110 T.C. No. 8



                UNITED STATES TAX COURT



          FOOTHILL RANCH COMPANY PARTNERSHIP,
BUCK EQUITIES, LTD., TAX MATTERS PARTNER, Petitioner v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 26341-95.                    Filed February 9, 1998.

     P is the tax matters partner of a partnership
comprised of four other partners. Two of the
partnership's partners are partnerships. P filed a
motion for reasonable litigation costs pursuant to sec.
7430, I.R.C., and contended that R was not
substantially justified in determining that petitioner
was not entitled, pursuant to sec. 460, I.R.C., to use
the percentage of completion method of accounting.
     1. Held: R's position, relating to whether P was
entitled to use PCM, was not substantially justified.
     2. Held, further, first-tier partners that meet
the net worth requirements of sec. 7430, I.R.C., are
eligible to receive an award.
     3. Held, further, a partner in a TEFRA
partnership proceeding may receive an award for
litigation costs that are paid or incurred by the
partnership only to the extent such fees are allocable
to that partner.
                               - 2 -

          4. Held, further, the amount sought by P for
     litigation costs is not reasonable and is adjusted
     accordingly.



     Michael S. Harms and McGee Grigsby, for petitioner.

     William H. Quealy, Jr. and Paul B. Burns, for respondent.



                              OPINION


     FOLEY, Judge:   This matter is before the Court on

petitioner's motion for an award of litigation costs pursuant to

section 7430 and Rule 231.   Unless otherwise indicated, all

section references are to the Internal Revenue Code in effect for

the year in issue, and all Rule references are to the Tax Court

Rules of Practice and Procedure.

                             Background

     In early 1987, Laguna Niguel Properties, a Delaware

corporation, purchased the Whiting Ranch, a parcel of

approximately 2,743 acres of undeveloped land.   Laguna

subsequently exchanged the Whiting Ranch for an interest in

Foothill Ranch Company Partnership (FRC), a California limited

partnership.

     In March of 1988, FRC and Orange County, California,

executed an agreement that provided: (1) FRC would be allowed to

build housing units on the Whiting Ranch; (2) FRC would construct

a library, a school, roads, water and sewer lines, and other
                                - 3 -

improvements; and (3) the county would incrementally issue FRC

permits to construct housing units as FRC fulfilled its

obligation to construct the aforementioned buildings and

improvements.

     In May of 1988, FRC executed separate agreements, with Lyon

Communities, Inc. (Lyon), and P.B. Partners (Partners), to sell

each of them a large parcel of the Whiting Ranch.    Lyon and

Partners entered into their respective agreements with the

intention to develop each of their parcels.    To ensure that the

county would issue the construction permits necessary for such

development, each sales agreement provided that FRC would fulfill

its construction obligations to the county.    The sales agreements

also imposed on FRC construction obligations that were unrelated

to its obligations to the county (e.g., the construction of

affordable housing units).    In addition, the sales agreements

provided that Lyon and Partners would perform some of the

construction required pursuant to FRC's obligations to the

county.

     By the end of FRC's 1988 tax year, FRC had not completed its

construction obligations.    On its 1988 Form 1065 (U.S.

Partnership Return of Income), which was filed on October 16,

1989, FRC used the percentage of completion method of accounting

(PCM) to calculate the income attributable to its property

transactions with Lyon and Partners.    On September 28, 1995,
                                 - 4 -

respondent mailed FRC a Notice of Final Partnership

Administrative Adjustment (FPAA).    In the notice, respondent

determined that FRC could not use PCM to calculate the income

attributable to the aforementioned property transactions and that

FRC underreported its gross receipts by $90,801,873.

     On December 18, 1995, Hon Property Investments, Inc., on

behalf of FRC, filed a petition.    On the date the petition was

filed, FRC was comprised of Hon Property Investments, Inc., Hon

Family Trust, Hon Family Ventures, Ltd., Hon Irrevocable Income

Trust, and Buck Equities, Ltd.    On February 16, 1996, respondent,

contending that Hon Property Investments, Inc., was not FRC's tax

matters partner, filed a motion to dismiss for lack of

jurisdiction.   FRC subsequently amended the petition to list Buck

Equities, Ltd., as the tax matters partner, and on September 17,

1996, we denied respondent's motion.     On November 4, 1996,

respondent filed his answer.

     Petitioner on January 30, 1997, filed a motion for summary

judgment contending that, pursuant to section 6229(a), the 3-year

period of limitations on assessment was applicable and this

period had expired before respondent issued the FPAA.     The

parties subsequently settled the case and filed a stipulation,

which made no adjustments to FRC's reported income.     Petitioner,

on June 10, 1997, filed its motion for litigation costs.

