T.C. Summary Opinion 2008-130



                      UNITED STATES TAX COURT



          STEVEN AND MARGUERITE KROFF, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 5511-07S.                Filed October 14, 2008.



     Steven and Marguerite Kroff, pro se.

     Brooke S. Laurie, for respondent.



     GOEKE, Judge:   This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect

at the time the petition was filed.1   Pursuant to section

7463(b), the decision to be entered is not reviewable by any



     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year at issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                                - 2 -

other court, and this opinion shall not be treated as precedent

for any other case.

     Respondent determined a $16,606 deficiency in petitioners’

Federal income tax and a $3,321.20 accuracy-related penalty under

section 6662(a) for 2002.   The issues for decision are:

     (1)   Whether petitioners are entitled to claim a deduction

for business worthless debts in the amount of $550,317.      We hold

that they may not, but that they may treat $150,000 of

nonbusiness worthless debts as a short-term capital loss;

     (2)   whether petitioners may claim miscellaneous itemized

deductions in an amount above that allowed by respondent.      We

hold that petitioners may claim $23,776 of miscellaneous itemized

deductions related to tax preparation and petitioner Steven

Kroff’s (petitioner) lending activities;

     (3)   whether petitioners are liable for an accuracy-related

penalty under section 6662.    We hold that they are not.

                              Background

     Some facts have been stipulated and are so found.      The

stipulated facts and the accompanying exhibits are incorporated

herein by this reference.   Petitioners resided in California at

the time they filed their petition.

     In 2002 petitioner was engaged in rental and lending

activities.   Petitioner conducted these activities through his

sole proprietorship, Professional Service Co.    Petitioner spent
                               - 3 -

approximately 750 hours or less working on his rental activity

during 2002.

      Respondent sent petitioners a statutory notice of deficiency

dated December 5, 2006, for the 2002 tax year.

I.   Business Worthless Debt

      On their joint Form 1040, U.S. Individual Income Tax Return,

petitioners claimed a loss of $550,317 as “Other income”, mostly

attributable to business bad debts owed by the following debtors:

                          Debtor            Debt
                Mr. Murray                 $90,000
                Mr. Bettencourt            150,000
                Mr. Whalen (Whalen I)      184,440
                Mr. Whalen (Whalen II)     125,975
                  Total                    550,415

The difference between the amount of bad debts and the amount

claimed as a loss is attributable to $98 of other income, prizes,

awards, etc., that petitioners reported on the same statement on

which they reported their business bad debt losses.    Respondent

disallowed the entire $550,415 of business bad debt losses and

also reduced petitioners’ other income by $98.     Petitioners also

reported $81,312 of taxable interest income, of which $68,658 was

attributable to interest from loans to individuals in 2002.    This

was petitioners’ most significant source of income for the year.
                                 - 4 -

     A.   Murray Debt

     Petitioner met Mr. Murray through his former employment as

an automobile salesman.    Petitioner loaned $90,000 to Mr. Murray

on or about October 1, 1998.    According to the promissory note,

Mr. Murray agreed to repay petitioner the entire $90,000 in one

lump-sum payment on December 31, 1999, as well as 10-percent

interest on the unpaid balance annually commencing on December

31, 1998.

     On January 27, 2000, petitioner sent a notice of default to

Mr. Murray demanding full payment and all interest.    According to

the notice of default, Mr. Murray owed $9,000 of interest, plus

additional interest accruing from January 1, 2000.

     On April 17, 2000, petitioner obtained a judgment against

Mr. Murray in the amount of $101,675 in the District Court of

Clark County, Nevada.    The judgment included the $90,000

principal and $11,675 in interest.

     On June 6, 2000, Mr. Murray filed a chapter 7 voluntary

petition for bankruptcy.     On September 18, 2000, the bankruptcy

court issued a discharge of debtor for Mr. Murray.

     B.   Bettencourt Debt

     Petitioner also met Mr. Bettencourt while working as an

automobile salesman.    Petitioner loaned $150,000 to Mr.

Bettencourt in 1997 or 1998.    Mr. Bettencourt agreed to repay the

principal, plus a fee of $7,500 for services, on July 28, 1999.
                                 - 5 -

     Mr. Bettencourt and his wife filed a chapter 7 voluntary

petition for bankruptcy on November 7, 2003.     The bankruptcy

court ordered a discharge of debtor for Mr. Bettencourt and his

wife on February 9, 2004.

