HAJIYANI v. COMMISSIONER

T.C. Summary Opinion 2001-183

UNITED STATES TAX COURT

MEHDI H. HAJIYANI, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 5818-00S. Filed December 12, 2001.

Mehdi H. Hajiyani, pro se.

Roger W. Bracken, for respondent.

DEAN, Special Trial 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. Unless otherwise

indicated, subsequent section references are to the Internal

Revenue Code in effect for the years at issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.
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The decision to be entered is not reviewable by any other court,

and this opinion should not be cited as authority.

Respondent determined deficiencies in petitioner's Federal

income taxes of $4,256, $6,858, and $16,977 for 1992, 1993, and

1994, respectively. The issues for decision are whether

petitioner: (a) Was in the trade or business of lending money;

(b) and if so, is entitled to deductions for business expenses,

business bad debts, and the net operating losses therefrom; and

(c) is entitled to deduct real estate rental losses in excess of

$25,000. Our resolution of these issues will determine the

computational issue of whether petitioner is entitled to credit

for the elderly or disabled under section 22 in 1992 or 1993.

Background

The stipulation of facts and the accompanying exhibits are

incorporated herein by reference. Petitioner resided in

Rockville, Maryland, at the time his petition was filed in this

case.

Since 1971 petitioner has been employed as an associate

professor of chemistry at the University of the District of

Columbia (UDC). Petitioner was generally engaged in his

professorial duties from the middle of August through the middle

of May. In some years, petitioner taught evening classes and in

others, day classes. Because of the lack of a graduate chemistry
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program at UDC, petitioner had no research responsibilities

requiring additional time commitments to the school.

From 1985 through 1994, petitioner reported interest income

from loans. He made or purchased notes representing 75 loans in

amounts varying from $1,600 to $175,000.

Beginning in 1976, petitioner also engaged in purchasing

residential real estate for leasing and for resale.

Petitioner used an enclosed deck off his master bedroom as

an office for his professorial, loan, and real estate activities.

The office had a desk, a home telephone extension, a copy

machine, a computer, and miscellaneous items.

Petitioner's Money-Lending Activity

Petitioner reported income from lending money beginning in

1985. For each of the years 1992 and 1994, petitioner filed a

Federal income tax return to which he attached a Schedule C,

Profit or Loss From Business, reporting interest income from his

loan activity of $20,691 and $4,215 respectively. For 1993,

petitioner received interest income from the notes he was holding

in the total amount of $42,597. Petitioner, however, offset

against his interest income an amount claimed for bad debts of

$776,525 to arrive at a net bad debt loss of $733,928 reported on

Schedule C. After adding the loss to claimed business expenses

of $28,103, petitioner reported on Schedule C a net loss from

business of $762,031 for 1993.
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Respondent determined that petitioner had not established

the existence or bases of his loans, that they were related to a

trade or business, or that they became wholly worthless in 1993.

Respondent disallowed petitioner's bad debt deduction in 1993 and

instead allowed a $3,000 investment loss on Schedule D, Capital

Gains and Losses, in each of the years 1992, 1993, and 1994.

The loans for which petitioner claimed the bad debt

deduction in 1993 fall into five general categories: (1) A group

of 30 loans to real estate broker Dominick Aloi (Aloi debt); (2)

loans made in connection with the used-car business of Donald

Tooke (Tooke loans); (3) real estate loans made to individuals,

secured by mortgages or deeds of trust; (4) an unsecured loan

made to an individual; and (5) personal loans made to friends and

acquaintances.

The Aloi Debt

Dominick Aloi was a real estate broker or agent who in 1990

owned and operated the Nick Aloi Real Estate Co. in Frederick,

Maryland. Between May and August of 1990, Mr. Aloi executed a

series of 30 promissory notes totaling $512,700. The notes did

not represent new loan proceeds but were instead renewed promises

on unpaid loans made in earlier years. In the 2 years prior to

1990, Mr. Aloi had not been making full payments on the loans.

