JULICHER v. COMMISSIONER

T.C. Memo. 2002-55

UNITED STATES TAX COURT

HENRY A. JULICHER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 1102-99. Filed February 27, 2002.

Alan L. Frank and Robert A. Cohen, for petitioner.

Keith L. Gorman and John Gilbert, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GALE, Judge: Respondent determined a deficiency in

petitioner’s 1994 Federal income tax of $95,727, an addition to

tax under section 6651(a)(1)1 of $23,932, and an accuracy-

1
Unless otherwise noted, 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.
 - 2 -

related penalty under section 6662(a) of $19,145. By amendment

to answer, respondent asserted an increase in the deficiency. By

motion at the end of trial to conform the pleadings to the

evidence under Rule 41(b)(1), respondent asserted that petitioner

is liable for a fraud penalty under section 6663 on the portion

of the alleged underpayment attributable to a claimed casualty

loss deduction.

We must decide the following issues:

Whether respondent is entitled under the circumstances of

this case to amend his answer under Rule 41(b)(1) to assert fraud

under section 6663. We hold that he is not so entitled. Having

so held, we need not, and do not, address the question of whether

petitioner is liable for fraud.

Whether petitioner is entitled to a casualty loss deduction

in 1994 under section 165 with respect to the collapse of a

portion of the roof of petitioner’s warehouse. We hold that

petitioner is not entitled to a casualty loss deduction because

there was a reasonable prospect of recovery of insurance proceeds

during 1994.

Whether, and to what extent, petitioner is entitled to a

depreciation deduction during the year in issue. We hold that

petitioner is entitled to a depreciation deduction in the amount

claimed on his 1994 Federal income tax return, based on his
 - 3 -

allocation of a portion of the purchase price to his basis in the

depreciable property.

Whether petitioner is entitled to certain bad debt

deductions under section 166 claimed on his 1994 return. We hold

that he is not.

Whether petitioner is entitled to a tax return filing status

of “married filing jointly” for the year in issue. We hold that

he is not.

Whether petitioner is liable for an addition to tax and

accuracy-related penalty as determined by respondent. We hold

that he is.

FINDINGS OF FACT

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

incorporate by this reference the stipulation of facts and

attached exhibits. At the time of filing the petition,

petitioner resided in Wayne, Pennsylvania.

Petitioner’s Businesses

Petitioner owned 100 percent of an S corporation, Julicher

Sports Facilities (Julicher Sports). Julicher Sports engaged in

the business of constructing sports facilities, with emphasis on

surfaces such as tennis courts, weight room floors, artificial

turf for football fields, ice-skating rinks, etc. In addition,

petitioner leased real property to Julicher Sports and to Rose

Weinstein, both discussed in greater detail below.
 - 4 -

Casualty Loss and Depreciation Deductions

Petitioner owned real property at 10 Balligomingo Road, West

Conshohocken, Pennsylvania (Property). The Property consisted of

6.836 acres with improvements, including three buildings, which

were referred to at trial as the north building (7,839 square

feet), the finger building (2,959 square feet), and the south

building (9,324 square feet). The majority of the land was

unimproved, and consisted of a creek and adjoining flood plain

and steep slopes. In addition, the neighboring landowner held

access and maintenance easements over the Property.

The south building consisted of three sections that we shall

refer to as the western section, the middle section, and the

eastern section. The three sections were separated by walls.

During the year in issue, petitioner leased the south building to

Julicher Sports and to other acquaintances and business

associates, as a warehouse. On both his 1993 and 1994 Federal

income tax returns, petitioner reported rental income from the

foregoing leasing activities.

Petitioner acquired the Property, including land and

improvements, on April 14, 1988, for a purchase price of

$393,378.2 In order to finance the purchase, petitioner obtained

2
Petitioner’s wife at the time, Melanie Julicher, was also
a purchaser, but in 1991 she transferred her interest in the
Property to petitioner. For convenience, we shall refer to
(continued...)
 - 5 -

a loan of $500,000 from a bank, which was secured by a first

mortgage. In a document from the loan officer to the bank’s loan

committee recommending approval of the loan, the loan officer

stated:

Although property in question is an old one and in
considerable need of repair, the property should be
desirable when rehabilitated and will have substantial
value.

With the potential rental income combined with the rent
saving of Julicher, cash flow should be adequate to
service the debt.

Petitioner used the balance of the loan over the purchase price

to make repairs to the buildings on the Property. Petitioner did

not increase his basis in the buildings by the amount of these

repairs. Petitioner bought the Property because he had lost his

lease on a previous location where his corporation conducted its

business, and the buildings on the Property were suitable for use

in the corporation’s business.

Petitioner allocated $107,759 of the purchase price to the

land and $285,619 to the buildings. Petitioner took depreciation

deductions on the buildings beginning in April 1988 using a basis

for depreciation of $285,619, the straight-line method, and a

recovery period of 31.5 years.3 Through 1993, petitioner had

2
(...continued)
petitioner as the only purchaser.
3
Petitioner did not allocate basis individually among the
(continued...)
 - 6 -

claimed depreciation deductions for the buildings of $9,068 per

year4 (prorated for the partial year 1988). In 1994, petitioner

claimed depreciation for the buildings of $4,179.

In 1988, petitioner was issued a citation from the Borough

of Conshohocken indicating there was an actual and immediate

danger of collapse of part of the south building. In 1992, the

eastern section of the south building suffered water damage

caused by sprinklers that were set off as a result of a fire in a

building on the land adjacent to the Property. The cost of any

repairs or improvements resulting from these incidents, or the

cost of any other repairs or improvements, was not added to the

buildings’ basis.

In the fall of 1993, petitioner sought to reduce the tax

assessment on the Property. In his request for a lower

assessment (assessment request), petitioner stated that he

purchased the Property in 1988 for $373,000 and that his opinion

of the market value of the Property at the time of the assessment

request was $350,000. In the assessment request petitioner

claimed: “There are currently about 20,000 SF [square feet] of

3
(...continued)
buildings at the time of purchase and did not claim separate
depreciation deductions for each building; rather, petitioner
claimed one composite depreciation deduction for all the
buildings, based on the composite basis figure.
4
The basis figure of $285,619 divided by a recovery period
of 31.5 years yields a yearly deduction of $9,067.27.
 - 7 -

dilapidated leaky buildings on the site of which 12,000 SF is

over 100 years old. The buildings are in poor condition and in

fact only 8,000 SF is even safe to use as warehouse.”5 In

November 1993 the local board of assessment appeals rejected the

assessment request.