     C.     Whalen Debts

     Petitioner met Mr. Whalen through a real estate broker.

Petitioners claimed a bad business debt deduction of $184,440

attributable to four loans that petitioner made to Mr. Whalen in

the following amounts:     $107,000 on August 5, 1997; $8,000 on

June 1, 1998; $12,000 on September 1, 1998; and $106,400 on

January 13, 1999 (Whalen I debt).     The annual interest rate on

these loans ranged from 16 to 20 percent.     Mr. Whalen repaid at

least $40,061 of principal on the $107,000 loan as of January 5,

2000.     Petitioner was unable to establish to which loans the

remaining $8,899 of payments were attributable.

     Petitioners also claimed a $125,975 bad business debt

attributable to a promissory note Mr. Whalen signed on June 26,

1999, related to petitioner and Mr. Whalen’s hay business (Whalen

II debt).     In 1997 petitioner and Mr. Whalen planned to buy hay

in the spring and sell it in the future at a profit.     Petitioner

paid money to Mr. Whalen and other hay dealers for hay purchased

in 1997 as well as equipment to be used in the hay business.

Petitioner claims he paid approximately $286,912.28 for hay and

$39,766.80 for other items related to the hay business.     However,
                                 - 6 -

the hay petitioner purchased in 1997 was destroyed by a flood,

making it unusable for resale.    On June 26, 1999, petitioner and

Mr. Whalen signed a promissory note whereby Mr. Whalen agreed to

pay petitioner $125,975.27 for the destroyed hay on March 1,

2000, plus monthly interest payments.    By March 20, 2000, Mr.

Whalen owed petitioner $136,031 on this note.

     On March 20, 2000, Mr. Whalen filed a voluntary petition for

relief under chapter 11 of the Bankruptcy Code.    Mr. Whalen’s

bankruptcy estate objected to petitioner’s claim in the amount of

$136,031 for the Whalen II debt.    The bankruptcy estate argued

that petitioner did not provide Mr. Whalen with any additional

consideration for the promissory note but required Mr. Whalen to

sign the note by threatening to enforce an earlier loan not

before the Court.

     On March 14, 2001, the bankruptcy court ordered a discharge

of debtor for Mr. Whalen.

     The bankruptcy estate brought a suit against petitioner

alleging that:   (1) Petitioner’s loans to Mr. Whalen were

usurious; (2) petitioner had received fraudulent conveyances; (3)

the Whalen II loan was fraudulent; and (4) petitioner

deliberately defaulted on a bank loan that petitioner and/or Mr.

Whalen had taken out as part of the hay business.    The bankruptcy

estate estimated that $63,319 of the payments from Mr. Whalen to

petitioner were fraudulent conveyances which the bankruptcy
                               - 7 -

estate would attempt to recover.   Because the bankruptcy estate

was forced to repay a loan from South Valley National Bank (SVNB)

that petitioner failed to pay related to the hay business, the

bankruptcy estate would be subrogated to the bank’s rights

against petitioner, which was estimated to be about $60,000.

      On June 5, 2001, petitioner and the bankruptcy estate

entered into an agreement whereby petitioner would cancel the

four promissory notes included in the Whalen I debt and pay Mr.

Whalen’s bankruptcy estate $40,000 for release of the usury and

attorneys’ fee claims.   According to a joint motion filed with

the bankruptcy court for approval of the settlement agreement, at

the time of the settlement Mr. Whalen had repaid $114,792 of the

$233,400 that he borrowed from petitioner.   Mr. Whalen repaid

$60,169 of this amount within a year of filing for bankruptcy.

Petitioner paid the bankruptcy estate $40,000 on August 21, 2001,

to settle the claims for usury and the related attorneys’ fees.

Petitioner paid an additional $87,538.05 to the bankruptcy estate

on or before November 19, 2002, in connection with the

subrogation claim and related attorneys’ fees.

II.   Miscellaneous Itemized Deductions

      Petitioners claimed on their Schedule A, Itemized

Deductions, $108,045 of miscellaneous itemized deductions. In the

notice of deficiency, respondent disallowed $101,869 of the

claimed miscellaneous itemized deductions.   Respondent did not
                                  - 8 -

specify which expenses were included in the $6,176 deduction that

he allowed.

       Petitioners deducted a $25,000 passive activity loss on

their Schedule E, Supplemental Income and Loss, for 2002, which

is the maximum amount allowed for passive rental real estate

activities under section 469(a) and (i).

