract SNF ancillary

services, Medicare, and HMO billings for noncontract patients. 

The ad hoc committee and Mr. Powell used slightly different

financial figures in their reports.
- 54 -

1. Appropriate Financial Information To Use

The ad hoc committee and Mr. Powell both relied primarily on

the financial information for 1997 and 1998 that was contained in

the Health Facility Information report. For 1998 revenues and

expenses, the committee relied on the 1998 financial document

that should have been included in the report. There are minor

differences between the figures presented in the 1998 financial

document and the report. Respondent has not argued that the

financial information used by the ad hoc committee is inaccurate

or unreliable, and Mr. Powell acknowledges in his report that the

1998 financial document was based on actual results for that

year. With respect to the explanation of expense allocation

assumptions by AFVW, Mr. Powell stated that he reviewed the

assumptions and relied on AFVW’s management’s judgment because he

believed the final results were reasonable. Accordingly, we

proceed under the assumption that the financial figures and

expense allocation assumptions contained in the Health Facility

Information report are appropriate, with the exception that

revenue and expense figures for 1998 should be based on the 1998

financial document.

2. Interest Expense and Depreciation and Amortization

In calculating total costs, the ad hoc committee subtracted

interest expenses and depreciation and amortization. In

calculating allocable medical costs, the committee also
- 55 -

subtracted interest expense and depreciation and amortization

allocable to the SNF, ALU, and SCU. Mr. Powell included both

interest expense and depreciation and amortization in his

calculations.

Mr. Powell testified that it was not technically accurate to

subtract depreciation and interest expense from total costs and

medical expenses. He explained that entrance fees and monthly

service fees are used to cover the total costs of AFVW, which

includes capital costs. Therefore, he felt that excluding these

two items from total costs would distort the allocation

percentages. Petitioners argue that under the percentage method

only operating expenses are included in the denominator of the

equation. They claim that interest should not be included

because it is simply the cost of borrowing capital to fund the

investment in Village West and does not represent an operating

expense. Petitioners claim that depreciation and amortization

are not operating expenses because they represent the initial

capital costs of investing in plant and equipment.

Under the percentage method, the medical expenses of the

CCRC are calculated and then compared to all the expenses of the

community to determine the appropriate percentage of expenses

allocable to medical care. In applying the percentage method in

this case, both the numerator and denominator in the equation

should include interest expenses and depreciation and
- 56 -

35The SCU was placed in service in June 1997 and started

operation at that time. Accordingly, in calculating the interest

expense allocable to the SCU for 1997 we include half the amount

that would have been allocable had the facility been in operation

for the entire year.

amortization because the evidence in the record indicates that

Village West offered a nursing care arrangement where the monthly

service fees for the years in issue were intended to cover all

expenses related to AFVW residents. Neither the residence

agreement nor the financial information submitted by the parties

indicates whether the entrance fees or monthly service fees are

allocated to specific costs or what that allocation is. Thus,

the denominator in this case should be based on the total costs

of the CCRC, which necessarily includes costs for these two

items. It is also logical to include interest expense and

depreciation and amortization costs related to medical facilities

when other expenditures relating to the operation of those

facilities (e.g., utilities, food services, health services) are

included. Therefore, we assume for purposes of this case that

the monthly service fees are applied equally to all expenses,

including interest expense and depreciation and amortization. 

Accordingly, we agree with respondent and Mr. Powell that, in

this case, interest expense and depreciation and amortization

should be included in both the numerator and denominator.35
- 57 -

3. Emergency-Pull-Cord System and Other Adjustments

The ad hoc committee made upward adjustments to the medical

expense figures to account for the emergency-pull-cord system and

food service, environmental service, utilities, and insurance

figures that it felt were not adequately reflected in AFVW’s

financial records. The committee’s calculations for the

emergency-pull-cord system are based on Mr. Dalton’s calculation

contained in the Health Facility Information report.

Respondent’s general argument on this issue is that Mr.

Powell’s calculations should be followed. However, Mr. Powell

did not specifically discuss the emergency-pull-cord system or

other adjustments either in his report or during trial. 

Respondent’s only specific argument is contained in his reply

brief wherein he states that “Although it is petitioners’

contention that the pull cord was not included as a medical

expense, * * * Mr. Dalton testified the pull cord system became

an indirect cost.”