On March 7, 1994, a part of the roof of the western section

of the south building collapsed. The roof was supported by

wooden trusses, which showed evidence of rot and decay at the

time of the collapse. During the period leading up to the

collapse, the roof of the south building was covered with ice and

snow from extensive storms in the area.

At the time of the collapse, Julicher Sports maintained

insurance on the buildings on the Property through Atlas

Assurance Company (Atlas). The insurance policy lists only

“CORPORATION” (i.e., Julicher Sports) as the “NAMED INSURED”; but

both Julicher Sports and petitioner are listed at the top of the

policy as follows:

JULICHER SPORTS FACILITIES,
INC., HENRY JULICHER, SPORT [sic]
PO BOX 720, 10 BALLIGOMINGO RD
W. CONSHOHOCKEN PA 19428

The policy, which was obtained in 1993, provided replacement

coverage for the north, finger, and south buildings collectively

5
We note that the square footage of the north building was
7,839, and the square footage of the south building (9,324) and
finger building (2,959) totaled 12,283.
 - 8 -

up to a limit of $852,000, subject to certain coinsurance. The

policy also covered damage to personal property owned by the

insured and used in the insured’s business.

Following the roof collapse, petitioner engaged Len Orloff

of Claims International, Inc., to submit to Atlas a claim of loss

from the collapse. On April 27, 1994, Mr. Orloff submitted a

claim to Atlas on behalf of Julicher Sports. The claim reflects

an estimated cost of damage to the south building of $68,365 and

to its contents of $172,177, for a total of $240,542. To provide

the estimate for the south building itself, Mr. Orloff engaged an

independent builder who prepared a written estimate of the cost

of repairing the building.

Atlas raised questions about the validity of the contents

claim as initially submitted because certain items claimed

thereon appeared duplicative of earlier losses submitted in

connection with a previous incident or otherwise appeared

unfounded. As a result of concerns expressed by Atlas,

petitioner’s adjuster submitted a revised inventory that reduced

the contents damage claim from $172,177 to $70,095. The damage

claim with respect to the building remained $68,365.

Atlas subsequently requested a sworn proof of loss, which

petitioner’s adjuster submitted on his behalf in October 1994.

The sworn proof of loss included the revised inventory claim of

$70,095 and the original claim for damage to the building of
 - 9 -

$68,365, totaling $138,460 less a deductible of $1,000.

Sometime during the fall of 1994, the zoning and building

official for the Borough of West Conshohocken, William Keil,

learned of the roof collapse. After inspecting the south

building, Mr. Keil determined that the collapse required the

western section of the south building to be either promptly

repaired or demolished. Mr. Keil also determined that the middle

and eastern sections of the south building were not affected by

the collapse and did not require immediate repair or removal.

However, Mr. Keil believed that, independent of the collapse of

the roof of the western section, the roofs of the middle and

eastern sections were not safe for persons to stand on, and he

notified the borough fire chief that, in the event of a fire in

the south building, firemen should not go onto the roof of, or

into, any section of the south building. Nonetheless, during a

later visit to the Property, Mr. Keil observed a landscape

contractor using the middle section of the south building for

equipment storage.

In accordance with his inspection of the south building, in

a letter dated November 17, 1994, Mr. Keil informed petitioner

that petitioner was required to repair or remove the damaged

section of the south building within 30 days of the receipt of

the letter. Mr. Orloff replied to Mr. Keil in a letter dated

December 21, 1994, indicating that petitioner intended to restore
 - 10 -

the building to a safe condition upon receipt of insurance

proceeds from Atlas. Mr. Orloff further indicated that appraisal

was being sought with respect to the insurance claim. Mr. Orloff

believed the 30-day limit prescribed by the November 17 letter

was not likely to be strictly enforced.

At some point during 1994, Atlas offered petitioner $22,000

for damage to the south building, but nothing for the contents;

petitioner rejected this offer. After the offer was rejected,

petitioner requested an “appraisal”, a formal procedure

authorized in the insurance policy designed to resolve

disagreements between insurer and insured as to the amount of

damages from a particular loss. In this procedure, each party to

the insurance policy nominates an appraiser, and the two

appraisers select an independent party who reaches a value of the

loss binding on both parties. From December 1994 until at least

February 1995, petitioner made repeated requests for appraisal.

Atlas did not respond to those requests, and informed petitioner

in February 1995 that petitioner’s claim was not ripe for

appraisal, primarily because Atlas had concluded that petitioner

was not entitled to coverage at all under the policy.

In March 1995, William Stewart (Mr. Stewart), an attorney

representing Atlas, conducted an examination under oath of

petitioner with respect to his claim for coverage arising from

the roof collapse. After the examination, in a letter to
 - 11 -

petitioner in May of 1995, Mr. Stewart informed petitioner that

Atlas was denying coverage. This letter (denial letter) alleges,

as the primary reason for denying coverage, that Julicher Sports

or its representatives had misrepresented or concealed material

facts concerning the loss. The denial letter further alleges

that, among other things, Julicher Sports overvalued, and

overstated the quantity of, the damaged property, misrepresented

the obsolescence of damaged property, and misrepresented the

condition of the building prior to the collapse. In addition to

misrepresentation, the denial letter alleges other grounds for

denying coverage, including certain exclusions in the policy and

the policy’s coinsurance provision.

Following the denial letter, on or about July 24, 1995,

petitioner and Julicher Sports initiated a lawsuit against Atlas

in Federal District Court. The complaint filed in the lawsuit

asserts that the value of plaintiffs’ loss due to the roof

collapse was $138,4606 and claims damages of $137,460 (the

asserted value of the loss minus $1,000 deductible).

Atlas, through Mr. Stewart, responded by filing an answer to

the complaint, a counterclaim against petitioner and Julicher

Sports, and joinder complaints against unrelated third parties.

