LENEHAN v. COMMISSIONER

T.C. Summary Opinion 2002-124

UNITED STATES TAX COURT

WILLIAM LENEHAN III AND BARBARA LENEHAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2653-01S. Filed October 2, 2002.

Andrew Shabshelowitz, for petitioners.

Christine Colley, for respondent.

ARMEN, Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time that the petition was filed.1 The decision to

be entered is not reviewable by any other court, and this opinion

should not be cited as authority.

1
Unless otherwise indicated, all subsequent section and
subtitle references are to the Internal Revenue Code in effect
for 1997, the taxable year in issue, and all Rule references are
to the Tax Court Rules of Practice and Procedure.
 - 2 -

Respondent determined a deficiency in petitioners’ Federal

income tax for 1997 in the amount of $6,062.

The only issue for decision is whether investment income, as

defined by section 163(d)(4)(B), includes a long-term capital

loss carryover (loss carryover) for purposes of calculating the

section 163(d)(1) limitation on the investment interest expense

deduction. We hold that it does.

Background

This case was submitted fully stipulated under Rule 122. We

incorporate by reference the parties’ stipulation of facts and

accompanying exhibits.

Petitioners resided in Sarasota, Florida, at the time their

petition was filed with the Court.

A. Petitioners’ Form 1040 for 1997

Petitioners timely filed a joint Form 1040, U.S. Individual

Income Tax Return, for 1997. Petitioners attached to their Form

1040 the following Schedules and Forms that are pertinent to this

case: Schedule A, Itemized Deductions; Schedule B, Interest and

Dividend Income; Schedule D, Capital Gains and Losses; Form 4797,

Sales of Business Property; and Form 4952, Investment Interest

Expense Deduction.

On Schedule A, petitioners claimed, inter alia, a $26,721

investment interest expense deduction. Petitioners calculated

this amount on Form 4952, as shown below:
 - 3 -
Part I. Total Investment Interest Expense
Line 1. Investment interest expense
paid or accrued in 1997 $2,505
Line 2. Disallowed investment interest
expense from 1996 Form 4952, line 7 24,216
Line 3. Total investment interest expense 26,721

Part II. Net Investment Income
Line 4a. Gross income from property held for
investment (excluding any net gain from the
[1]
disposition of property held for investment) 5,044
Line 4b. Net gain from the disposition
of property held for investment $114,738
Line 4c. Net capital gain from the
disposition of property held for
investment 65,721
Line 4d. Subtract line 4c from line 4b 49,017
Line 4e. Enter all or part of the amount
on line 4c that you elect to include
in investment income 0
Line 4f. Investment Income.
Add lines 4a, 4d, and 4e. 54,061
Line 5. Investment expenses 0
Line 6. Net investment income.
Subtract line 5 from line 4f. 54,061

Part III. Investment Interest Expense Deduction
Line 7. Disallowed investment interest
expense to be carried forward to 1998.
Subtract line 6 from line 3. 0
Line 8. Investment interest expense deduction.
Enter the smaller of line 3 or 6. 26,721

1
This is the total amount of petitioners’ interest ($1,075) and
dividend ($3,969) income reported on Schedule B.

Petitioners calculated most of the lines on Form 4952 from

Schedule D, column f, where they reported the following amounts:

Line 1. Short-term capital gains and losses $4,002
Line 2. Enter your short-term totals,
if any, from Schedule D-1, line 2 45,015
Line 7. Net short-term capital gain or (loss) $49,017
Line 8. Long-term capital gains and losses (3,601)
Line 9. Enter your long-term totals,
if any, from Schedule D-1, line 9 69,322
[1]
Line 11. Gain from Form 4797, Part I * * * 12,751
Line 14. Long-term capital loss carryover (141,621)
Line 16. Net long-term capital gain or (loss) (63,149)

1
This gain resulted from petitioners’ sale of a condominium that was
sec. 1250 property and, therefore, was not included as an item of investment
income. See sec. 163(d)(4)(D).
 - 4 -

Petitioners also reported an overall capital loss of $14,132

as follows:

Net long-term capital loss ($63,149)
Net short-term capital gain 49,017
1
Overall capital loss (14,132)
1
On Form 1040, Line 13 (Capital gain or (loss)), petitioners deducted
the maximum of $3,000 of the $14,132 overall capital loss against ordinary
income. See sec. 1211(b). Petitioners carried forward the remaining $11,132
of net capital loss pursuant to sec. 1212(b)(1)(B).