Mr. Dalton prepared the allocation worksheet for the

emergency-pull-cord system. He testified that there is a pullcord system in all ILUs so that in case of an emergency a

resident can pull the cord connected to the front desk and

Village West can provide a crisis nurse within a number of

minutes. Mr. Dalton testified that there were seven or eight

persons who worked at the front desk and that although other
- 58 -

services were provided by front desk staff one of the main

functions was to address the emergency-pull-cord system. In

making the allocation, Mr. Dalton assumed that the allocable cost

of front desk staff to monitor the system would be an average

hourly rate for one person for 24 hours a day for 365 days a

year. Mr. Dalton explained that the expenditures for the system

are not set out in a specific account but are charged to a

general ledger account. Specifically, he testified that the

payroll and benefits for a person monitoring the system would be

found under the resident services expense category, which

includes certain expenses related to the staffing of the front

desk.

After reviewing the financial information and the ad hoc

committee’s report, we find that no amount from the resident

services expense account (other than the committee’s allocation

for the pull-cord system) was included by either Mr. Powell or

the committee in their medical expense calculations. Respondent

does not challenge the amount of the allocation by Mr. Dalton for

medical expenses associated with the emergency-pull-cord system,

and we find the calculation to be reasonable based on the

evidence in the record. Because respondent has not raised any

other arguments on this issue or specifically argued or presented

adequate evidence that the other upward adjustments are
- 59 -

inappropriate, we accept the allocations to the pull-cord system

and the other adjustments made by the ad hoc committee.

4. SNF Ancillary Services, Medicare, and HMO 

Billings, and ALU and SCU Noncontract Patient Fees

In his calculations, Mr. Powell excluded from both total

costs and medical costs expenses for SNF ancillary services,

Medicare, and HMO billings for AFVW residents and noncontract

patients, and ALU and SCU noncontract patient fees. However, Mr.

Powell stated that he could not obtain an accurate amount of SNF

ancillary services, Medicare, and HMO billings for AFVW

residents, and therefore he did not exclude any amount in his

calculations. Respondent has not specifically argued or provided

any amount that we should exclude for SNF ancillary service,

Medicare, and HMO billings for AFVW residents. Accordingly, we

need only address the remaining items as they relate to whether

expenses related to noncontract patients should be excluded from

total costs and medical expenses.

Both the ad hoc committee and Mr. Powell subtracted

noncontract patient fees related to the SNF from total costs and

medical costs. The committee also subtracted noncontract patient

fees related to the ALU and SCU. After reviewing Mr. Powell’s

reasoning and respondent’s arguments (discussed in further detail

below) with respect to expenses and reimbursements related to

noncontract patients, we infer that this was an oversight on the

part of Mr. Powell, and the committee’s position on this issue is
- 60 -

not being challenged. Accordingly, the noncontract patient fees

related to the SNF, ALU, and SCU should all be excluded from

total costs and medical expenses.

In his report, Mr. Powell states that it is reasonable to

subtract SNF ancillary service, Medicare, and HMO billings from

total costs and medical expenses. Respondent argues that the

entrance fees and monthly service fees are expected to cover the

costs of care for residents of a CCRC, and therefore it is

reasonable to subtract expenses not expected to be covered by the

fees. Respondent contends that ancillary services that are paid

on a fee-for-service basis, and expected reimbursements from

Medicare and HMO insurance are expenses not covered by the

entrance fees and monthly service fees.

 At trial, Mr. Dalton testified that if medical care was

covered by insurance, then the fees were charged directly to the

insurance company and charged to an expense account. If payment

was received from Medicare or an HMO insurance company, the

payments were credited to a revenue account.

We agree with respondent on this issue. Our understanding

of the facts of this case is that the monthly service fees are

paid to cover costs related to AFVW residents. The ad hoc

committee allocated SNF, ALU, and SCU expenses to medical care;

however, these facilities are also used by noncontract patients. 