The notes were short-term notes, usually for 30 days, were often

renewed more than once, and gradually grew in number to 30. The
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face amounts of the notes often exceeded the loan proceeds the

borrower received. Two of the "new" notes, both dated July 11,

1990, are promises to pay unpaid interest on earlier loans.

Petitioner and Mr. Aloi had worked together on some real

estate deals in prior years. During the course of their

relationship, petitioner made between 50 and 80 loans to Mr.

Aloi. Because of their previous dealings, when he made the loans

at issue here, petitioner did not receive a loan application from

Mr. Aloi, request a financial statement, require collateral, or

check the credit references of Mr. Aloi.

In November of 1991 petitioner filed against Mr. Aloi, in

the Circuit Court for Frederick County, Maryland, a Complaint for

Confession of Judgment for the face amount on notes including the

30 described above. Among other allegations in response, Mr.

Aloi alleged that the interest rate on some of the notes was

usurious. The court agreed that interest on some of the notes

was usurious, assessed monetary penalties against petitioner, and

in February of 1995 entered judgment against Mr. Aloi to the

extent of $474,140.38.

Since February 27, 1995, petitioner has received nominal

payments on the judgment he obtained against Mr. Aloi. On August

7, 1996, Mr. Aloi, petitioner, and Dr. Douglas Tavenner (another

judgment creditor of Mr. Aloi) executed an agreed payment
 - 6 -

schedule for allocating payments by Mr. Aloi on their respective

judgments.

The Tooke Loans

Mr. Tooke, doing business as Alliance Leasing Co.

(Alliance), solicited investors through a Houston newspaper

advertisement to finance his purchase of used cars for resale

(floor planning). He also sought financing for buyers who wanted

to purchase his used cars. Petitioner and Mr. Tooke eventually

agreed that petitioner would guarantee up to $30,000 of floor-

planning debt with Independence Bank, N.A. (bank).

On or about May 10, 1989, the bank granted a line of credit

to Mr. Tooke to finance his floor planning. Petitioner

guaranteed Mr. Tooke's promissory note by pledging as security

with the bank a $30,000 certificate of deposit (CD).

Beginning in November of 1989, Mr. Tooke defaulted on his

loan agreement with the bank. In December of 1989, petitioner

sued Mr. and Mrs. Tooke and the bank seeking repayment of the

loans made to Mr. Tooke and the return of the $30,000 CD that he

had pledged as security for the Tooke loan. The bank notified

petitioner that it intended to foreclose on the CD and on June 5,

1990, filed a counterclaim against Mr. Tooke and petitioner.

Petitioner thereafter agreed to the liquidation of his CD and

paid attorney's fees to the bank. Because of the illness of Mr.

Tooke and his lack of assets, petitioner's lawyer, in a letter
 - 7 -

dated June 4, 1991, recommended that he also reach a settlement

with Mr. Tooke.

As part of his business, Mr. Tooke provided financing to

buyers of his used cars. During their business relationship,

petitioner purchased used-car-buyers' notes from Mr. Tooke at a

discount. When Mr. Tooke sold a car on credit, he would accept a

promissory note for the amount of the loan and place a lien on,

and retain title to, the vehicle sold. He would then sell the

note to petitioner for an amount less than the face amount of the

note. Petitioner would receive the note, the lien, and the title

to the vehicle.

During 1989 petitioner purchased from Mr. Tooke 10

discounted auto loan notes. Before the end of 1989 all 10 of the

borrowers on the notes petitioner purchased from Mr. Tooke had

defaulted on their payments to petitioner. For all loans save

one, petitioner received title to the financed vehicle. Of the

nine for which he received title, petitioner retains the title to

all except one for which he received payment of $800 on April 27,

1992. During 1992, four of the vehicles were the subject of

notice to petitioner by mechanics lienors that they intended to

foreclose on the vehicles because of unpaid bills for towing,

storage, or repairs. Petitioner did not pay any of the claims

and permitted the liens to be foreclosed.
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Real Estate Loans

Petitioner worked primarily through a loan or mortgage

broker. The loan broker solicits both lenders and borrowers

through various methods, including advertisements. Typically,

higher risk borrowers will go to a loan broker to obtain a loan,

and the broker will in turn seek a lender like petitioner.