6
Although the complaint does not describe how this amount
was determined, we note that it is the same as in the sworn proof
of loss; i.e., the sum of the second contents claim of $70,095
and the original claim for damage to the building of $68,365.
 - 12 -

The answer lists nine affirmative defenses, most of which follow

along the lines of the reasons for denial provided in the denial

letter. The lawsuit was eventually settled by agreement of all

the parties thereto.7 In the settlement, no party admitted or

conceded liability, and no damages were awarded.

The western portion of the south building was torn down in

1996. The middle and eastern portions of the south building were

not torn down.

Petitioner filed his 1994 Federal income tax return (the

1994 return) on April 26, 1996. The 1994 return was due to be

filed on October 15, 1995. Petitioner’s accountant, Charles

Finder, began preparing the 1994 return sometime in 1995. In

November or December 1995, petitioner gave Mr. Finder a document

for use in preparing the 1994 return. This document provides

brief descriptions of some of the buildings on the Property, and

claims that two masonry buildings, exceeding 50 years of age and

with a combined value of approximately $154,000, were damaged by

the collapse in 1994. It further claims that the value of the

damaged buildings after the collapse was zero. Mr. Finder relied

on the document in preparing the 1994 return. On Form 4684,

Casualties and Thefts, of the 1994 return, petitioner claimed a

casualty loss in connection with the collapse. The Form 4684

7
The record does not disclose the date of the settlement.
 - 13 -

states a basis for the damaged building of $155,836 and states

that the fair market value of the damaged building before

casualty was $154,000, and after casualty was $0.8 The Form 4684

claims a total casualty loss of $155,836.9

Respondent’s examination in the instant case commenced prior

to July 22, 1998. During the examination, Mr. Finder submitted

the document petitioner had given him to the revenue agent

conducting the examination to support the claimed deduction.

In the notice of deficiency, respondent determined that

petitioner was not entitled to the claimed loss deduction because

he did not (1) establish the decrease in the fair market value of

the Property as a result of the roof collapse, (2) establish his

adjusted basis in the Property, and (3) provide documentation to

support the claimed deduction.

Bad Debt Deduction (Ms. Weinstein)

In addition to leasing buildings to his corporation,

petitioner also leased real property to successive businesses

owned by Rose Weinstein (Ms. Weinstein), a professional tennis

instructor. The businesses operated swim and tennis clubs.

The businesses paid annual rents to petitioner ranging from

8
The record does not reflect how these figures were
generated.
9
Because the building was alleged to have been totally
destroyed, the Form 4684 uses the stated basis as the casualty
loss deduction, even though that amount exceeded the stated value
of the south building of $154,000. See sec. 1.165-7(b)(1)(ii),
Income Tax Regs.
 - 14 -

$60,000 to $80,000, including $60,000 in 1994. One of these

businesses, a corporation called Indian Falls Racquet Club

(Indian Falls), experienced financial difficulties soon after it

opened. Ms. Weinstein borrowed money from petitioner in order to

keep Indian Falls running.

Petitioner lent the money in installments of irregular

amounts at irregular intervals, over a period of approximately 8

months. There was no formal agreement as to the terms of a

loan; rather, it was understood that Ms. Weinstein would pay back

the amounts as soon as possible. She did not pay back any of the

amounts, and petitioner continued lending additional amounts

until the total grew to $44,000. Eventually, on August 23, 1989,

she and petitioner formalized the existence of the debt and

established a repayment schedule with a document entitled “Loan

Agreement”. The Loan Agreement provides for a loan from

petitioner to Ms. Weinstein of $44,000 for a period of 3 years at

10 percent interest.

Indian Falls was a seasonal business, opening April 1 and

closing after Labor Day each year. At the end of each season up

to and including 1993, Ms. Weinstein did not make a profit from

Indian Falls, and the income she received from offering tennis

lessons (separate from Indian Falls’s business) was sufficient

only to maintain her standard of living. In each year from 1989

through 1993, after the close of Indian Falls for the season, Ms.
 - 15 -

Weinstein told petitioner she was insolvent and that she could

not repay the loan.

In January of each year, Ms. Weinstein sought additional

funding in order to maintain the financial condition of Indian

Falls to ensure it could open in April. In January 1994,

however, Ms. Weinstein was unable to obtain the additional

funding necessary to open in the spring. Thus, Indian Falls

ceased doing business in January 1994. However, in July 1994 Ms.

Weinstein obtained sufficient funding to begin a new business

operating a swim and tennis club, which was essentially the same

business as Indian Falls, operating at a different site. This

business was operating as of the end of 1994. At some point

during 1994, petitioner told Ms. Weinstein that if she did not

pay him the $44,000 she owed, he might sue her to recover.

On Schedule E, Supplemental Income and Loss, of the 1994

return, petitioner reported rental income of $143,059, a portion

of which was received from Ms. Weinstein. Also, on Schedule E,

petitioner claimed a bad debt deduction of $44,000 by listing

that amount as an item of expense with respect to the rental

income.10

10
Petitioner’s accountant, Mr. Finder, believed it was
correct to claim the bad debt deduction on the schedule reporting
the rental income from Ms. Weinstein’s business, since the bad
debt, in his view, was directly related to rental operations.
 - 16 -

In the notice of deficiency, respondent determined that

petitioner was not entitled to the claimed bad debt deduction

because he did not (1) establish a business purpose for the loss,

(2) show that the loss resulted from a bad debt and in particular

his bad debt, and (3) show that all reasonable steps were taken

to collect the debt.

Bad Debt Deduction (Attieh Bros.)

In 1987 Julicher Sports was engaged by Attieh Bros. Co.

(Attieh Bros.), a family-owned business in Amman, Jordan, to

install the rink and other flooring materials for a skating rink

called the Skating Palace in Amman. Attieh Bros. paid Julicher

Sports approximately $150,000 for the installation. Petitioner

developed a close relationship with the Attieh family, in

particular the brothers Thair and Nidal Attieh and their father

Raouf, and soon he was treated as if he were a member of the

family. Raouf was a commercial attaché for the Jordanian

Government with ties to the King of Jordan, and petitioner felt

he would be a valuable business contact in Jordan.

On October 15, 1989, petitioner individually (i.e., not

Julicher Sports) and Attieh Bros. entered into a loan agreement

(First Loan Agreement) whereby petitioner would lend Attieh Bros.