       Petitioners claimed $300 of tax preparation expenses and

$1,263 of depreciation expenses.     In addition, petitioners

claimed as expenses related to lending activities:      (1) $2,447

of dues and subscription expenses; (2) $3,335 of office supplies

and postage expenses; (3) $3,573 of telephone expenses; (4)

$1,789 of furniture expenses; and (5) $87,538 as expenses

incurred in connection with the settlement of Mr. Whalen’s

bankruptcy estate’s subrogation claim.     Petitioners also claimed

$7,718 of automobile expenses related to rental activities.

III.    Computational Adjustments

       If we sustain respondent’s adjustments, there may be

corresponding computational adjustments to petitioner’s Social

Security income, medical expense deduction, and charitable

contribution deduction.    These adjustments will be addressed in a

Rule 155 computation and need not be discussed in this opinion.

IV.    Accuracy-Related Penalty

       Respondent determined that petitioner was liable for an

accuracy-related penalty of $3,321.20 under section 6662.
                                 - 9 -

                               Discussion

      Deductions are a matter of legislative grace, and taxpayers

bear the burden of proving entitlement to the deductions claimed.

Rule 142(a); Welch v. Helvering, 

, 115 (1933).

Petitioners do not allege, nor do we find, that section 7491(a)

applies.

I.   Business Worthless Debt

      Petitioners claim that they are entitled to a deduction of

$550,317 for business worthless debt.

      Section 166(a) allows a deduction for any business debt that

becomes worthless during the taxable year.     A nonbusiness debt of

an individual that becomes wholly worthless during the year is

not deductible under section 166(a) but is instead treated as a

short-term capital loss.   Sec. 166(d)(1); sec. 1.166-5(a)(2),

Income Tax Regs.

      A business debt is either (1) a debt created or acquired in

connection with a trade or business of the taxpayer, or (2) a

debt the loss from the worthlessness of which is incurred in the

taxpayer’s trade or business.     Sec. 166(d)(2).

      Respondent argues that petitioners are not entitled to a

business bad debt deduction because they have not shown that:

(1) A debt was owed; (2) the debts became worthless in 2002; (3)

the debts were business debts; or (4) petitioners are entitled to

claim the face value of the promissory notes as a deduction.
                               - 10 -

     In order to prove that petitioners are entitled to a

deduction under section 166(a), they must show that the

deductions relate to a bona fide debt, which is defined as “a

debt which arises from a debtor-creditor relationship based upon

a valid and enforceable obligation to pay a fixed or determinable

sum of money.”   Sec. 1.166-1(c), Income Tax Regs.

     We have found that the Murray, Bettencourt, and Whalen I

debts were valid debts.   However, we find that a debtor-creditor

relationship did not exist between petitioner and Mr. Whalen at

the time that the Whalen II promissory note was signed.     There is

no evidence that petitioner loaned Mr. Whalen $125,975 with the

intent that Mr. Whalen would repay that amount plus interest.

The evidence shows that petitioner and Mr. Whalen were in a

business relationship in order to make a profit from an

investment in hay, and petitioner invested money in the business

to purchase hay and supplies to be used in that business.

Petitioner intended to earn a profit from sales of hay, not from

interest on a loan.    Mr. Whalen signed the promissory note 2

years after the hay had been purchased and destroyed, suggesting

that Mr. Whalen did not sign the promissory note for the purpose

of receiving a loan.   Therefore, we find that petitioner is not

entitled to a bad debt deduction for the Whalen II debt.

     We find that the Bettencourt debt became worthless in 2002.

Debts are worthless when the taxpayer has no reasonable
                                - 11 -

expectation of repayment.     Crown v. Commissioner, 

,

598 (1981); Egan v. Commissioner, T.C. Memo. 2005-234.    While Mr.

Bettencourt’s debt was not discharged until 2004, the fact that

this event confirmed the debt’s worthlessness does not mean that

the debt became worthless in that year.    See sec. 1.166-2(c)(2),

Income Tax Regs.   Petitioner credibly testified that it became

clear in 2002 that Mr. Bettencourt would not be able to repay the

loans, and respondent has offered no evidence that petitioner has

or could have taken deductions for the worthless debts in any

other year.   Therefore, petitioner has satisfied his burden of

proof that the Bettencourt debt became worthless in 2002.