Usually the broker will collect all the information about the

borrower, including a loan application and credit check, and then

send a "package" to the potential lender for consideration. The

lender may then meet with the borrower to negotiate the interest

rate and to go to settlement. The loan broker charges a fee that

is paid by the borrower.

The Daniels Loan

In April of 1991 James and Suzanne Daniels (the Danielses)

executed a promissory note in the amount of $12,500 payable to

Merwin Coad secured by a deed of trust. At the time of this

loan, the property was burdened by an existing first deed of

trust in favor of Redstart Corp. (Redstart). Merwin Coad sold

the Danielses' second deed of trust note to petitioner. In June

of 1991 Redstart informed petitioner that the Danielses were in

default on their first deed of trust note.

On July 23, 1991, petitioner authorized a foreclosure sale

of the Daniels property in an attempt to ensure payment of the

debt due to him, secured by a second deed of trust. Notice of
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the trustee sale was published on August 19, 22, and 28, 1991,

and the auction was held on August 29, 1991. There were no bids,

and petitioner retained his lien interest in the Daniels property

at the date of trial.

The Brown Loans

In July of 1991 petitioner lent Robert and Megan Brown (the

Browns) $9,500 toward the purchase of an interest in a

cooperative located in Washington, D.C. The Browns gave

petitioner a promissory note in the face amount of $10,000

bearing annual interest of 18 percent. Petitioner received a

security interest in the Browns' cooperative. At the time of

petitioner's loan, the cooperative was encumbered by an existing

security interest for an earlier loan of $83,000 made by NCB

Savings Bank (NCB).

On August 1, 1992, petitioner and the Browns signed an

agreement revising the terms of the Browns' note, increasing it

from $10,000 to $15,000 to account for unpaid interest.

Petitioner was notified in October of 1993 and March of 1994

that the Browns were delinquent in making payments on their

obligation to NCB.

On December 10, 1996, Mr. Brown filed a petition in

bankruptcy. Under an Amended Chapter 13 Plan filed January 23,

1997, petitioner was to be paid directly by the debtor, Mr.

Brown, as a secured creditor. On February 17, 1998, NCB held a
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foreclosure sale of the Browns' cooperative share certificate

subject to its lien.

The Johnson Loan

On June 29, 1990, petitioner purchased a $38,000 promissory

note made by Robert Johnson, which was secured by a second deed

of trust. Petitioner purchased the note for $30,400. At the

time petitioner purchased the $38,000 note, the Johnson property

was subject to a first deed of trust securing a note of $105,155

in favor of "Barclay's American Mortgage" (Barclay's).

Petitioner foreclosed on the Johnson property to collect on

his note and in February of 1994 obtained a judgment that

resulted in petitioner's taking title to the property, subject to

Barclay's first deed of trust. Mr. Johnson subsequently filed a

petition for bankruptcy.

The Norman/Beard Loan

On January 15, 1988, Tony Norman and Jeffrey Beard executed

a promissory note payable to petitioner for $25,000 secured by a

second deed of trust on property located in Washington, D.C. The

borrowers received loan proceeds of $21,275. Petitioner

foreclosed on the property in June of 1988, acquiring title to

the property subject to a first deed of trust. After obtaining

title to the property, petitioner leased the house to various

tenants. On February 8, 1998, the first trust lender foreclosed

on the property.
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The Fuller Loans

In October of 1990 Edwin Fuller executed a promissory note

payable to petitioner for $30,000 secured by a first deed of

trust on unimproved property located in the State of Maryland.

In 1991, Mr. Fuller agreed to sell the property to Michael Mason

subject to the deed of trust. In September of 1991, Mr. Mason

executed a promissory note for $68,000 payable to petitioner

secured by a first deed of trust. The $68,000 face amount of the

note was to retire the Fuller note for $30,000 with the remaining

$38,000 intended to fund a construction loan the proceeds of

which were to be released in stages. At settlement Mr. Mason

received a construction draw of $6,000.

On March 2, 1993, petitioner foreclosed on the property.