$50,000 for a period of 5 years, to be repaid on or before

October 15, 1994. The money was to be used to add a franchise

restaurant to the Skating Palace. The First Loan Agreement
 - 17 -

provides for 25 percent interest per year and calls for quarterly

payments of interest only (i.e., no principal) in the amount of

$3,125 beginning January 15, 1990, and ending at the end of the

loan term, October 15, 1994. The First Loan Agreement also

provides for fees in the event of late payments.

At some point after January 15, 1990, Attieh Bros. made the

first payment called for by the First Loan Agreement. Sometime

around March 1990, members of the Attieh family asked petitioner

to lend Attieh Bros. an additional $20,000. Petitioner agreed,

and he sent Nidal Attieh a letter dated March 28 outlining the

terms of a new agreement under which the $20,000 would be added

to the previous principal of $50,000. Petitioner subtracted from

the $20,000 certain amounts, totaling $8,000, that he felt were

owed him: $3,925 for video games he had purchased on behalf of

Attieh Bros.; $3,125 for the next quarterly payment under the

First Loan Agreement, which was due April 15, 1990; and $950 in

late fees and interest arising from the untimeliness of the

January 15, 1990, quarterly payment. At some point in late March

or early April, petitioner sent Attieh Bros. the additional

$12,000.

On April 2, petitioner and Attieh Bros. entered into a loan

agreement (Second Loan Agreement) that replaced and superseded

the first, providing for a principal amount of $70,000 (original

$50,000 plus additional $20,000), with an interest rate of 25
 - 18 -

percent per year and a term of 5 years ending April 15, 1995.

The Second Loan Agreement calls for quarterly payments of

interest in the amount of $4,375, plus concurrent quarterly

payments of principal in the amount of $3,500, for a total of

$7,875 each quarter. The first such payment was due July 15,

1990.

Neither Attieh Bros. nor the Attiehs made this payment or

any other payment due under the Second Loan Agreement, with the

exception of $1,500 paid to petitioner in July 1991. Beginning

July 31, 1990, and continuing periodically for the next several

years, petitioner sent telefax correspondence to Thair, Nidal, or

Raouf Attieh inquiring about the lack of payment and requesting

payment.11 The Attiehs replied sometimes with explanations for

their failure to pay (such as the Gulf War, which, according to

the correspondence, reduced business and limited the ability to

transfer money out of Jordan) and sometimes with promises to

begin paying after money became available from a new source, such

as the sale of property.12 The correspondence reflects

petitioner’s mounting frustration at receiving virtually no

payments on the loan.

11
The record contains seven faxes from petitioner in 1990,
two in 1991, seven in 1992, and one in 1993. The record contains
no faxes sent in 1994 or later.
12
The record contains four faxes from the Attieh family in
1990, five in 1991, two in 1992, and two in 1993. The record
contains no faxes sent in 1994 or later.
 - 19 -

From the period the loan was made through the year in issue,

the Attiehs advised petitioner that they intended to repay the

loan. In a fax dated August 3, 1993, Thair informed petitioner

that the Attiehs would begin paying $2,000 per month starting

September 15, 1993, which was repeated in a fax dated August 19,

1993. During this period and through the time of trial, Thair

and petitioner spoke often on the telephone. Petitioner remained

in a close personal relationship with the Attiehs and

occasionally sought further business dealings with them.

The Skating Palace operated as a going concern until at

least 1998.

On the 1994 return, petitioner claimed a bad debt deduction

of $70,000. In the notice of deficiency, respondent determined

that petitioner was not entitled to the claimed bad debt

deduction because he did not (1) establish a business purpose for

the loss, (2) show that the loss resulted from a bad debt and in

particular his bad debt, and (3) show that all reasonable steps

were taken to collect the debt.

Joint Filing Status

On their 1993 joint Federal income tax return, petitioner

and his wife at the time Margit Julicher (Mrs. Julicher) selected

“married filing joint” status. Petitioner, Mrs. Julicher, and

Mr. Finder (as return preparer) signed the 1993 return. On the

1994 return, petitioner selected “married filing separate”
 - 20 -

status. Petitioner and Mr. Finder (as return preparer) signed

the 1994 return.

In late 1997 or early 1998, during the examination of

petitioner’s 1994 taxable year, Mr. Finder, petitioner’s

authorized representative before the Internal Revenue Service,

met with the revenue agent conducting the examination, Venita

Lucas. In one of the meetings, which took place before February

6, 1998, Mr. Finder raised an issue with respect to a net

operating loss carryback deduction. Mr. Finder discussed the net

operating loss with Ms. Lucas, and Ms. Lucas requested from Mr.

Finder a Form 1040 (1994 Form 1040) to be used in claiming the

net operating loss deduction. Mr. Finder tendered the requested

1994 Form 1040, and Ms. Lucas informed him that he should

consider it filed. The 1994 Form 1040 reflects a filing status

of “married filing joint”. The “label” field of the 1994 Form

1040 contains petitioner and Mrs. Julicher’s names, and both

petitioner’s and Mrs. Julicher’s Social Security numbers are

contained on the 1994 Form 1040. Mr. Finder said nothing to Ms.

Lucas with respect to the “married filing joint” filing status of

the 1994 Form 1040. The 1994 Form 1040 was not signed by

petitioner, Mrs. Julicher, or Mr. Finder, and contains no

inscription to the effect of its being an amended return.

The notice of deficiency in this case was issued to

petitioner only. Attached to the notice was Form 4549, Income
 - 21 -

Tax Examination Changes, prepared by Ms. Lucas and dated March 6,

1998. The Form 4549 used “Married - Separate” filing status in

computing the amount of the adjustments to income.

OPINION

Respondent’s Motion To Amend the Pleadings

At the conclusion of the trial, respondent moved to amend

the pleadings to conform to the evidence under Rule 41(b)(1). In

his motion, respondent argues that he should be permitted to

assert a fraud penalty under section 6663 against petitioner on

the basis that the issue of fraud had been tried by consent of

the parties. Respondent contends that petitioner committed fraud

by claiming a casualty loss deduction to which he knew he was not

entitled, by falsely claiming that the Property’s south building

had been completely destroyed and providing false information

regarding the building’s value. We shall deny respondent’s

motion to amend the pleadings.