     However, we find that the Murray debt became worthless in

2000 when it was discharged by the bankruptcy court.    While

petitioner argues that he still believed that he would be able to

collect the debt because of assurances from Mr. Murray, we do not

find this belief to be reasonable because Mr. Murray had no legal

obligation to repay the debt.    As to the Whalen I loan, we find

that those notes became worthless in 2001 when petitioner signed

a settlement agreement with Mr. Whalen’s bankruptcy estate and

agreed to cancel the notes.    Considering the bankruptcy estate’s

claims against petitioner, it was unreasonable for petitioner to

believe that he could collect on those debts after that date.

     Respondent next argues that the debts were nonbusiness debts

because petitioner was not in the trade or business of loaning
                              - 12 -

money to individuals or that the debts were otherwise incurred in

petitioner’s trade or business.

     A taxpayer may deduct bad debts as business losses if the

taxpayer’s activities in making loans are so extensive as to

constitute a business.   Sales v. Commissioner, 

, 580

(1961); Barish v. Commissioner, 

, 1286 (1959).

Factors we have considered to determine whether a taxpayer is in

the business of lending money include:    (1) The total number of

loans made; (2) the time period over which the loans were made;

(3) the adequacy and nature of the taxpayer’s records; (4) the

amount of time devoted to the lending activity; (5) whether the

taxpayer actively sought out lending business; (6) whether the

taxpayer advertised; (7) whether the taxpayer maintained a

separate office for the business; (8) whether the taxpayer

maintained separate books and accounts for the business and

tracked profit and loss; (9) the taxpayer’s general reputation in

the community as a lender; (10) and the relationship of the

debtors to the taxpayer-lender.   Serot v. Commissioner, T.C.

Memo. 1994-532, affd. without published opinion 

(3d

Cir. 1995); Ruppel v. Commissioner, T.C. Memo. 1987-248.

     Excluding the Whalen II debt, petitioner provided evidence

of making six loans totaling $424,440 between 1997 and January

13, 1999.   Petitioner also earned nearly $70,000 of interest from

loans made to individuals in 2002.     However, even if these loans
                              - 13 -

were sufficient to indicate that petitioner was in the trade or

business of making loans, these factors alone are not sufficient

to support a finding that petitioner was in the business of

making loans because the remaining factors weigh against such a

finding.   See Scallen v. Commissioner, T.C. Memo. 2002-294.

     Petitioner provided no evidence as to how much time he spent

engaged in lending activities.   Petitioner provided no evidence

that he actively sought lending business or advertised; to the

contrary, petitioner testified that he met Mr. Murray and Mr.

Bettencourt through an automobile business that he was involved

in and Mr. Whalen through a real estate broker.    Petitioner

testified that he met the other people to whom he loaned money

through business connections unrelated to a lending business.

Therefore, petitioner generally did not make loans to people who

sought him out for his lending services.    Petitioner provided no

evidence that he maintained an office for a lending business or

maintained any records for the business other than the promissory

notes.   When asked whether it was common for petitioner to lend

money to individuals, petitioner replied “I’ve lent money to

individuals before, yes.”   This indicates that petitioner

commonly loaned money to individuals he knew through his other

business dealings, but not that he was actively engaged in the

trade or business of loaning money.    Therefore, we find that

petitioners are not entitled to a business worthless debt
                               - 14 -

deduction under section 166(a).   However, even if petitioner was

not in the business of making loans, petitioners may be able to

treat the bad debts as short-term capital losses.

      Respondent argues that petitioner is not entitled to any

deductions related to the loans because petitioner has not

satisfied his burden of showing how much money petitioner

actually loaned or what payments he received from the notes.

Secs. 166(b), 1011.

      Petitioner credibly testified that he in fact loaned the

amounts shown on the promissory notes.    Petitioner also credibly

testified that he received no payments on the Bettencourt loan.

Therefore, we find that petitioner provided sufficient evidence

to prove that petitioners were owed the face value of the

Bettencourt loan and may treat it as a short-term capital loss

under section 166(d).

II.   Miscellaneous Itemized Deductions

      Section 162(a) allows deductions for ordinary and necessary

expenses of carrying on a trade or business.   Section 212(1)

allows individual taxpayers to deduct ordinary and necessary

expenses paid for the production or collection of income.    No

deductions are allowed for personal, living, or family expenses

except as otherwise allowed.   Sec. 262(a).   Because petitioners

deducted a $25,000 passive activity loss for their rental

activities, the maximum allowed by section 469(i), additional
                               - 15 -

deductions attributable to petitioner’s rental activities are not

allowed for the year in issue but may be carried over to the next

year under section 469(b).