In addition, petitioners calculated the $114,738 net gain

(Form 4952, line 4b) and the $65,721 net capital gain (Form 4952,

line 4c) as follows:

Schedule D, line 8 $(3,601)
Schedule D, line 9 69,322
NET CAPITAL GAIN 65,721
Plus: Net Short-Term Capital Gain 49,017
NET GAIN 114,738

Petitioners did not include their $141,621 loss carryover as

an item of investment income. Petitioners determined that

because their net investment income of $54,061 was greater than

their total investment interest expense of $26,721, they were

entitled to take a full deduction of $26,721 for investment

interest expense.

B. Respondent’s Deficiency Notice

In the notice of deficiency, respondent disallowed $21,677

of petitioners’ $26,721 investment interest expense deduction on

the basis that the deductible amount is limited to petitioners’

net investment income of $5,044. Respondent determined that

petitioners’ $141,621 loss carryover was an item of investment

income and, therefore, resulted in zero net gain, zero net
 - 5 -

capital gain, and net investment income of $5,044. Respondent

recalculated petitioners’ Form 4952 as shown below:

Part I. Total Investment Interest Expense
Line 1. Investment interest expense
paid or accrued in 1997 $2,505
Line 2. Disallowed investment interest
expense from 1996 Form 4952, line 7 24,216
Line 3. Total investment interest expense 26,721

Part II. Net Investment Income
Line 4a. Gross income from property held for
investment (excluding any net gain from the
disposition of property held for investment) 5,044
Line 4b. Net gain from the disposition
of property held for investment $0
Line 4c. Net capital gain from the
disposition of property held for
investment 0
Line 4d. Subtract line 4c from line 4b 0
Line 4e. Enter all or part of the amount
on line 4c that you elect to include
in investment income 0
Line 4f. Investment Income.
Add lines 4a, 4d, and 4e. 5,044
Line 5. Investment expenses 0
Line 6. Net investment income.
Subtract line 5 from line 4f. 5,044

Part III. Investment Interest Expense Deduction
Line 7. Disallowed investment interest
expense to be carried forward to 1998.
Subtract line 6 from line 3. 21,677
Line 8. Investment interest expense deduction.
Enter the smaller of line 3 or 6. 5,044

Respondent’s disallowance of $21,677 of petitioners’

investment interest expense deduction increased petitioners’

taxable income by $21,677 and resulted in a deficiency in income

tax of $6,062. Respondent further determined that petitioners

may carryforward and deduct in 1998 the $21,677 of investment

interest expense disallowed for 1997.2

2
We cannot (and do not) decide whether petitioners are
entitled to such a deduction because only the 1997 tax year is
before us. Sec. 7442.
 - 6 -

Discussion3

The parties do not dispute petitioners’ entitlement to an

investment interest expense deduction under section 163(a), but

the parties do dispute the calculation of that deduction. The

main issue of contention between the parties is whether the term

“investment income”, as defined by section 163(d)(4)(B), includes

petitioners’ loss carryover for purposes of calculating the

limitation on the investment interest expense deduction.

The parties have not cited any case deciding the narrow

legal question presented herein, and we are not aware of any such

case. In resolving this issue, we rely on section 163(d) and its

underlying framework and legislative history.