Because Mr. Mason had failed to pay the required property taxes,

petitioner paid property taxes of $7,147 before receiving title

to the property. Petitioner, having received title to the

property, sold it in 1999.

The International Loan Network Loans

In November of 1991 petitioner purchased at a discount from

Merwin Coad two promissory notes each secured by a second deed of

trust on respective properties located in Washington, D.C. Each

note was in the amount of $10,500 for which he paid $8,500. In

1991 the maker of the notes, International Loan Network, filed

for bankruptcy. The trustee in bankruptcy subsequently
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determined that the fair market values of the properties securing

petitioner's loans were less than the amounts owed on the

properties and abandoned them in bankruptcy. Both properties

were sold at foreclosure on July 24, 1992, in order to pay the

senior secured creditor.

The Unsecured Swift Loan

For $4,500 petitioner obtained from Jed Wilbourn a note for

$5,000 made by Gerald Swift in 1991. On October 18, 1993,

petitioner became a judgment lien creditor of Gerald and Jolynn

Swift in the amount of $20,000 with respect to the advancement to

them of loan proceeds of $15,000 in 1991.

In 1996, the Swifts filed a petition for bankruptcy.

Petitioner filed a proof of claim for both notes with the

bankruptcy court.

Personal Loans

Wooton

Petitioner lent his friends Lorenzo and Betty Wooton $4,000

for which they executed a note to him for $4,400. In June of

1991 the Wootons issued to petitioner in payment of the loan a

check for $4,000 that was dishonored for nonsufficient funds.

Rawoof

Petitioner lent his friend Mohamed Rawoof $5,000 on January

11, 1991, to pay for utilities for apartment buildings he owned

in New York. In December of 1993, Mr. Rawoof petitioned for
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bankruptcy and listed petitioner as an unsecured creditor. On

May 5, 1994, petitioner was notified by the bankruptcy court that

Mr. Rawoof had been discharged from certain of his debts

including that to petitioner.

Petitioner's Real Estate Activity

In 1993 petitioner owned 21 separate parcels of residential

real property either individually or in partnership with his

spouse. Petitioner owned one other parcel of real estate in

partnership with someone other than his spouse. The properties

were usually subject to 1-year or 6-month leases but became

month-to-month upon lapse.

Petitioner reported income or loss from his real estate

rental activities on Schedule E, Supplemental Income and Loss.

On his Forms 1040, U.S. Individual Income Tax Return, for 1992,

1993, and 1994, petitioner reported total rental losses of

$62,903, $35,456, and $82,230.1

Discussion

Petitioner's Money-Lending Activity

Respondent argues that petitioner was not engaged in the

trade or business of lending money and alludes to section 183,

Activities Not Engaged In For Profit. To conclude from the

record in this case that petitioner did not intend to make a

1
Petitioner reported on Schedule E a total loss of $80,159,
but on line 17 of the Form 1040 for 1994 he claimed a rental real
estate loss of $82,230. The discrepancy is unexplained.
 - 14 -

profit from his lending activity would defy common sense. The

Court will not reiterate all the facts and circumstances in

support but finds from the record that petitioner lent money with

the intent to make a profit. See Hirsch v. Commissioner, 315

F.2d 731, 737 (9th Cir. 1963), affg. T.C. Memo. 1961-256; Golanty

v. Commissioner, 72 T.C. 411, 426 (1979), affd. without published

opinion 647 F.2d 170 (9th Cir. 1981); sec. 1.183-2(a), Income Tax

Regs.

Determining whether petitioner's lending money for profit

rose to the level of a trade or business is a somewhat more

difficult inquiry. That petitioner was a chemistry professor

does not preclude him from also being in another trade or

business at the same time. See Curphey v. Commissioner, 73 T.C.

766, 775-776 (1980). But petitioner must show not only that his

primary purpose for engaging in the activity was for income or

profit, but also that he engaged in the activity with "continuity

and regularity". Groetzinger v. Commissioner, 480 U.S. 23, 35

(1987). In order to be considered a trade or business,

petitioner's lending activity must be extensively carried on.