     Petitioner claims that all of the miscellaneous itemized

deductions relate to petitioner’s lending activities except for

the deductions for tax preparation and depreciation and the

deductions for vehicle expenses, which are related to his rental

activities.   In the notice of deficiency respondent allowed

$6,176 as a deduction for miscellaneous itemized deductions.

Respondent has offered no evidence related to the $6,176.

Therefore, petitioners are entitled to a deduction of $6,176 in

addition to the deductions for which they have satisfied their

burden of proof.   See Rule 142(a).

     A.   Tax Preparation Deduction

     Petitioners claimed $300 for tax preparation expenses.     As

evidence, petitioner credibly testified that he paid his

accountant $300 and provided a copy of the canceled check.     We

find that petitioners have satisfied this burden of proof and are

entitled to the deduction.

     B.   Depreciation

     Petitioners claimed $1,263 in depreciation expenses.

However, petitioners have not provided any evidence to explain or

substantiate this deduction.   Therefore, petitioners are not

entitled to this deduction.
                                 - 16 -

     C.   Dues and Subscription Expenses

     Petitioners claimed $2,447 of dues and subscription expenses

as business loan expenses.   Petitioners provided no explanation

as to how these expenses are connected to petitioner’s lending

activities.   Petitioners submitted copies of a number of checks

made out to Direct TV, a travel club, and various illegible

payees.   These amounts appear to have been paid for personal

expenses and petitioners are therefore not entitled to those

deductions.   See sec. 262(a).

     D.   Office Supplies and Postage

     Petitioners claimed $3,335 of office supply and postage

expenses as business loan expenses.       Petitioners provided copies

of checks written to various payees such as Costco, Orkin, Sees

Candies, Bank of America, and moving companies; receipts from

Fry’s Electronics; credit card statements; and a list of cash

expenses.   However, petitioners have not established that these

expenses were paid in connection with petitioner’s lending

activities instead of personal activities.      Petitioner has not

established that he maintained an office for his lending

activities.

     However, petitioner has shown that he paid substantial

office supply and postage expenses, some of which are related to

his lending activity during 2002.     Therefore, under Cohan v.

Commissioner, 

, 543-554 (2d Cir. 1930), we estimate
                                - 17 -

that petitioner paid $300 of office supply and postage expenses

related to his lending business.

     E.   Telephone Expenses

     Petitioners claimed $3,573 of telephone expenses as business

loan expenses.   As evidence, petitioner provided copies of checks

made out to various telephone companies and copies of monthly

statements from the telephone companies.

     Section 262(a) and (b) provides that any charge for basic

local telephone service with respect to the first telephone line

provided to any residence of the taxpayer shall be treated as a

nondeductible personal expense.    Petitioners have not established

whether any of the telephone expenses relate to the first

telephone line at their residence.       Furthermore, section 274(d)

provides that no deduction shall be allowed with respect to any

listed property, including cellular telephones and similar

telecommunications equipment, see sec. 280F(d)(4)(A)(v), unless

the taxpayer substantiates, inter alia, the business use of the

property.   Petitioners have not provided any evidence that the

telephone expenses were paid for a business use.      Therefore,

petitioners are not entitled to this deduction.

     F.   Automobile Expenses

     Petitioners claimed $7,718 of automobile expenses as

business loan expenses.   As evidence, petitioners provided a

handwritten log that indicates they paid $205.24 for bridge tolls
                               - 18 -

and parking, $3,075.10 for gas, and $276.29 for other automobile

expenses, and a daily calendar listing mileage driven to rental

properties.   The daily calendar shows that in 2002 petitioner

traveled 14,637 miles between his home and his rental properties

in Sacramento, California, and 1,776 miles between his home and

Watsonville, California.

     Automobiles are listed property under section

280F(d)(4)(A)(i).    Taxpayers may also use the standard mileage

rate to calculate their business expense mileage deduction if

they substantiate the business purpose of the travel and the

amount of mileage.    Sec. 1.274-5(j)(2), Income Tax Regs.   In

2002 the standard mileage rate was 36.5 cents per mile for

business use.   Rev. Proc. 2001-54, sec. 5, 2001-2 C.B. 530, 531.