A. Statutory Framework

The starting point for the interpretation of a statute is

the language itself. Consumer Prod. Safety Comm. v. GTE

Sylvania, Inc., 447 U.S. 102, 108 (1980); see also United States

v. Bryant, 671 F.2d 450, 453 (11th Cir. 1982); Warbelow’s Air

Ventures, Inc. v. Commissioner, 118 T.C. 579, 583 (2002). We

interpret the statute with reference to the legislative history

primarily to learn the purpose of the statute and to resolve any

ambiguity in the words contained in the text. Allen v.

3
We need not decide whether sec. 7491, concerning burden of
proof, applies to the present case because the facts are not in
dispute and the issue is one of law. See Higbee v. Commissioner,
116 T.C. 438 (2001).
 - 7 -

Commissioner, 118 T.C. 1, 7 (2002) (and cases cited therein); see

also City of New York v. Commissioner, 103 T.C. 481, 489 (1994),

affd. 70 F.3d 142 (D.C. Cir. 1995). Moreover, even where the

statutory language appears clear, we may seek out any reliable

evidence as to legislative purpose. City of New York v.

Commissioner, supra.

1. Section 163

For individual taxpayers, section 163(a) allows a deduction

for all interest paid or accrued within the taxable year on

indebtedness. Section 163(d), however, limits the amount of the

investment interest expense deduction to the taxpayer’s net

investment income for the taxable year.4 In other words, the

higher the taxpayer’s net investment income, the more investment

interest expense the taxpayer is allowed to deduct for the

taxable year. Furthermore, section 163(d)(2) allows the taxpayer

to carryforward any investment interest expense disallowed under

the general limitation for the taxable year and deduct it as

investment interest expense paid or accrued in the succeeding

taxable year to the extent that the taxpayer has investment

income in that year.

4
The Tax Reform Act of 1969, Pub. L. 91-172, sec. 221(a), 83
Stat. 478, 574, originally enacted sec. 163(d) effective for
taxable years beginning after Dec. 31, 1971.
 - 8 -

Section 163(d)(4)(A) defines net investment income as the

excess of investment income over investment expense. Section

163(d)(4)(B),5 in turn, defines investment income as follows:

(B) Investment Income.--The term “investment
income” means the sum of–-

(i) gross income from property held for
investment (other than any gain taken into
account under clause (ii)(I)),

(ii) the excess (if any) of–-

(I) the net gain attributable
to the disposition of property held
for investment, over

(II) the net capital gain
determined by only taking into
account gains and losses from
dispositions of property held for
investment, plus

(iii) so much of the net capital gain
referred to in clause (ii)(II) (or, if
lesser, the net gain referred to in clause
(ii)(I)) as the taxpayer elects to take into
account under the clause. [Emphasis added.]

At issue in the instant case is the calculation of section

163(d)(4)(B)(ii). To that end, the meaning of the terms “net

gain” and “net capital gain” are integral to our analysis.

2. Net Gain

Neither section 163, the regulations, the case law, nor the

statute’s legislative history defines the term “net gain”. If a

5
The Omnibus Budget Reconciliation Act of 1993, Pub. L. 103-
66, sec. 13206(d)(1), 107 Stat. 312, 467, amended sec.
163(d)(4)(B) effective for taxable years beginning after Dec. 31,
1992.
 - 9 -

term is used in the Internal Revenue Code (I.R.C.) without

definition and the legislative history fails to provide any

insight or guidance as to the appropriate definition, we will use

the ordinary and common usage of the term in applying that

provision. Texaco Inc. and Subs. v. Commissioner, 101 T.C. 571,

575 (1993), affd. 98 F.3d 825 (5th Cir. 1996); see Commissioner

v. Brown, 380 U.S. 563, 570-571 (1965); Crane v. Commissioner,

331 U.S. 1, 6-7 (1947); Rome I, Ltd. v. Commissioner, 96 T.C.

697, 704 (1991); Union Pac. Corp. v. Commissioner, 91 T.C. 32,

38-40 (1988); First Sav. & Loan Association v. Commissioner, 40

T.C. 474, 482 (1963). We look, therefore, to the ordinary and

common usage of the term “net gain” in applying the statute.