Imel v. Commissioner, 61 T.C. 318, 323 (1973); Rollins v.

Commissioner, 32 T.C. 604, 613 (1959), affd. 276 F.2d 368 (4th

Cir. 1960); see also Barrish v. Commissioner, 31 T.C. 1280, 1286

(1959).
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Some of the factors which have been considered in

determining whether a taxpayer is engaged in the trade or

business of lending money include: The total number of loans

made; the time period over which the loans were made; the

adequacy and nature of the taxpayer's records; whether the loan

activities were kept separate and apart from the taxpayer's other

activities; and whether the taxpayer actively sought out lending

business. Ruppel v. Commissioner, T.C. Memo. 1987-248; McCrackin

v. Commissioner, T.C. Memo. 1984-293. We have also considered

the amount of time and effort expended in pursuit of the lending

activity and the relationship between the taxpayer and his

debtors. See Zivnuska v. Commissioner, 33 T.C. 226, 237-238

(1959); Fuller v. Commissioner, 21 T.C. 407, 412-413 (1953); see

also United States v. Henderson, 375 F.2d 36, 41 (5th Cir. 1967).

The Court finds that the factors in the record are

indicative of petitioner's being in the trade or business of

lending money in the years 1992 through 1994. See Serot v.

Commissioner, T.C. Memo. 1994-532, affd. without published

opinion 74 F.3d 1227 (3d Cir. 1995); Ruppel v. Commissioner,

supra. The Court therefore concludes that petitioner was in the

trade or business of lending money during the years at issue.

Petitioner is entitled to deduct business expenses on

Schedule C for the years 1992 through 1994 associated with his

money-lending business. If petitioner shows all the necessary
 - 16 -

elements, he may also deduct the bad debts claimed for 1993.

A bad debt is deductible in the taxable year during which it

becomes wholly or partially worthless. Sec. 166(a). Generally,

the taxpayer must show that the debt is worthless and the year

the debt became worthless. See Rule 142(a); Mueller v.

Commissioner, 60 T.C. 36, 41 (1973), affd. in part, revd. in part

and remanded 496 F.2d 899 (5th Cir. 1974). Petitioner has made

no argument that the burden of proof shifting provisions of

section 7491(a)(1), effective for Court proceedings arising in

connection with examinations commencing after July 22, 1998, have

application to this case, nor has he offered any evidence that he

has complied with the requirements of section 7491(a)(2).

Worthlessness

There is no standard test or formula for determining the

worthlessness of a debt within a given taxable year; the

determination depends on the particular facts and circumstances

of each case. Crown v. Commissioner, 77 T.C. 582, 598 (1981).

The facts and circumstances must show both the fact and the year

of worthlessness. Lucas v. Am. Code Co., 280 U.S. 445, 449

(1930); Crown v. Commissioner, supra. It is generally accepted

that the year of worthlessness is fixed by identifiable events

that form the basis of reasonable grounds for abandoning any hope

of recovery. Crown v. Commissioner, supra at 598; Federated

Graphics Cos. v. Commissioner, T.C. Memo. 1992-347. In
 - 17 -

determining worthlessness, the value of any collateral as well as

the financial condition of the debtor will be taken into

consideration. Sec. 1.166-2(a), Income Tax Regs. Facts are

sufficient to show worthlessness where debt is uncollectible and

legal action to enforce payment would probably not result in

satisfaction of a judgment. Sec. 1.166-2(b), Income Tax Regs. A

debt is "worthless" where it lacks present value and appears to

lack potential for collectibility at any time in the future.

Dustin v. Commissioner, 53 T.C. 491, 501 (1969), affd. 467 F.2d

47 (9th Cir. 1972); LeLandais v. Commissioner, T.C. Memo. 1976-

345. "Bankruptcy is generally an indication of the worthlessness

of at least part of an unsecured and unpreferred debt." Sec.

1.166-2(c), Income Tax Regs.

Petitioner claimed the debts at issue here as a lump-sum

deduction for total worthlessness on his Schedule C for 1993.

Respondent argues that even if petitioner was lending money as a

trade or business, he has not shown his bases in the amounts lent

or established that the debts were wholly worthless in 1993.