                            Discussion
                                - 5 -

      Pursuant to section 7430, we may award reasonable litigation

and administrative costs to a prevailing party in any tax

proceeding with the United States.      Litigation costs will not be

awarded unless the prevailing party establishes that it exhausted

its administrative remedies.    Sec. 7430(b)(1).   In addition, the

prevailing party may not receive an award relating to any portion

of the proceedings that such party unreasonably protracted.      Sec.

7430(b)(4).    Respondent concedes that petitioner has exhausted

its administrative remedies, but contends that petitioner has

failed to establish:    (1) It was a prevailing party; (2) it did

not unreasonably protract this proceeding; and (3) its litigation

costs were reasonable.

I.   Prevailing Party

      To be a "prevailing party", a party in the proceeding must:

(1) Establish that the position of the United States was not

substantially justified; (2) substantially prevail in the

controversy; and (3) meet the net worth and number of employees

requirements (net worth requirements) of the Equal Access to

Justice Act (EAJA), 28 U.S.C. sec. 2412(d)(2)(B) (1994).     Sec.

7430(c)(4)(A).    Respondent concedes that petitioner has

substantially prevailed in this controversy, but contends that

petitioner has failed to satisfy the remaining requirements.

      A.   Substantial Justification

      Respondent's positions are substantially justified only if

they have a reasonable basis in law and fact.      Norgaard v.
                                - 6 -

Commissioner, 

, 881 (9th Cir. 1991), affg. in part

and revg. in part T.C. Memo. 1989-390.    The justification for

each of respondent's positions must be independently determined.

See, e.g., Powers v. Commissioner, 

, 35 (5th Cir.

1995); Swanson v. Commissioner, 

, 92, 97 (1996).

     During the course of this proceeding, respondent contended:

(1) The petition was defective because it did not designate the

proper tax matters partner; (2) the period of limitations on

assessment had not expired; and (3) petitioner was not entitled

to use PCM to report its income.   Petitioner does not challenge

respondent's position relating to the tax matters partner and

period of limitations issues.   As a result, petitioner is not

entitled to fees relating to those issues.    Petitioner contends,

however, that respondent's position, regarding the PCM issue, was

not substantially justified.

     Section 460(a) requires taxpayers to use PCM to report

income from any long-term contract.     A long-term contract is "any

contract for the manufacture, building, installation, or

construction of property if such contract is not completed within

the taxable year in which such contract is entered into."    Sec.

460(f)(1).   Notice 89-15, 1989-1 C.B. 634, provides additional

guidance regarding the definition of a long-term contract.    The

notice provides, in pertinent part, that a long-term contract

includes "any contract for the production or installation of real

property or any improvements to real property", if the contract
                               - 7 -

is not completed within the taxable year in which it is entered

into.   Notice 89-15, Q&A-2, 1989-1 C.B. 634.   The notice further

provides that a contract for the sale of property may be a long-

term contract if the "building, installation, or construction of

the subject matter of the contract is necessary in order for the

taxpayer's contractual obligations to be fulfilled".     Notice 89-

15, Q&A-4, 1989-1 C.B. 634.

     Petitioner's sales agreements required the construction of

buildings and improvements to real property.    Nevertheless,

respondent, relying on Notice 89-15, Q&A-4, 1989-1 C.B. 634,

contended that the agreements were not long-term contracts

because the sale of the parcels, rather than construction of

buildings and improvements, was the "primary subject matter" of

the agreements.

     Contrary to respondent's contention, the construction of

buildings or improvements to real property need not be the

primary subject matter of the contract.   Rather, such

construction need only be necessary to fulfill the taxpayer's

contractual obligation.   Pursuant to the sales agreements, FRC

was obligated to construct buildings and improvements relating to

the Whiting Ranch.   Moreover, Lyon's and Partners' rights to

develop their land were limited until these obligations were

fulfilled (i.e., the county would incrementally issue

construction permits as the obligations were fulfilled).    In

addition, the sales agreements imposed on FRC construction
                                  - 8 -

obligations that were unrelated to its obligations to the county

(e.g., the construction of affordable housing units).       As a

result, the construction of buildings and improvements to real

property was necessary to fulfill FRC's obligations under the

sales agreements, and these obligations were not completed within

the 1988 tax year.      Accordingly, we conclude that respondent's

position relating to this issue was not substantially justified.