Neither Black’s Law Dictionary (6th ed. 1990) nor Webster’s

Third New International Dictionary (1993) specifically defines

the term “net gain”. However, the ordinary and common usage of

the term “net gain” connotes the pecuniary gain remaining after

offsetting gains against losses. Presumably, a prerequisite to

the existence of net gain is that the taxpayer’s gains exceed the

taxpayer’s losses.

Black’s Law Dictionary 957 (7th ed. 1999) defines the term

“net loss” as “The excess of all expenses and losses over all

revenues and gains.” By analogy, the natural, ordinary, and

familiar meaning of the term “net gain” is the excess of all
 - 10 -

gains over all losses.6 Therefore, we conclude as a matter of

law that the term “net gain” for purposes of section 163(d)(4)(B)

means the excess, if any, of total gains over total losses from

the disposition of property held for investment.7

3. Capital Gains and Losses

Sections 1201 through 1223 generally define capital gains

and losses under Subtitle A, Income Taxes, unless otherwise

indicated.8 Accordingly, we turn to sections 1222 and 1212 to

define the term “net capital gain”.

Section 1222(11) defines the term “net capital gain” as “the

excess of the net long-term capital gain for the taxable year

over the net short-term capital loss for such year.” (Emphasis

added.) The phrase “long-term” applies to the category of gains

and losses arising from the sale or exchange of capital assets

held for more than 1 year; the phrase “short-term” applies to the

category of gains and losses arising from the sale or exchange of

6
See, e.g., similar definitions under sec. 1222(9) that
defines “capital gain net income” as “the excess of the gains
from the sales or exchanges of capital assets over the losses
from such sales or exchanges”, and under sec. 1.469-
2T(e)(3)(ii)(E)(3), Temporary Income Tax Regs., 53 Fed. Reg. 5719
(Feb. 25, 1988), that defines “net gain” for purposes of that
section as “the amount by which the gains from the sale of all of
the property * * * exceed the losses (if any) from such sale”.
7
We note that respondent has adopted this view and has
utilized this definition on Form 4952, General Instructions, for
Line 4b.
8
Subtitle A includes sec. 163.
 - 11 -

capital assets held for 1 year or less. Sec. 1.1222-1(a), Income

Tax Regs; see also sec. 1222(1) through (4). The term net short-

or long-term capital gain means the excess of the short- or long-

term gains over the short- or long-term losses for a given tax

year, as the case may be. Sec. 1222(5), (7). The term net

short- or long-term capital loss means the excess of the short-

or long-term losses over the short- or long-term gains for a

given tax year, as the case may be. Secs. 1222(6), (8).

In the definition of “net long-term capital gain”, the prior

year’s long-term capital loss that is carried forward to the

current taxable year under section 1212(b)(1)(B)9 is treated as a

long-term capital loss for such taxable year. Sec. 1.1222-

1(b)(2), Income Tax Regs. Furthermore, the pertinent parts of

the regulations provide:

[A] long-term capital loss carryover shall be carried
over to the succeeding taxable year and treated as a
long-term capital loss sustained in such succeeding
taxable year. The carryovers are included in the
succeeding taxable year in the determination of the
amount of the short-term capital loss, the net short-
term capital gain or loss, the long-term capital loss,
and the net long-term capital gain or loss in such
year, the net capital loss in such year, and the
capital loss carryovers from such year. [Sec. 1.1212-
1(b)(1), Income Tax Regs.; emphasis added.]

