76 T.C. 351">*352 In these consolidated cases, respondent determined the following deficiencies in petitioners' Federal income taxes and additions to tax:

1981 U.S. Tax Ct. LEXIS 171">*174 These cases have been consolidated for the purposes of trial, briefing, and opinion. After concessions, two issues remain for our determination: (1) What are the useful lives for depreciation purposes of the components of certain apartment projects owned by limited partnerships in which petitioners are limited partners, and (2) whether various fees paid by petitioners to Financial Management Service or its successors in interest (hereinafter FMS) are deductible under section 212 or 165(c)(2), I.R.C. 1954.

76 T.C. 351">*353 FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts together with the exhibits attached thereto are incorporated herein by this reference.

Petitioners Robert C. Honodel and Claire E. Honodel, husband and wife, resided in Missoula, Mont., at the time of the filing of the petitions herein. They filed joint individual income tax returns with the Internal Revenue Service Center at Ogden, Utah, for the calendar years 1973 and 1975.

Petitioners Lawrence E. Thatcher and Helen F. Thatcher, husband and wife, resided in Salt Lake City, Utah, at the time of the filing of the petition herein. They filed a joint individual income tax1981 U.S. Tax Ct. LEXIS 171">*175 return with the Internal Revenue Service Center at Ogden, Utah, for the calendar year 1973.

Petitioners Ernest M. Bargmeyer and Janice L. Bargmeyer, husband and wife, resided in Missoula, Mont., at the time of the filing of the petition herein. They filed joint individual income tax returns with the Internal Revenue Service Center at Ogden, Utah, for the calendar years 1972 and 1973.

Petitioners Conrad J. Knowles and Concetta Knowles, husband and wife, resided in Salt Lake City, Utah, at the time of the filing of the petition herein. They filed joint individual income tax returns with the Internal Revenue Service Center at Ogden, Utah, for the calendar years 1972 and 1973.

Petitioners Glenn L. Momberger and Nanieve G. Momberger, husband and wife, resided in Salt Lake City, Utah, at the time of the filing of the petition herein. They filed joint individual income tax returns with the Internal Revenue Service Center at Ogden, Utah, for the taxable years 1972 and 1973.

Petitioners R. Duncan Wallace and Patricia F. Wallace, husband and wife, resided in Salt Lake City, Utah, at the time of the filing of the petition herein. They filed joint individual income tax returns with the Internal1981 U.S. Tax Ct. LEXIS 171">*176 Revenue Service Center at Ogden, Utah, for the taxable years 1972 and 1973.

Petitioners Marlan J. Haslam and Patricia L. Haslam, husband and wife, resided in Ogden, Utah, at the time of the filing of the petition herein. They filed joint individual income tax returns with the Internal Revenue Service Center at Ogden, Utah, for the taxable years 1971, 1972, and 1973.

Petitioners William L. Cimino and Joyce Cimino, husband and wife, resided in Missoula, Mont., at the time of the filing of the 76 T.C. 351">*354 petition herein. They filed joint individual income tax returns with the Internal Revenue Service Center at Ogden, Utah, for the taxable years 1972 and 1973.

Petitioners Robert D. Briggs and Joan R. Briggs, husband and wife, resided in Albuquerque, N. Mex., at the time of the filing of the petition herein. They filed joint individual income tax returns with the Internal Revenue Service Center at Ogden, Utah, for the taxable years 1972 and 1973.

Petitioners Claire E. Honodel, Helen F. Thatcher, Janice L. Bargmeyer, Concetta Knowles, Nanieve G. Momberger, Patricia F. Wallace, Patricia L. Haslam, Joyce Cimino, and Joan R. Briggs are parties herein solely by virtue of having filed joint1981 U.S. Tax Ct. LEXIS 171">*177 individual income tax returns with their respective husbands for the years at issue.

Petitioners were limited partners in four limited partnerships. The names of the limited partnerships and the petitioners' respective percentage interests are shown in the following table:

The relevant general partner in each partnership was Spence Clark.

Rancho Fulton (hereinafter Fulton) is a Utah limited partnership which utilizes the cash method of accounting for Federal income tax purposes. Its taxable year is a calendar year. Fulton was formed for the purpose of acquiring, developing, building, and operating a 204-unit apartment complex named Rancho Fulton and located in Sacramento, Calif. On its 1973 Federal partnership income tax return, Fulton claimed a depreciation deduction of $ 224,991 on the apartment complex. Depreciation 76 T.C. 351">*355 was computed on a component basis using useful lives for each component as determined1981 U.S. Tax Ct. LEXIS 171">*178 by its general partners.

Rancho Fulton apartment complex consists of 204 units, situated on 9.5 acres of land, at 1530 Fulton Avenue, Sacramento, Calif. The construction may be described as two-story wood frame with a pitched asbestos shingled roof. The exterior walls are stucco with a wood trim. In the Rancho Fulton apartment complex, there are 52 one-bedroom/one-bath units; 76 two-bedroom/one-bath units; 50 two-bedroom/one-and-one-half-bath units; and 26 three-bedroom/one-and-one-half-bath units. There are four groups of apartment buildings, each with its own laundry facility. In the center of the property is the office, a recreation room, and one conventional-sized pool. Approximately 1.5 open parking places per apartment are provided. The complex also includes a day care center. Each apartment has central air-conditioning and heating, a dishwasher, and a disposal. These units were ready for occupancy in 1973.