The Court examines first the issue of worthlessness.

Section 166(a)(1) provides that for debts that become wholly

worthless within the taxable year "there shall be allowed" a

deduction. In contrast, under section 166(a)(2) Congress has

provided the Secretary with discretion. He "may allow" the

deduction of a partially worthless debt in an amount "not in
 - 18 -

excess of the part charged off within the taxable year". See

sec. 1.166-3(a)(2)(iii), Income Tax Regs. Courts have recognized

the Commissioner's discretion and will not disturb his

determination unless it is plainly arbitrary and unreasonable.

Sika Chem. Corp. v. Commissioner, 64 T.C. 856, 862-863 (1975),

affd. without published opinion 538 F.2d 320 (3d Cir. 1976);

Bullock v. Commissioner, 26 T.C. 276, 299 (1956), affd. per

curiam 253 F.2d 715 (2d Cir. 1958); Findley v. Commissioner, 25

T.C. 311 (1955), affd. per curiam 236 F.2d 959 (3d Cir. 1956).

Petitioner has not raised the issue of partial worthlessness of

any of the specific debts here at issue, and we will not consider

it. See Mayer Tank Manufacturing Co. v. Commissioner, 126 F.2d

588 (2d Cir. 1942); accord Lehman v. Commissioner, 129 F.2d 288

(2d Cir. 1942).

Petitioner is therefore entitled to claim a bad debt

deduction under section 166(a)(1) only for debts that became

wholly worthless within the taxable year. The Court, however,

has examined the record and is unable to find by a preponderance

of the evidence that any of petitioner's loans became wholly

worthless within any of the years before the Court.

The Aloi Debt

The group of 30 notes from Mr. Aloi to petitioner was the

subject of a lawsuit brought by petitioner to reduce his claims

to judgment. The litigation proceeded through the years at
 - 19 -

issue, and not until 1995 did the court enter judgment largely in

favor of petitioner. It seems unlikely that a reasonable

business person would spend substantial time and money to collect

a wholly worthless debt. Petitioner still receives payments,

albeit nominal in amount, on the Aloi judgment.

The Tooke Loans

With respect to petitioner's $30,000 guarantee of the Tooke

floor-planning credit line, and its attendant litigation, the

parties stipulated evidence of a settlement recommendation by

petitioner's attorney in June of 1991. The recommended

settlement required that petitioner acquiesce in the liquidation

of his collateral by the creditor. If the settlement was entered

into in 1991, and there is no evidence to show otherwise,

petitioner's debt became worthless in 1991. See sec. 1.166-9(a),

(d), Income Tax Regs. There was no right of subrogation in the

agreement between petitioner and Mr. Tooke that would delay the

determination of the year of worthlessness. See sec. 1.166-

9(e)(2), Income Tax Regs.

As to the 10 used-car-buyers' notes petitioner purchased

from Mr. Tooke, all the borrowers defaulted in 1989. Of the nine

for which he received title, petitioner retains the title to all

except one which he exchanged for a payment of $800 on April 27,

1992. Petitioner testified that it was not clear when some of

the notes became worthless. Petitioner had not obtained credit
 - 20 -

or financial reports on the persons whose auto loans he bought

from Mr. Tooke. He added that he had "nothing to gain by taking

action" so his attitude was, "in many cases, just wait and see

what happens." Although petitioner allowed mechanics lienors to

foreclose on four of the vehicles in 1991 or 1992,2 there is no

evidence that the notes secured by the vehicles did not become

worthless in years before or after the foreclosures.

A debt does not become worthless merely because the creditor

elects not to enforce the obligation. Southwestern Life Ins. Co.

v. United States, 560 F.2d 627, 644 (5th Cir. 1977); Brewer v.

Commissioner, T.C. Memo. 1992-530; Suman v. Commissioner, T.C.

Memo. 1967-84. Petitioner's failure to attempt collection allows

the inference that the notes were already worthless in 1989,

1990, or 1991.