The granting of a motion to conform the pleadings to the

evidence is within the discretion of the Court, tempered by sound

reason and fairness. Federated Graphics Cos. v. Commissioner,

T.C. Memo. 1992-347. Our review of the entire record in this

case convinces us that respondent was aware before trial of the

essential facts upon which his assertion of fraud is based. This

is demonstrated by an examination of respondent’s specific

allegations. Respondent relies primarily on the document
 - 22 -

petitioner gave to his accountant in support of the claimed

casualty loss deduction. Respondent notes petitioner’s claim in

the document of a loss of about $156,000 resulting from damage to

two buildings that rendered them completely useless, compared

with petitioner’s claim in the lawsuit against Atlas of a loss of

about $68,000 resulting from damage to one building. However,

respondent discussed this discrepancy in his trial memorandum,

which was served on petitioner more than 2 weeks before trial.

As further support for fraud, respondent cites the

discrepancy between petitioner’s claim in the document given to

his accountant that the Property’s two masonry buildings were

over 50 years old and rendered useless by the collapse, with

petitioner’s claim in a document given to the local board of

property assessment appeals (before the collapse) that the same

buildings were over 100 years old and not safe for use. However,

respondent almost certainly had both documents before trial. The

document petitioner gave his accountant had, at a minimum, been

exchanged prior to trial,13 and the document given to the board

of assessment appeals was mailed to respondent’s counsel more

than 2 weeks before trial.

13
Respondent did not cite any failure to receive this
document in advance of trial when petitioner sought to have it
admitted, whereas respondent did object to several other
documents on this ground.
 - 23 -

Respondent also cites the discrepancy between (i)

petitioner’s claim in the document given to his accountant and in

his petition that the buildings in issue were valuable before,

and useless after, the claimed casualty, and (ii) the testimony

of Mr. Keil, the building inspector, to the effect that the

buildings in question were being used after the roof collapse.

But Mr. Keil was respondent’s witness, and his testimony was

characterized in respondent’s trial memorandum as concerning the

buildings’ condition before and after the claimed casualty. Thus

respondent knew prior to trial that he had an independent witness

to contradict petitioner’s various assertions that the buildings

were rendered useless by the claimed casualty.

We conclude that the essential facts on which respondent

bases his allegations of fraud were known to respondent’s counsel

prior to trial. Under the circumstances of this case, the

failure to give notice to petitioner that he was required to

defend against fraud results in significant prejudice. Cf.

Pallante v. Commissioner, T.C. Memo. 1989-334 (counsel for

respondent sought amendment to pleadings to assert fraud after

trial, based on facts known prior to trial). While there is

evidence in the record that might support a finding that

petitioner committed fraud, petitioner was entitled to notice and

an adequate opportunity to rebut respondent’s evidence.

Accordingly, respondent’s motion to amend is denied.
 - 24 -

Casualty Loss Deduction

Respondent determined that petitioner is not entitled to a

casualty loss deduction of $155,836 claimed on the 1994 return.

We sustain respondent’s determination for the reasons discussed

below.

Section 165(a) permits a deduction for “any loss sustained

during the taxable year and not compensated for by insurance or

otherwise.” There is no question that the collapse of a portion

of the roof of the south building occurred in 1994 and was not

compensated for by insurance or otherwise. However, the

deduction under section 165 is allowed only for the year in which

the loss is “sustained”, as defined in section 1.165-1(d), Income

Tax Regs. Because we find that the loss in the instant case was

not sustained in 1994, the only year before us, we conclude the

deduction is not allowable in that year.

A loss is sustained when it is evidenced by closed and

completed transactions and fixed by identifiable events. Sec.

1.165-1(d)(1), Income Tax Regs. If the taxpayer has a claim for

reimbursement of a casualty loss and there is a reasonable

prospect of recovery, the casualty loss is not sustained until it

can be ascertained with reasonable certainty whether or not the
 - 25 -

reimbursement will be received. Sec. 1.165-1(d)(2)(i), Income

Tax Regs.14

Petitioner had a claim for reimbursement in this case. The

buildings were insured for replacement costs of up to $852,000

and petitioner had submitted a claim that was pending as of the

close of the taxable year at issue.15 Thus, we must decide

whether petitioner had a reasonable prospect of recovery.

Whether the taxpayer has a reasonable prospect of recovery is a

question of fact. Boehm v. Commissioner, 326 U.S. 287, 292-293

(1945); Estate of Wagner v. Commissioner, T.C. Memo. 1998-338.

We rely on objective facts primarily, but the taxpayer’s

14
Respondent disputes whether the roof collapse was a
casualty within the meaning of sec. 165, arguing that the
collapse resulted from the slow deterioration of the roof
trusses, and thus lacked the requisite suddenness to qualify as a
casualty. See Maher v. Commissioner, 76 T.C. 593 (1981), affd.
680 F.2d 91 (11th Cir. 1982). Neither party produced admissible
expert testimony on the cause of the collapse. Assuming arguendo
that the collapse constituted a casualty, it still must be shown
that there was no reasonable prospect of recovery during the year
in issue before petitioner would be entitled to the claimed
deduction. Because we hold that there was a reasonable prospect
of recovery during the year in issue, we need not, and do not,
decide whether the collapse was a casualty.
15
Although Julicher Sports, rather than petitioner, was the
named insured, petitioner does not argue that he had no claim for
reimbursement and therefore that he, as the only petitioner in
the instant case, should be entitled to a casualty loss
deduction. Indeed, petitioner owned the building and joined in
the lawsuit against Atlas. Moreover, Mr. Stewart, Atlas’s
attorney during the investigation of the claim, testified that
Atlas would have been “hard pressed” to deny coverage to
petitioner on the ground that he was not the named insured, since
his name was on the insurance policy in conjunction with the name
of Julicher Sports.
 - 26 -

subjective beliefs are also relevant. Estate of Wagner v.

Commissioner, supra; see Boehm v. Commissioner, supra; see also

Ramsay Scarlett & Co. v. Commissioner, 61 T.C. 795, 812 (1974),

affd. 521 F.2d 786 (4th Cir. 1975). Denial of liability by an

insurance company is one factor in deciding whether a reasonable

prospect of recovery exists, but not the sole factor. Gale v.