     There is no indication that expenses listed on the cash

expenditure log and receipts represent expenses paid for

petitioner’s business activities.    However, the daily calendar

lists the dates that petitioner traveled to his rental properties

and provides the mileage for each trip.    Petitioner corroborated

the information on the calendar by credibly testifying at trial

that he drove to his rental properties on the days indicated in

the calendar and that the mileage was accurate.    Therefore, we

find that petitioners are eligible for a deduction of $5,990.75

for business mileage related to petitioner’s rental activities.

However, as discussed above, petitioner is limited to a loss of
                               - 19 -

$25,000 from rental activities under section 469 and petitioner

has already been allowed that amount.    Therefore, petitioner may

not deduct additional mileage in 2002 but may carry this

deduction forward to the next taxable year.    Sec. 469(b).

     G.   Furniture Expenses

     Petitioners claimed $1,789 of furniture expenses as business

loan expenses.   Petitioners provided no evidence to substantiate

these expenses and have not shown that these expenses are related

to petitioner’s loan activity.   The expenses therefore are not

deductible.

     H.   Jeffrey Whalen Loan Expenses

     Petitioners claimed $87,538 as expenses incurred in

connection with the settlement of the suit with Mr. Whalen’s

bankruptcy estate as business loan expenses.    As evidence,

petitioner provided:   (1) The bankruptcy estate’s cash receipts

and disbursements record, indicating a receipt from petitioner of

$87,538.05 on November 19, 2002, under the label

“PAYMENT/JUDGMENT”, and a receipt from petitioner of $40,000 on

August 21, 2001, under the label “Claim”; (2) a letter from the

attorneys for the bankruptcy estate confirming receipt of $40,000

on or about August 21, 2001, and $17,000 on or about November 19,

2002, for an award of attorney’s fees under the settlement on the

subrogation claim; and (3) a copy of a check dated November 30,

2001, for $63,137.85 made out to SVNB.
                                - 20 -

       Petitioner testified that the $87,538 claimed includes the

$63,137.85 check paid to SVNB and legal fees.     Because petitioner

paid $63,137.85 in 2001, petitioner may not deduct that amount in

2002.     We find that petitioner has satisfied his burden of

proving that he paid $17,000 in legal fees related to his hay

investment in 2002 and may deduct that amount on his Schedule A.

However, petitioners have not accounted for the remaining $7,401

or provided sufficient evidence to prove that it was paid in 2002

and therefore they may not deduct that amount.

III.    Accuracy-Related Penalty

        Respondent determined that petitioners are liable for an

accuracy-related penalty under section 6662.     Section 6662(a) and

(b)(1) and (2) provides a 20-percent penalty on the portion of

the underpayment of tax attributable to a substantial

understatement of income tax, negligence, or disregard of rules

and regulations.

        Section 7491(c) places the burden of production on the

Commissioner to present sufficient evidence that the imposition

of a particular addition to tax is appropriate.     Higbee v.

Commissioner, 

, 446 (2001).     Once the Commissioner

meets his burden of production, the burden of proof shifts to the

taxpayer to provide evidence sufficient to negate the

appropriateness of the penalty.

     Negligence is defined as “any failure to make a reasonable

attempt to comply with the provisions of this title” and

disregard includes any “careless, reckless, or intentional

disregard.”   Sec. 6662(c).

     There is a substantial understatement of an individual’s

income tax if the amount of the understatement of the taxable

year exceeds the greater of 10 percent of the tax required to be

shown on the return, or $5,000.    Sec. 6662(d)(1)(A).   The amount

of the understatement may be reduced in some circumstances if

there is substantial authority for the treatment of the item or

if the taxpayer discloses the facts affecting the treatment and

it has a reasonable basis.    Sec. 6662(d)(2)(B).

     The penalty does not apply to any portion of an underpayment

if it is shown that there was reasonable cause for such portion

and that the taxpayer acted in good faith with respect to such

portion.   Sec. 6664(c).

     We find that regardless of whether respondent has satisfied

his burden of production, the penalty does not apply.    Petitioner

made a sufficient amount of loans to individuals that a

reasonable person could believe he was in the business of making

loans, and we find that petitioner’s belief that he was in such a

business, although erroneous, was made in good faith.

Furthermore, petitioners maintained many records of their

itemized deductions.   While their records were insufficient to
                             - 22 -

substantiate many of their claimed deductions, they made a

reasonable effort and acted in good faith in making their claims.

Therefore, the Court is satisfied that the section 6662(a)

accuracy-related penalty should not be imposed.

     To reflect the foregoing,


                                        Decision will be entered

                                   under Rule 155.