Real Estate Loans

Petitioner failed to produce evidence of identifiable events

that could fix the year of total worthlessness of his real estate

loans. In some instances, even if the year could be determined,

we are unable to determine what the amount of the loss might have

been because of partial collection in kind. The Daniels loan was

the subject of default, foreclosure, and nonsale at foreclosure

2
The stipulation by the parties recites an unlikely
chronology: That petitioner received notices from mechanics
lienors in 1992 and that petitioner permitted the liens to be
foreclosed on the cars in 1991.
 - 21 -

all in the year 1991. Petitioner retained a lien interest of

unknown value. The Brown note was made in 1991 and renewed in

1992. The next relevant event was the filing of a petition in

bankruptcy by Mr. Brown in 1996. The Johnson note was the

subject of a foreclosure suit resulting in a judgment conveying

to petitioner the deed of trust property of unknown value. At

some later unknown date, Mr. Johnson filed for bankruptcy.

Petitioner obtained title to property of unknown value securing

the Norman/Beard loan in 1988 and then leased the property to

various tenants until 1998. The Fuller property, of unknown

worth, foreclosed on by petitioner in 1993, was sold by him in

1999 for an unknown amount. The maker of the ILN notes filed for

bankruptcy in 1991, and the property securing petitioner's notes

was insufficient to pay secured creditors senior to petitioner.

Without evidence of the financial situation of the debtors

and the value of collateral petitioner obtained, we are unable to

determine that in 1992 through 1994 the subject loans became

totally lacking in value and lacked any potential for future

collectibility. See Pierson v. Commissioner, 27 T.C. 330, 338-

339 (1956), affd. 253 F.2d 928 (3d Cir. 1958); Dean v.

Commissioner, T.C. Memo. 1970-75. The evidence is insufficient

to show that the real estate loans became worthless in the years

at issue.
 - 22 -

Unsecured Swift Loan

Petitioner became a judgment lien creditor of the Swifts in

1993 as a result of their failure to pay notes made in 1991. The

next relevant event for which we have any evidence is that in

1996 the Swifts filed a petition in bankruptcy. There are no

other identifiable events that can be considered to fix the

worthlessness of the Swift notes in 1992, 1993, or 1994.

Personal Loans

The Wooton and Rawoof loans were made to friends of

petitioner. In June of 1991 the Wootons gave petitioner a check

that was subsequently dishonored on an unspecified date. The

Rawoof loan was discharged in bankruptcy in 1994. There is no

evidence that the Wooton loan became worthless during the years

at issue. There is evidence that the Rawoof loan became

worthless in 1994.

Petitioner, however, has not shown that the dominant, as

opposed to merely a significant, motivation for either loan was

business related. See United States v. Generes, 405 U.S. 93, 106
(1972). Self-serving statements alone will not suffice to prove

a taxpayer's business purpose in advancing money. Id.

The record in this case is not sufficient for the Court to

find that petitioner is entitled to a deduction with respect to

his loans other than as allowed by respondent on Schedules D for

the years under consideration. Because petitioner has failed to
 - 23 -

prove the year and fact of worthlessness of the loans deducted in

1993, we need not reach the issue of whether he has shown his

bases in the various loans.

Petitioner's Real Estate Rental Activity

Respondent determined that petitioner is not entitled to

real estate rental losses claimed in 1992 and 1993 because his

rental activity is a "passive activity" for which losses are

disallowed. Additionally, respondent determined that petitioner

is not entitled to the real estate rental loss claimed for 1994

because his rental activity is a passive activity and he was not

a real estate professional engaged in a "real property business"

for the year.

Under section 469(a), if a taxpayer is an individual, the

"passive activity loss" for the taxable year shall not be

allowed. The term "passive activity loss" means the amount by

which "the aggregate losses from all passive activities" exceed

"the aggregate income from all passive activities" for the

taxable year. Sec. 469(d)(1). Except for taxpayers entitled to

treatment under section 469(c)(7), Special rules for taxpayers in

real property business, the term "passive activity" includes any

rental activity. Sec. 469(c)(2).