Commissioner, 41 T.C. 269, 276 (1963). The fact that a taxpayer

files a lawsuit to recover the loss gives rise to an inference of

a reasonable prospect of recovery. Dawn v. Commissioner, 675

F.2d 1077, 1078 (9th Cir. 1982), affg. T.C. Memo. 1979-479.

The evidence in this case shows that petitioner had a

reasonable prospect of recovery in 1994 with respect to his

claimed casualty loss. Although Atlas developed suspicions

regarding petitioner’s contents claim, Atlas sought a sworn proof

of loss in October 1994. At some point Atlas offered $22,000

with respect to the damage to the building. Petitioner rejected

it and was seeking to invoke an appraisal as of December 1994.

On December 21, petitioner intended to make repairs to the

building once the insurance proceeds were received. Petitioner

was still pursuing his claim in March 1995, when he gave

testimony in an examination under oath with a representative of

Atlas. There was no denial of coverage by Atlas until May 1995.

Further, petitioner and Julicher Sports filed suit against Atlas

in July 1995, asserting that petitioner was entitled to $137,460,
 - 27 -

a figure that encompassed his claim of damage to the building.16

Atlas filed its answer and counterclaims in August of that year.

Some time thereafter, the lawsuit was settled, with no damages

awarded.17

Based on the foregoing, we find that not only did petitioner

believe he had a reasonable prospect of recovery at the end of

1994, he in fact had a reasonable prospect of recovery with

respect to the building damage at the end of that year. Thus, we

sustain respondent’s disallowance of the deduction for 1994.

Depreciation Deduction

Petitioner claimed a depreciation deduction with respect to

the Property’s buildings of $4,179 for 1994. In an amendment to

answer, respondent asserted an increase in deficiency on the

ground that petitioner was not entitled to the claimed

depreciation. Respondent concedes he has the burden of proof on

this issue. See Rule 142(a). We hold that petitioner is

entitled to the depreciation deduction as claimed.

In support of his position, respondent argues that

petitioner improperly allocated basis between the Property’s

16
As noted in our Findings of Fact, the amount claimed by
petitioner in the lawsuit against Atlas is the sum of the repairs
estimated for the building ($68,365) and the amount of contents
damage asserted in the second claim ($70,095). Thus,
petitioner’s averments included a claim for compensation with
respect to damage to the building.
17
The date of the settlement is not in the record, although
it clearly occurred sometime after August 1995.
 - 28 -

buildings and land. When depreciable and nondepreciable property

are acquired together for a lump-sum purchase price, the

regulations under section 167 require basis to be apportioned

based on relative value at the time of purchase. Sec. 1.167(a)-

5, Income Tax Regs. Under the regulation, the ratio of (i) the

portion of the purchase price allocated as basis of the

depreciable property to (ii) the total purchase price cannot

exceed the ratio of (a) the value of the depreciable property to

(b) the value of the entire property. Id. Of the total purchase

price of $393,378, petitioner allocated $285,619 as basis in the

depreciable property, i.e., the buildings; thus, under

petitioner’s allocation the value of the buildings equaled

approximately 73 percent ($285,619 ÷ $393,378) of the value of

the whole. Respondent’s argument is that the value of the

buildings was proportionally less. We find that respondent has

failed to carry his burden of proof.

Respondent has not presented any appraisals or other

specific evidence of the value of the buildings and land at the

time petitioner purchased the Property. Rather, respondent

relies on more general evidence to cast doubt on petitioner’s

allocation, such as the fact that in 1988 (the year petitioner

acquired the Property), petitioner was issued a citation because

a portion of the south building was at risk of collapse.

Respondent’s argument, essentially, is that the buildings had
 - 29 -

little to no value and that petitioner bought the Property

solely, or primarily, for the land.

There is substantial independent evidence demonstrating that

respondent’s basic premise, that the buildings had little to no

value when acquired, is wrong. A loan officer for the bank

extending a $500,000 loan for petitioner’s purchase of the

Property recommended approval of the loan, on the grounds that

the buildings, although “old” and in “need of repair”, could be

rehabilitated to produce rental income to service the debt.

Moreover, in 1993 an unrelated insurer issued a policy providing

$852,000 in coverage for the buildings, and there was no evidence

of substantial capital improvements to the buildings between the

time of their acquisition by petitioner in 1988 and the issuance

of the policy. We believe it is unlikely an insurer would have

extended coverage of this magnitude for buildings of negligible

value. In addition, the land contained steep slopes and a flood

plain and was subject to maintenance and access easements held by

petitioner’s neighbor, the combination of which would suggest

that any attempt to use the land in a configuration other than

the one existing at the time would require considerable capital

investment. Given the lack of evidence of relative value offered

by respondent, we conclude that respondent has failed to carry

his burden of showing that petitioner is not entitled to the

depreciation deduction in the amount claimed on the 1994 return.
 - 30 -

Bad Debt Deductions-–Weinstein and Attieh Bros.

Petitioner claimed bad debt deductions for the amounts lent

to Ms. Weinstein and Attieh Bros. In the notice of deficiency,

respondent disallowed both deductions. Petitioner has the burden

of proof. Rule 142(a).18 We sustain respondent’s determination

on the ground that petitioner has not carried his burden of

proving that the debts became worthless during the year in issue.

The initial step in establishing entitlement to a bad debt

deduction is proof of a bona fide debtor-creditor relationship

that obligates the debtor to pay a fixed or determinable amount.

Calumet Indus., Inc. v. Commissioner, 95 T.C. 257, 284 (1990);

sec. 1.166-1(c), Income Tax Regs. A gift or contribution to

capital is not a debt. Calumet Indus., Inc. v. Commissioner,

supra; sec. 1.166-1(c), Income Tax Regs. We find that the loans

at issue were genuine debts. In both cases, loan agreements

providing for interest payments evidenced the existence of the

debts. See Lerma v. Commissioner, T.C. Memo. 1995-586; sec.