9
Sec. 1212(b)(1) provides in pertinent part: “If a taxpayer
other than a corporation has a net capital loss for any taxable
year, * * * (B) the excess of the net long-term capital loss over
the net short-term capital gain for such year shall be a long-
term capital loss in the succeeding taxable year.”
 - 12 -

B. Legislative History

Section 163(d) was enacted to curb the practice of using the

investment interest expense deduction to offset taxable income

(e.g., noninvestment income) in a current taxable year; i.e., to

prevent the "mismatching" of investment income and investment

expenses.10

As relevant to this case, the Tax Reform Act of 1969 (TRA

1969), Pub. L. 91-172, sec. 221(a), 83 Stat. 478, 574, initially

limited the deduction for investment interest expense to $25,000,

plus the amount of net investment income, plus the amount of

long-term capital gain.11 Again as relevant to this case, the

TRA 1969 amendment defined investment income as (i) the gross

income from interest and dividends, (ii) the net short-term

capital gain attributable to the disposition of property held for

investment, and (iii) any amount treated under sections 1245 and

1250 as ordinary income. See sec. 163(d)(3)(B), I.R.C. 1954 as

amended by TRA 1969.

10
H. Rept. 91-413, at 72 (1969), 1969-3 C.B. 200, 245,
states in pertinent part:

Where the taxpayer's investment, however, produces
little current income, the effect of allowing a current
deduction for the interest is to produce a mismatching
of the investment income and related expenses of
earning that income. In addition, the excess interest,
in effect, is used by the taxpayer to offset other
income, such as his salary, from taxation.
11
Sec. 163(d)(1)(C), I.R.C. 1954 as amended by TRA 1969, is
similar to the sec. 163(d)(4)(B)(ii)(II) net capital gain prong.
 - 13 -

In 1976, Congress revised section 163(d) to reduce the use

of this deduction to shelter noninvestment types of income.12

See sec. 209(a) of the Tax Reform Act of 1976 (TRA 1976), Pub. L.

94-455, 90 Stat. 1520, 1542. The definition of investment income

remained unchanged, but the TRA 1976 amendment eliminated any

offset of investment interest expense against long-term capital

gain. Id.

In 1986, Congress expanded the scope of the investment

interest expense limitation and altered the calculation of the

limitation by including “any net gain attributable to the

disposition of property held for investment”. Sec. 511(a) of the

Tax Reform Act of 1986 (TRA 1986), Pub. L. 99-514, 100 Stat.

2085, 2320; see H. Conf. Rept. 99-841 (1986), 1986-3 C.B. (Vol.

4) 152, wherein the conference committee articulated the intent

to expand the definition of investment income “to include the

same items as under * * * [TRA 1976] plus the taxable portion of

net gain from the disposition of investment property.”13

(Emphasis added.) The TRA 1986 amendment allowed capital gains

12
See H. Rept. 94-658 at 102, 1976-3 C.B. (Vol. 2) 695, 794;
S. Rept. 94-938 at 106, 1976-3 C.B. (Vol. 3) 49, 144; Staff of
Joint Comm. on Taxation, General Explanation of the Tax Reform
Act of 1976 at 103 (J. Comm. Print 1976).
13
See also H. Rept. 99-426, 1986-3 C.B. (Vol. 2) 300
(“[investment income] also includes the nondeductible portion of
net long-term capital gain on investment property.”); S. Rept.
99-313, 1986-3 C.B. (Vol. 3) 805 (“[investment income] also
includes the gain on investment property.”).
 - 14 -

to be taken into account as investment income primarily because

capital gain and ordinary income were taxed at the same rates.14

However, by 1992, the tax rate differential had widened,

thereby encouraging individuals to structure their transactions

in order to maximize their capital gain potential. Therefore, in

1993, Congress reversed the treatment of capital gains under

section 163(d)(4)(B) so that net capital gain was again excluded

from investment income unless the taxpayer expressly elected to

include it.15 See sec. 13206(d) of the Omnibus Budget

Reconciliation Act of 1993, Pub. L. 103-66, 107 Stat. 312, 467.