Rancho Verde A is a Utah limited partnership which utilized the cash method of accounting for Federal income tax purposes. The taxable year of Rancho Verde A partnership is the calendar year. Rancho Verde B is a Utah limited partnership which also utilized the 1981 U.S. Tax Ct. LEXIS 171">*179 cash method of accounting for Federal income tax purposes. The taxable year of the Rancho Verde B partnership is also the calendar year. Rancho Verde A and Rancho Verde B partnerships (hereinafter collectively called Verde) each were formed for the purpose of acquiring, developing, building, and operating one-half of a 220-unit apartment complex named Rancho Verde and located in Sacramento, Calif. Each partnership claimed depreciation on half of the apartment complex on their 1972 and 1973 Federal partnership income tax returns. Depreciation was calculated on a component basis using useful lives for each component as determined by its general partners. The resulting depreciation deductions taken for the calendar years 1972 and 1973 by Rancho Verde A were $ 98,848 and $ 219,347, respectively, and those taken by Rancho Verde B were $ 86,655 and $ 226,310, respectively.

The parties have stipulated that the useful lives for depreciation purposes as determined by this Court for the components of the Rancho Fulton apartment complex also will be utilized for the Rancho Verde A and Rancho Verde B apartment complex.

College Gardens Utah is a Utah limited partnership which 76 T.C. 351">*356 utilizes1981 U.S. Tax Ct. LEXIS 171">*180 the accrual method of accounting for Federal income tax purposes. The taxable year of the partnership is the calendar year. College Gardens II is a California limited partnership which utilizes the accrual method of accounting for Federal income tax purposes. The taxable year of the partnership is the calendar year. College Gardens Utah is a limited partner in College Gardens II, owning approximately a 98-percent interest in the capital and profits and losses therein.

College Gardens II was formed for the purpose of acquiring, developing, building, and operating a 200-unit apartment project in Sacramento, Calif., under the federally subsidized assistance program implemented by section 236 of Title II of the National Housing Act (12 U.S.C. sec. 1715z-1). On its 1973 Federal partnership income tax return, College Gardens II claimed a depreciation deduction of $ 98,884 on the apartment complex computed on a component basis using useful lives for each component as determined by its general partners.

There are 200 units included in the College Gardens II apartment complex. They are situated on approximately 9.6 acres of an irregular "L"-shaped1981 U.S. Tax Ct. LEXIS 171">*181 parcel of land. The units are two-story wood framed structures with a plywood panel exterior. There are 80 one-bedroom/one-bath units and 120 two-bedroom/one-bath units in the project. The apartments are available for rental to anyone who qualifies to live in the subsidized low-income housing. To qualify, prospective tenants must have incomes within certain prescribed guidelines. There are 1.5 open parking spaces per apartment. Each unit also has an electric wall air-conditioner.

Respondent determined in his notices of deficiency, all dated in January 1978, except in docket No. 4522-79 where the notice was dated March 6, 1979, issued to the respective petitioners, that the useful lives of the component structures of rental apartment buildings owned by the subject partnerships were understated, thereby resulting in an overstatement of depreciation expense. Accordingly, the partnership losses in the years at issue were decreased by respondent as were the petitioners' proportionate shares of such losses.

During the years at issue, petitioners were clients of FMS. FMS was formed by Spence Clark in 1967 for the purpose of providing financial management, investment, and tax analysis1981 U.S. Tax Ct. LEXIS 171">*182 76 T.C. 351">*357 and advice to its clients. It presently has approximately 300 clients. It has been remarkably successful.

In the subject years, FMS provided a full range of investment advisory services with the emphasis on real estate investments. The goal was to minimize a client's income taxes while enhancing and enlarging his estate. New clients generally were obtained through referrals from existing clients. Initially, they attended financial investment planning sessions. These planning sessions were designed (1) to familiarize the client with FMS and its various services, (2) to analyze in detail the client's existing financial position, (3) to determine the client's personal and financial objectives, and (4) to recommend an investment and financial approach in light of those objectives.

Once these initial planning sessions were completed and the client agreed to commit himself to an investment program with FMS, the client's name was placed on an investment waiting list. The waiting list also stated each client's available capital and tax shelter needs. The waiting list priority was based upon the seniority or chronology of each client's investment commitment. If a client 1981 U.S. Tax Ct. LEXIS 171">*183 thereafter refused to invest in investments recommended by FMS, FMS would not keep that person as a client.

Each client's financial position, needs, and objectives were reviewed and updated in periodic (at least annual) planning sessions. The results of these sessions were reflected in the investment waiting list.

During the years in question, acceptable investment projects came about through a long and arduous process, sometimes lasting several years. FMS developed business relationships with professional brokers who located potential real estate and other investments throughout the country and thereafter presented such investments to FMS for its analysis. If the investment was purchased by FMS, the broker was paid a finder's fee either by FMS or the seller.