1.166-1(c), Income Tax Regs. Moreover, Ms. Weinstein’s business

and Attieh Bros. were going concerns at the time the loans were

made. See Lerma v. Commissioner, supra. Finally, the

communications between both Ms. Weinstein and the Attiehs and

18
Sec. 7491 does not apply to this case because the
examination commenced prior to July 22, 1998, the effective date
of that section. See Internal Revenue Service Restructuring and
Reform Act of 1998, Pub. L. 105-206, sec. 3001(c)(1), 112 Stat.
726.
 - 31 -

petitioner indicate that the parties to the loans intended

genuine debts. See id.

In order to be entitled to a bad debt deduction, petitioner

must prove that each debt had value at the beginning of 1994 and

became worthless during that year. Milenbach v. Commissioner,

106 T.C. 184, 204 (1996). There is no standard method to decide

worthlessness within the taxable year; rather, each case depends

on all its facts and circumstances. Id.; Crown v. Commissioner,

77 T.C. 582, 598 (1981). The year of worthlessness is generally

fixed by identifiable events that form the basis for reasonable

grounds for abandoning any hope of recovery. Milenbach v.

Commissioner, supra at 205; Crown v. Commissioner, supra at 598.

As for the Weinstein debt, we find petitioner has failed to

prove that any part of it became worthless during 1994. In

testimony, petitioner justified claiming the deduction in 1994

merely on the basis that it had been 5 years since he had made

the loan. However, “the fact that accounts are overdue, standing

alone, does not warrant deducting them as worthless.” Milenbach

v. Commissioner, supra at 205. Petitioner pointed to no

identifiable event that provided reasonable grounds for

abandoning hope of recovery of even a part of the debt in 1994.

Ms. Weinstein testified that she paid $60,000 in rent to

petitioner in 1994, and Mr. Finder recalled that Ms. Weinstein’s

rent payments made up “the bulk” of the $143,059 in rental income
 - 32 -

reported as one line item on the 1994 return. That rent was well

in excess of the $44,000 debt Ms. Weinstein owed petitioner,

suggesting her ability to pay. Moreover, even if Ms. Weinstein’s

successive businesses were “insolvent” at the end of each season,

as she told petitioner, she maintained the businesses as going

concerns, providing an apparent source from which to pay the

debt. Cf. Riss v. Commissioner, 56 T.C. 388, 408 (1971) (even

where liabilities of business exceed assets, fact that it

continues to operate as going concern is evidence that its debts

are not uncollectible), affd., revd. and remanded on another

issue 478 F.2d 1160 (8th Cir 1973), affd. sub nom. Commissioner

v. Transport Manufacturing & Equip. Co., 478 F.2d 731 (8th Cir.

1973). As respondent points out on brief, the fact that Ms.

Weinstein’s business, Indian Falls, failed in 1994, which might

suggest that she no longer had a source of income to pay the

debt, see Bowman v. Commissioner, T.C. Memo. 1995-259, is

unavailing to petitioner here: Ms. Weinstein began a new

business in July 1994. Thus, not only has petitioner failed to

point to an identifiable event indicating the debt was

uncollectible, the evidence shows that Ms. Weinstein had sources

from which to pay the debt. Petitioner has failed to prove the

Weinstein debt became worthless in 1994, and we sustain

respondent’s disallowance of the bad debt deduction.
 - 33 -

As for the Attieh Bros. debt, we reach the same conclusion.

Petitioner has not shown any identifiable event that occurred in

1994 which demonstrates the Attieh Bros. debt would not be

repaid.19 The most significant factor in our reaching this

conclusion is the fact that the Skating Palace continued to

operate as a going concern throughout 1994. See Riss v.

Commissioner, supra. Petitioner twice on brief cites the failure

of the Attieh Bros.’ business in support of his bad debt claim,

but the record establishes that the Skating Palace continued

operation until at least 1998.

In addition, we find it remarkable that the extensive

written correspondence, i.e., faxes, between petitioner and the

Attiehs concerning the loan and its repayment ends abruptly in

August 1993. The volume of this correspondence before 1993

demonstrates that it was petitioner’s and the Attiehs’ well-

established practice to communicate by fax concerning the loan.

They exchanged at least 11 such faxes in 1990, 7 in 1991, and 9

in 1992. Yet petitioner produced no faxes subsequent to an

19
Respondent disputes the amount of the debt, arguing (1)
that a portion of the $20,000 second loan amount was not part of
the debt since it was held back to pay amounts already owed by
the Attiehs to petitioner and (2) that a portion of both the
$50,000 original loan and the $20,000 second loan was equipment
rather than cash, and that petitioner, having failed to prove his
basis in the equipment, would be denied a deduction under sec.
166(b). Because we hold the entire bad debt deduction to be
disallowed because petitioner has not proven worthlessness during
the year in issue, we do not address these arguments.
 - 34 -

August 19, 1993 fax (in which the Attiehs represent that a

payment will be made in September). While it is clear that

petitioner and the Attiehs remained in close contact through the

time of trial, petitioner would have us believe that all contact

with the Attiehs after the August 19, 1993, fax was oral only.

On this record, we do not believe that the fax correspondence

between petitioner and the Attiehs ceased in August 1993. See

Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). We can conclude

only that petitioner was either unable or unwilling to produce

later faxes that might bear more directly on the prospects for

recovery in 1994.20 Petitioner bears the burden of proving that

the Attieh Bros. loan became worthless in 1994. The last piece

of documentary evidence shows that the Attiehs were still

attempting to make repayment arrangements into September of 1993.

Even if we believed no later faxes were sent, the testimony given

by petitioner and Thair is too vague to provide any basis to

conclude that the situation as documented in August 1993

specifically changed in 1994. On this record, we conclude that

petitioner has failed to show that the Attieh Bros. loan became

worthless in 1994.

20
The numerous instances in the record where petitioner
gave conflicting statements in connection with the casualty loss
have damaged his credibility with respect to all issues in the
case.
 - 35 -

Accordingly, we sustain respondent’s determination

disallowing the bad debt deductions claimed by petitioner in

1994.

Filing Status

Petitioner argues that he is entitled to joint filing status

(and the rates under section 1(a)) in accordance with section

6013(b), because the 1994 Form 1040 constitutes a joint income

tax return filed by petitioner and Mrs. Julicher after he filed

separately for taxable year 1994.21 Respondent argues that the

1994 Form 1040 relied on by petitioner is not a valid joint

return and consequently that petitioner did not elect to make a

joint return prior to the issuance of the notice of deficiency.22

We agree with respondent.