The noncontract patients are charged fees for use of the
- 61 -

36We are unable to derive the amount for 1998 for SNF

ancillary services, Medicare, and HMO billings for noncontract

patients from the 1998 financial document that should have been

included in the Health Facility Information report. Therefore,

like Mr. Powell, we rely on the 1998 information contained in the

report.

facilities, and petitioner has not disputed that noncontract

patients also pay for certain services on a fee-for-service

basis. Additionally, AFVW can receive reimbursement from

Medicare and HMO insurance for care given to noncontract

patients. These fee-for-service and reimbursement proceeds are

included as revenue in AFVW’s books. Although these proceeds are

not used specifically to offset expenses in the noncontract

patient expense accounts, the revenue relates to care given to

noncontract patients in the SNF, ALU, and SCU, and we believe

that the expenses of these facilities should be reduced to

accurately reflect the portion of the monthly service fees paid

for care of AFVW residents. In substance, this treatment is

consistent with the subtraction of SNF, ALU, and SCU noncontract

patient fees from total costs and medical expenses. We have

reviewed the figures used by Mr. Powell and find them consistent

with AFVW’s financial information and acceptable for purposes of

this calculation.36

D. The Court’s Application of the Percentage Method

Mr. Dalton and the ad hoc committee applied the allocation

percentage to a weighted average of monthly service fees paid by
- 62 -

37This application of the percentage method appears at odds

with a statement in the section of Mr. Powell’s report providing

an overview and criteria for the evaluation of the different

methods. In his report, Mr. Powell states that similar residents

have the same expected health care usage and thus should receive

the same deduction regardless of the size of their accommodations

or the fees they pay.

occupants of ILUs. Mr. Dalton’s calculations provide a deduction

per residence while the ad hoc committee’s calculations are per

resident. Mr. Powell applied the percentage based on the actual

monthly service fees paid by petitioners and calculated an

allocable amount per residence.37 Although respondent states

that Mr. Powell’s application of the percentage methodology is

correct, respondent argues that a weighted average should be used

because it provides some consistency among ILU residents and is

fair and objective. Petitioners argue that the allocation

percentages should be applied to the actual fees they paid.

We believe that the more appropriate application of the

percentage method is to allocate to each resident the same amount

for purposes of determining the appropriate medical deduction

related to the payment of monthly service fees. If we accepted

petitioners’ approach, single residents and residents of doubleoccupancy ILUs that are larger than the average ILU (and thus pay

higher monthly service fees) would get a larger medical expense

deduction based solely on the number of occupants of the ILU or

the square footage of the unit. We fail to see the relationship

between the health care expenses of residents and the size and
- 63 -

cost of their ILUs. Accordingly, we hold that the allocation

percentage must be applied based on the number of residents and

the average weighted monthly service fees (or weighted annual

service fees in the case of residents living in ILUs for the

entire year). 

On the basis of the undisputed assumptions by AFVW and our

findings above, we have calculated the amounts allocable to ILU

residents of Village West for medical care related to their

monthly service fees. Our calculations show that the amounts of

$7,766 and $8,476 paid by petitioners as service fees for 1997

and 1998, respectively, were for medical care. The details of

our calculations are contained in the attached appendix.

IV. Deductions for Use of Pool, Spa, and Exercise Facilities

Petitioners claim that they are entitled to deductions for

Mr. Baker’s use of the pool, spa, and exercise facilities

because: (1) The use of the facilities was necessary to

alleviate his chronic illnesses; and (2) a portion of the monthly

service fees is properly allocable to the operation and

maintenance of these facilities. Respondent argues that no

deductions are allowable because Mr. Baker’s use of the

facilities was personal in nature, any expense related to use of

the facilities would otherwise have been incurred by AFVW

residents, and the methodology used by petitioners to allocate a

portion of the monthly service fees to the operation and
- 64 -

maintenance of the facilities is flawed and should be

disregarded.

Deductions for expenditures for medical care are confined

strictly to expenses incurred primarily for the prevention or

alleviation of a physical or mental defect or illness. Haines v.

Commissioner, 71 T.C. 644, 647 (1979); sec. 1.213-1(e)(1)(ii),

Income Tax Regs. An expenditure which is merely beneficial to

the general health of an individual, such as an expenditure for a

vacation, is not an expenditure for medical care. Sec. 1.213-

1(e)(3)(ii), Income Tax Regs. An important condition that must

be satisfied for the claim to succeed is whether the expenditure

would have been made even if there had been no illness. Jacobs

v. Commissioner, 62 T.C. 813, 819 (1974); Lepson v. Commissioner,

T.C. Memo. 1982-304. 