       B.   Net Worth

       To be a "prevailing party", a party must meet EAJA's net

worth requirements.      Sec. 7430(c)(4)(A)(iii).   Specifically, a

party that is a corporation or partnership may not have a net

worth of more than $7,000,000 or more than 500 employees.       EAJA,

28 U.S.C. sec. 2412(d)(2)(B) (1994).      Petitioner and respondent

have differing views regarding who must meet the net worth

requirements.     We reject both parties' contentions.

       Petitioner contends that we must look to the partnership

entity, FRC, to determine whether the net worth requirements are

met.    This partnership proceeding, however, is governed by the

procedural rules of the Tax Equity and Fiscal Responsibility Act

of 1982 (TEFRA), Pub. L. 97-248, sec. 402(a), 96 Stat. 324, 648,

codified as secs. 6221-6233.      The partners, rather than the

partnership entity, are the parties in a TEFRA proceeding.         See

secs. 6226(c), 6228(a)(4); Rule 247; Chef's Choice Produce, Ltd.

v. Commissioner, 

, 395 (1990); see also Southwest

Marine, Inc. v. United States, 

 (9th Cir. 1994)
                                - 9 -

(holding that a nonparty could not be a "prevailing party" under

EAJA).

     Respondent contends that only those persons or entities

whose tax liabilities are affected by the outcome of the

proceeding are eligible to receive an award.   Because petitioner

and Hon Family Ventures, Ltd., are pass-through entities,

respondent contends that the Court should require petitioner's

and Hon Family Ventures, Ltd.'s partners to establish that they

meet the net worth requirements.   Respondent further contends

that if petitioner's and Hon Family Ventures, Ltd.'s partners are

pass-through entities, the "look-through" process must continue

until it reaches a person or entity whose tax liability is

affected by the outcome of the proceeding.   Respondent's proposed

"look-through rule", however, contradicts the congressional

determination that a partnership may receive litigation costs.

EAJA, 28 U.S.C. sec. 2412(d)(2)(B) (1994) (stating that a party

includes "any partnership" that meets the net worth and number of

employee requirements).

     Pursuant to EAJA and the TEFRA partnership rules, we hold

that first-tier partners that meet the net worth requirements are

eligible to receive an award.   Petitioner, Hon Family Ventures,

Ltd., and Hon Property Investments, Inc., have established that

they meet the net worth requirements.   Accordingly, they are

prevailing parties.   No evidence has been submitted relating to

the net worth of either Hon Family Trust or Hon Irrevocable
                                - 10 -

Income Trust and, as a result, they have not met the net worth

requirements.    We note that the presence of ineligible partners

does not preclude the eligible partners, petitioner, Hon Family

Ventures, Ltd., and Hon Property Investments Inc., from receiving

an award.    See, e.g., Sierra Club v. United States Army Corps. of

Engrs., 

, 393-394 (2d Cir. 1985) (concluding that the

presence of 1 ineligible party did not prevent 11 eligible

parties from receiving an award).

II.    Unreasonable Protraction of Proceeding

       Costs may not be awarded for any portion of the proceeding

which the prevailing party "unreasonably protracted".       Sec.

7430(b)(4).     Respondent contends that petitioner unreasonably

protracted this proceeding by failing to select properly a tax

matters partner and, therefore, the costs relating to the

preparation of petitioner's objection to respondent's motion to

dismiss should be denied.     Respondent's contention is moot

because we have already concluded that petitioner may not recover

costs relating to the tax matters partner issue.

III.    Determination of Reasonable Costs

       Petitioner claims litigation costs totaling $224,816.

Petitioner is only entitled to these costs, however, if such

costs were both incurred and reasonable.     Sec. 7430(a)(2).

       A.   Costs Incurred

       A party's award for litigation costs is limited to the costs

that the party actually paid or incurred.       Frisch v.
                               - 11 -

Commissioner, 

, 846 (1986); Thompson v. Commissioner,

T.C. Memo. 1996-468.   FRC paid all the litigation costs in issue.

We conclude that a first-tier partner of FRC may receive an award

for such costs only to the extent they were allocated (e.g.,

under the partnership agreement) to that partner.       The costs paid

by FRC were allocated to petitioner, Hon Family Ventures, Ltd.,

and Hon Property Investments, Inc., as follows:

                                 1995            1996             1997

Petitioner                    25.00%            19.88%            1%
Hon Family Ventures, Ltd.     23.08             25.36             3
Hon Property Investments, Inc. .52                .35             --

Therefore, petitioner, Hon Family Ventures, Ltd., and Hon

Property Investments, Inc., are eligible to receive an award for

costs to the extent of their allocable share in FRC during the

year in which the costs were paid.