Section 6013 in general entitles married taxpayers to make a

joint income tax return. See sec. 6013(a). Section 6013(b)(1)

further provides that even where a taxpayer has filed a separate

21
Petitioner also argues that, because he elected to make a
joint return under sec. 6013(b), the notice of deficiency is
invalid because it was sent to him alone. Because we conclude
herein that petitioner has not validly elected to make a joint
return under that section, this argument is likewise without
merit.
22
Respondent also asserts that this issue was not raised on
a timely basis by petitioner but concedes there is no prejudice
to him so long as the parties’ stipulation characterizing the
1994 Form 1040 as an “amended return” is not treated as binding
on respondent for purposes of this issue. Since petitioner has
not sought to rely on the stipulation for this purpose, we find
no prejudice and shall decide the issue.
 - 36 -

return for a taxable year and the time prescribed for filing has

expired, the taxpayer may nevertheless make a joint return with

his or her spouse, subject to specified limitations. One such

limitation is that the election to make a joint return may not be

made after a notice of deficiency for the year at issue has been

mailed to either spouse, if the spouse files a timely petition

with the Tax Court. Sec. 6013(b)(2)(C). A joint return filed

pursuant to section 6013(b)(1) constitutes the spouses’ return

for the taxable year. Sec. 6013(b)(1).

Petitioner argues that the submission of the 1994 Form 1040

by his authorized representative to the revenue agent examining

his 1994 taxable year, where the agent requested that it be

submitted to her and represented that it should be considered

filed, coupled with the failure of the Internal Revenue Service

subsequently to advise petitioner that the 1994 Form 1040 had not

been accepted, should constitute an election to make a joint

return under section 6013(b). We hold that no election was made,

because the 1994 Form 1040 was not a valid joint return.

Entitlement to joint filing status requires the filing of a

valid joint return. Thompson v. Commissioner, 78 T.C. 558

(1982). A return that is not signed by either spouse, as in the

instant case, is not a valid return. Olpin v. Commissioner, 270

F.3d 1297, 1300 (10th Cir. 2001), affg. T.C. Memo. 1999-426.

Thus, regardless of whether the submission of the 1994 Form 1040
 - 37 -

to the examining agent herein constitutes filing, the document is

not a valid joint return. Cf. Olpin v. Commissioner, supra

(unsigned joint return is invalid return even though IRS had

treated it as filed, processed it as joint return, and accepted

payment of liability reflected thereon). Since the unsigned 1994

Form 1040 is not a valid return, petitioner failed to elect to

make a joint return prior to the issuance of the notice of

deficiency in this case. See sec. 6013(b)(2)(C).23

Petitioner appears to argue that various actions and/or

inactions24 by Internal Revenue Service personnel should

constitute a waiver of the signature requirement. However, the

signature requirement for purposes of a valid joint return may

not be waived by Internal Revenue Service personnel. Olpin v.

Commissioner, supra at 1301 (“acceptance cannot cure an invalid

return”); see also Lucas v. Pilliod Lumber Co., 281 U.S. 245

23
Sec. 6013(b)(2)(C) is currently codified as sec.
6013(b)(2)(B), effective for taxable years beginning after July
30, 1996. Taxpayer Bill of Rights 2, Pub. L. 104-168, sec.
402(a), 110 Stat. 1459 (1996).
24
In addition to the arguments already noted, petitioner
contends that the Internal Revenue Service failed to advise him
that his attempt to claim joint filing status had not been
accepted. In response, respondent points to the Form 4549,
Income Tax Examination Changes, prepared by the revenue agent and
dated Mar. 6, 1998, which is attached to the notice of
deficiency. Respondent contends that the Form 4549, which
employed a “Married - Separate” filing status, put petitioner on
notice that his claim of joint filing status had not been
accepted. The record in this case, however, does not establish
that the Form 4549 was provided to petitioner prior to the
mailing of the notice of deficiency.
 - 38 -

(1930) (signature requirement may not be waived by IRS personnel

for purposes of statute of limitations); Bachner v. Commissioner,

81 F.3d 1274, 1279-1280 (3d Cir. 1996) (to same effect); Doll v.

Commissioner, 358 F.2d 713, 714 (3d Cir. 1966) (to same effect

where purported joint return lacked signature of either spouse),

affg. T.C. Memo. 1965-191.

Thus, we are satisfied that the 1994 Form 1040 was not a

valid joint return, the notice of deficiency was properly issued

to petitioner alone, and petitioner is not entitled to the income

tax rates applicable to joint filers.

Addition to Tax and Accuracy-Related Penalty

In the notice of deficiency respondent determined an

addition to tax under section 6651(a)(1) and an accuracy-related

penalty under section 6662(a). In both his petition and his

amended petition, petitioner assigned error with respect to

respondent’s determination of the deficiency, but he did not do

so with respect to either the addition to tax or the accuracy-

related penalty. Respondent, in a letter to petitioner

initiating informal discovery before trial, and also in his trial

memorandum, stated that these issues would be treated as conceded

by petitioner because they were not mentioned in the petition.

See Rule 34(b)(4). Petitioner, in his trial memorandum, asserted

that the addition to tax and accuracy-related penalty were in

dispute. Nonetheless, petitioner, on brief, still did not
 - 39 -

address either the addition to tax or the accuracy-related

penalty.25 Thus, either because of petitioner’s failure to

assign error to these determinations in the petition, Rule

34(b)(4), or because petitioner has abandoned the issue on brief,

see Zidar v. Commissioner, T.C. Memo. 2001-200 (citing Bradley v.

Commissioner, 100 T.C. 367, 370 (1993)), we sustain respondent’s

determinations.

An Order and Decision will be entered denying respondent’s

oral motion to conform the pleadings to the proof, and decision

will be entered for respondent with respect to the deficiency,

addition to tax, and accuracy-related penalty, as set forth in

the notice of deficiency, and for petitioner with respect to the

increase in deficiency.

To reflect the foregoing,

An appropriate Order and

Decision will be entered.

25
The only statement petitioner makes on brief with respect
to these issues is to request a reduction in the deficiency and
“a corresponding reduction in interest and penalties assessed
thereon.”