Petitioners introduced a calculation by Mr. Baker for

allocating a portion of the monthly service fees to the cost of

providing the facilities. Mr. Baker applied varying allocation

percentages to gross expense figures from eight different expense

categories to arrive at a total allocation amount. He then

divided this amount by the number of occupied ILUs in 1997 and

1998 to arrive at an allocation amount per residence. 

Petitioners did not explain or introduce credible evidence how

Mr. Baker arrived at the specific allocation percentages for each

expense category or the relevance of those specific categories. 
- 65 -

Although we are permitted in certain circumstances to

estimate a deductible amount, Cohan v. Commissioner, 39 F.2d 540,

543-544 (2d Cir. 1930), we can only do so when the taxpayer

provides evidence sufficient to establish a rational basis upon

which an estimate can be made, Vanicek v. Commissioner, 85 T.C.

731, 743 (1985). In this case, even assuming that all other

requirements for deductibility under section 213 have been

established, petitioners have failed to provide evidence upon

which we can make a rational estimate. Additionally, we note

that the facilities were available for recreational use by

petitioners and their family, and petitioners have failed to

establish what portion of Mr. Baker’s use was for medical

purposes. Accordingly, we hold that petitioners are not entitled

to deductions for Mr. Baker’s use of the pool, spa, and exercise

facilities.

Contentions we have not addressed are moot, irrelevant, or

meritless. To reflect the foregoing,

Decision will be entered

under Rule 155.
- 66 -

APPENDIX

I. 1997

 Total Costs Amount 

Total expenses $16,069,104

Issue cost (98,395)

SNF noncontract patient fees (1,207,747)

ALU noncontract patient fees (80,156)

SCU noncontract patient fees (3,640)

SNF ancillary services, Medicare, and (448,462) 

 HMO billings for noncontract patients

 Total costs 14,230,704

 Medical Expenses Amount 

SNF operating expenses $3,044,041

ALU and SCU operating expenses 929,275

Emergency pull-cord system 87,374

Food service adjustment 482,769

Environmental service adjustment 112,617

Utilities adjustment 81,146

Insurance adjustment 18,234

Interest expense for SNF 479,734

Interest expense for ALU 319,823

Interest expense for SCU 159,991

SNF noncontract patient fees (1,207,747)

ALU noncontract patient fees (80,156)

SCU noncontract patient fees (3,640)

SNF ancillary services, Medicare, and (448,462) 

 HMO billings for noncontract patients

 

 Medical expenses 3,974,999

Medical expenses divided by total costs equals an allocation

percentage of 27.93 percent.

The number of ILU residents was 574 and they paid a total annual

service fee of $7,979,906, or an average of $13,902.

Applying the allocation percentage of 27.93 percent to the

weighted average annual service fee of $13,902 results in a

medical care allocation of $3,883 per resident.
- 67 -

II. 1998

 Total Costs Amount 

Total expenses $16,986,770

Issue cost (107,134)

SNF noncontract patient fees (1,301,382)

ALU noncontract patient fees (104,083)

SCU noncontract patient fees (110,202)

SNF ancillary services, Medicare, and (378,905) 

 HMO billings for noncontract patients

 Total costs 14,985,064

 Medical Expenses Amount 

SNF operating expenses $3,330,031

ALU and SCU operating expenses 1,780,639

Emergency pull-cord system 88,257

Utilities adjustment 103,641

Interest expense for SNF 470,432

Interest expense for ALU 313,778

Interest expense for SCU 313,778

SNF noncontract patient fees (1,301,382)

ALU noncontract patient fees (104,083)

SCU noncontract patient fees (110,202)

SNF ancillary services, Medicare, and (378,905) 

 HMO billings for noncontract patients

 

 Medical expenses 4,505,984

Medical expenses divided by total costs equals an allocation

percentage of 30.07 percent.

The number of ILU residents was 591 and they paid a total annual

service fee of $8,329,241, or an average of $14,093.

Applying the allocation percentage of 30.07 percent to the

weighted average annual service fee of $14,093 results in a

medical care allocation of $4,238 per resident.