     B.   Reasonable Costs

           1.   Services of an Attorney

     Section 7430(c)(1) defines reasonable litigation costs as

reasonable fees paid or incurred for the services of attorneys in

connection with the court proceeding.     Section 7430(c)(3)

provides that fees for the services of an individual (whether or

not an attorney) who is authorized to practice before the Court

or IRS shall be treated as fees for the services of an attorney

for purposes of section 7430(c)(1).     See Cozean v. Commissioner,

, 234 (1997) (allowing litigation costs attributable

to services performed by accountants).     We have also allowed
                              - 12 -

costs attributable to services performed by individuals (e.g.,

paralegals and law clerks) under the supervision of someone who

was authorized to practice before the Court or IRS.   See, e.g.,

Powers v. Commissioner, 

, 492-493 (1993), affd. in

part, revd. in part and remanded 

 (5th Cir. 1995).

The costs claimed by petitioner are attributable to services

performed by individuals who meet these requirements.

Accordingly, petitioner is eligible to receive an award for such

costs.

          2.   Reasonable Fees

     Section 7430(c)(1)(B)(iii) limits the hourly rate for

attorney's fees to $75, with allowance for a higher rate for

increases in the cost of living and other special factors (e.g.,

the limited availability of qualified attorneys).

               a.   Special Factors

     Petitioner contends that it is entitled to fees in excess of

the statutory rate because (1) petitioner's advisers had special

expertise in real estate and tax law, and (2) the prevailing rate

in the Los Angeles area exceeds $75.   To qualify for a higher

statutory rate, the attorney must have tax expertise that is

necessary for the litigation in question.   Pierce v. Underwood,

, 572 (1988); Huffman v. Commissioner, 

,

1149-1150 (9th Cir. 1992), affg. in part and revg. in part T.C.

Memo. 1991-144; Powers v. Commissioner, 100 T.C. at 489.

Petitioner has failed to meet this standard.   In addition, the
                                - 13 -

prevailing hourly rates in the relevant area are not a special

factor.   Pierce v. Underwood, supra at 571-572; Powers v.

Commissioner, 100 T.C. at 489.     Therefore, we conclude that

petitioner is not entitled to fees in excess of the statutory

rate (i.e., as adjusted by increases in the cost of living) and

award petitioner attorney's fees at an hourly rate of $104.29 for

1995, $107.37 for 1996, and $109.83 for 1997.    See Huffman v.

Commissioner, supra at 1151 (stating that 1986 is the appropriate

base year for calculating cost of living increases); Galedrige

Constr., Inc. v. Commissioner, T.C. Memo. 1997-485 (providing the

rates for 1995, 1996, and 1997).




                b.    Apportioning and Awarding the Fees and Costs

     Petitioner requests an award for 848.5 hours in fees and

$4,844.65 in costs.    Because petitioner failed to challenge

respondent's position relating to the tax matters partner or the

period of assessment, petitioner may not receive an award for the

231.2 hours that are attributable to those issues.    Therefore,

petitioner is eligible to receive an award of fees based on 617.3

hours (i.e., 95.6 hours in 1995, 225.2 hours in 1996, and 296.5

hours in 1997) and $4,844.65 (paid in 1997) in costs.

     Accordingly, petitioner is entitled to an award of $7,674;

Hon Family Ventures, Ltd., is entitled to an award of $9,555; and
                               - 14 -

Hon Property Investments, Inc., is entitled to an award of $137

for litigation costs.1

     All other arguments made by the parties are either

irrelevant or without merit.

     To reflect the foregoing,


                                      An appropriate order and

                                 decision will be entered.




     1
        The awards are determined pursuant to the following
formula: (1995 partnership allocation x (1995 hours x 1995
rate)) + (1996 partnership allocation x (1996 hours x 1996 rate))
+ (1997 partnership allocation x (1997 hours x 1997 rate) + (1997
allocation x costs) = total award. Thus, the parties' awards
were as follows: (1) Petitioner = (.25 x (95.6 x 104.29)) +
(.1988 x (225.2 x 107.37)) + (.01 x (296.5 x 109.83)) + (.01 x
4,844.65)); (2) Hon Family Ventures, Ltd. = (.2308 x (95.6 x
104.29)) + (.2536 x (225.2 x 107.37)) + (.03 x (296.5 x 109.83))
+ (.03 x 4,844.65)); and (3) Hon Property Investments, Inc. =
(.0052 x (95.6 x 104.29)) + (.0035 x (225.2 x 107.37)). All
totals are rounded to the nearest dollar.