Subsection (c)(7), governing taxpayers in a real property

business, was added to section 469 as part of the Revenue

Reconciliation Act of 1993, Pub. L. 103-66, secs. 13001,
 - 24 -

13143(a), 107 Stat. 416, 440. The provisions of subsection

(c)(7) of section 469 are effective for taxable years beginning

after December 31, 1993. Id. sec. 13143(c), 107 Stat. 441. Two

of the taxable years before us, 1992 and 1993, precede the

effective date of the "Special rules for taxpayers in real

property business" contained in subsection (c)(7). Thus, for

those years petitioner may not rely on the special rules to

relieve him of the generally applicable strictures of section 469

denying deductions for passive activity losses.

Section 469(i), with respect to rental real estate

activities in which an individual actively participates, provides

that the section 469(a) disallowance will not apply to a maximum

of $25,000 of passive activity losses.3 There is allowed only

one $25,000 offset for all of petitioner's rental activities per

year. Sec. 469(i)(2).

For the year 1992, petitioner reported items on Schedule E.

After taking into consideration rental (passive) income,

petitioner reported individually owned real estate rental losses

of $50,779, partnership real estate rental losses of $12,125, and

3
This nonapplication or "exemption" begins to be phased out
where the taxpayer's adjusted gross income exceeds a certain
level, in some circumstances $100,000. Sec. 469(i)(3).
 - 25 -

total rental real estate (passive activity) losses of $62,903.4

Petitioner reported no other income from passive activities.

Petitioner's passive activity loss for the year 1992 is therefore

$62,903. For the years 1993 and 1994, petitioner's returns

reveal on Schedules E respective passive activity losses from

individually and partnership owned residential rental property

totaling $35,456 and $82,230.

Because respondent determined that petitioner actively

participated in the listed rental activities, the section 469(a)

disallowance of a passive loss deduction will not apply to

$25,000 of petitioner's passive losses for each of the years

1992, 1993, and 1994. The remainder of petitioners' passive

activity losses from each respective year that is disallowed as a

deduction may be carried over to the next taxable year for

application against income from passive activities, if any, and

the $25,000 offset. Sec. 469(b); sec. 1.469-1(f)(4), Income Tax

Regs.

For petitioner's 1994 tax year, the provisions of subsection

(c)(7) of section 469 are effective. The "Special rules for

taxpayers in real property business" contained in subsection

4
For purposes of sec. 469, petitioner must aggregate his
individual and partnership real estate rental income and losses
as passive activity income and losses. Sec. 1.702-
1(a)(8)(ii),(iii) and (b), Income Tax Regs.; see also sec. 1.469-
2T(d)(6)(v)(B), Temporary Income Tax Regs., 53 Fed. Reg. 5717
(Feb. 25, 1988).
 - 26 -

(c)(7) provide that if its provisions apply to a taxpayer, real

estate rental activity will not be a passive activity, and each

of the taxpayer's interests in real estate rental will be treated

separately under the section. Sec. 469(c)(7)(A).

To qualify for treatment under section 469(c)(7), petitioner

must show that more than half the personal services he performed

in trades or businesses during 1994 were performed in real

property trades or businesses in which he materially

participated. Sec. 469(c)(7)(B)(i). In addition, petitioner

must show that he performed more than 750 hours of services

during the year in real property trades or businesses in which he

materially participated. Sec. 469(c)(7)(B)(ii).

The evidence shows that in 1994 petitioner spent substantial

time in the trades or businesses of teaching chemistry and

lending money. Aside from petitioner's vague testimony, the only

evidence of the amount of petitioner's personal services

performed in 1994 with respect to his real estate rental property

consists of two calendars that do not describe the amount of time

he spent related to the rental properties, either individually or

in the aggregate. See sec. 1.469-5T(f)(4), Temporary Income Tax

Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988).

Because the evidence does not support the application of

section 469(c)(7) to petitioner and his real estate rental

activity in 1994, the Court concludes that he is not entitled to
 - 27 -

deduct losses from passive activity in excess of those allowed by

respondent for the year.

Reviewed and adopted as the report of the Small Tax Case

Division.

To reflect the foregoing,

Decision will be entered

under Rule 155.