FMS analyzed between 30 and 50 projects in the years at issue in order to unearth the projects that it chose to recommend to petitioners. The investment research and analysis involved in evaluating these projects included: (1) Market, location, and competition analysis, (2) cost flow analysis, (3) depreciation analysis, (4) tax shelter analysis, (5) investment return analysis, and (6) legal analysis. Such evaluations involved1981 U.S. Tax Ct. LEXIS 171">*184 devoting varying degrees of time and energy by FMS depending on the 76 T.C. 351">*358 nature and characteristics of the individual investment opportunities. On a few occasions during the subject years, rejected projects demanded inordinate amounts of time and energy, exceeding that expended on the projects which came to fruition. Other less promising projects might have been rejected following a cursory examination.

Once accepted by FMS, investment projects were recommended to petitioners according to the waiting list priority. None of the petitioners refused to invest in projects recommended to them by FMS although the option to refuse was available. Projects rejected by FMS were not presented to or discussed with clients.

A client's investment in these recommended projects was generally evidenced by a limited partnership interest. Investors were required to make capital contributions to the limited partnership exclusive of the investment fees paid to FMS.

During the years in issue, FMS engaged outside counsel to negotiate the acquisition of investments and to prepare the various legal and other documents necessary to consummate their purchase. Outside counsel also drafted and prepared1981 U.S. Tax Ct. LEXIS 171">*185 partnership agreements and other documents necessary to create the limited partnerships, the investment vehicle generally selected by FMS to hold title to its investment projects. Further, outside counsel regularly rendered legal and tax advice to FMS on miscellaneous matters relating to accepted and rejected investments and other issues concerning its clients.

Besides engaging outside assistance, FMS was also extensively involved in the acquisition phase of an accepted project. Its efforts included supervision and review of outside counsel and their work product, negotiation of terms of purchase and assistance, and participation at closing.

Petitioners invested in the subject limited partnerships, created at the direction of FMS, primarily for appreciation and "tax shelter" potential. The intent of FMS and petitioners was to sell each investment project when the desired tax benefits were no longer present. At the time of purchase, FMS and petitioners expected the investment properties to sell for at least their original cost basis.

The fee schedule used by FMS in the years at issue had two components: (1) An investment fee component and (2) a monthly retainer component. The 1981 U.S. Tax Ct. LEXIS 171">*186 investment fee was a flat fee representing 76 T.C. 351">*359 a specific percentage of the total cost of a project. A portion of this fee was charged to each of the investors in a particular project including Spence Clark and the petitioners herein. Each paid an amount that varied according to his respective ownership interest. The amount of this flat fee was arrived at by FMS based in part upon the time and effort, the degree of difficulty, and the extensiveness of the evaluation required in analyzing the purchased investment, as well as numerous other projects which were rejected prior thereto. Some of the time and effort spent by FMS and considered in the calculation of this flat fee occurred before some of the petitioners became clients of FMS.

FMS also charged petitioners nonrefundable monthly retainer fees ranging from $ 300 to $ 1,500 per month. The magnitude of these monthly fees depended upon both the individual petitioner's income level and his financial planning, tax advice, and investment needs. At least with respect to one petitioner, the monthly retainer fees were waived for a particular year because he made substantial investments in projects recommended by FMS in that 1981 U.S. Tax Ct. LEXIS 171">*187 year.

In the years at issue, FMS did not maintain detailed records summarizing the potential investments which were analyzed, the time and effort expended on such investments, and the time and effort expended directly on each individual.

The fees charged by FMS were paid in cash by each of the petitioners and were deducted on their 1971, 1972, and 1973 returns as follows:

1981 U.S. Tax Ct. LEXIS 171">*188 76 T.C. 351">*360 In addition, on its 1973 Federal partnership income tax return, the College Gardens Utah partnership deducted an investment fee in the amount of $ 86,456 paid to FMS. Only $ 61,456 of this amount is at issue herein because petitioners have conceded that $ 25,000 is a nondeductible capital expenditure. The parties have stipulated that the fee paid by the partnership shall be treated as though each partner paid his ratable share of this amount directly.

Respondent disallowed these deductions because petitioners allegedly failed to establish that the payments represent valid business expenses or were incurred for the management, conservation, or maintenance of property held for the production of income or in connection with the determination, collection or refund of any tax.

OPINION

We are called upon to decide, for depreciation purposes, the useful lives of various components of the Rancho Fulton, Rancho Verde, and College Gardens II apartment complexes. This issue is inherently one of fact, and the burden rests with petitioners to prove that respondent's determination of the useful lives of the various components is erroneous. Casey v. Commissioner, 38 T.C. 357">38 T.C. 357, 38 T.C. 357">38176 T.C. 351">*361 (1962).1981 U.S. Tax Ct. LEXIS 171">*189 The parties have agreed that the component useful lives determined by this Court for the Rancho Fulton apartment complex will also be utilized for the Rancho Verde apartment complex.

Section 167 states, in pertinent part, as follows:

(a) General Rule. -- There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) --

(1) of property used in the trade or business, or

(2) of property held for the production of income.