The purpose of this amendment was to prevent a taxpayer who

recognizes long-term capital gain taxed at a favorable capital

gain rate from using that same gain to deduct otherwise

nondeductible investment interest expense against ordinary

14
See Staff of Joint Comm. on Taxation, General Explanation
of the Tax Reform Act of 1986:

Under prior law, no part of long-term capital gains were
included in net investment income. Congress concluded that
the continuation of this rule was inappropriate because
long-term capital gains are generally taxed at the same
effective rate as ordinary income when the Act is fully
phased in.”
* * * * * * *

Investment income includes * * * gain (whether long-term or
short-term) attributable to the disposition of property held
for investment * * *. [Comm. Print 1987 at 263, 265.]
15
Sec. 1.163(d)-1(a), Income Tax Regs., further provides
that “As a consequence, the capital gains affected by this
election are not eligible for the maximum capital gain rate of 28
percent.”
 - 15 -

income. See H. Rept. 103-111, at 641-642 (1993), 1993-3 C.B.

167, 217-218; H. Conf. Rept. 103-213, at 578 (1993), 1993-3 C.B.

393, 456. To that end, Congress intended to account for

“taxable” capital gains for purposes of section 163(d). To

accept a broader reading to include nontaxable capital gains

would thus defeat the purpose of the section 163(d)(1)

limitation.

C. Analysis

For the reasons stated below, we conclude that petitioners’

loss carryover is an item of investment income under section

163(d)(4)(B) and, accordingly, that it serves to limit

petitioners’ investment interest expense deduction to $5,044.

Petitioners contend that respondent mischaracterized their

investment income by including the loss carryover. Petitioners

argue that section 163(d)(4)(ii) requires inclusion of only their

short-term capital gains and, furthermore, that net gain and net

capital gain do not require inclusion of their loss carryover.

On brief, petitioners argue that Zohoury v. Commissioner, T.C.

Memo. 1983-597, and section 4940(c)(4)(C) support their

contention. We reject petitioners’ arguments.

First, petitioners’ reliance on Zohoury is misplaced. The

issue in Zohoury involved whether interest paid on an intra-

family indebtedness constituted investment interest. After

concluding that the taxpayers’ intrafamily indebtedness interest
 - 16 -

constituted investment interest, the Court then discussed the

investment interest expense deduction limitation for the limited

purpose of determining the taxpayers’ allowable deduction for the

taxable year. The Court did not address the treatment of a loss

carryover for purposes of calculating investment income because

the taxpayers did not have a loss carryover. Furthermore, at the

time Zohoury was decided, net investment income did not include

long-term capital gain. See TRA 1976 sec. 209(a), 90 Stat. 1542.

Therefore, the Court in Zohoury did not undertake the type of

substantive analysis of the term “investment income” that is

required here.

Second, petitioners' reading of the statute is at odds with

the plain language of the statute. Essentially, petitioners

attempt to attach the phrase "short-term gain” under the TRA 1976

amendment to the current definition of investment income, even

though the phrase does not appear anywhere in section

163(d)(4)(B)(ii). If Congress intended investment income to

include only short-term gain, the phrase "short-term gain" would

have remained in the definition of investment income, which it

does not. If we were to adopt petitioners’ reading of the

statute, we would render meaningless Congress’s explicit

reference in section 163(d)(4)(B)(ii) to the terms “net gain” and

“net capital gain”. Clearly, Congress did not intend this

result, nor do we adopt it.
 - 17 -

Lastly, petitioners argue that the reference in section

4940(c)(4)(C) to "no capital loss carryovers" clearly means that

investment income does not include the loss carryover for

purposes of section 163(d). We disagree.

Section 4940(c)(4)(C) defines the term “net investment

income”, in part, as follows:

(1) In General.--For purposes of subsection (a),
the net investment income is the amount by which (A)
the sum of the gross investment income and the capital
gain net income exceeds (B) the deductions allowed by
paragraph (3). Except to the extent inconsistent with
the provisions of this section, net investment income
shall be determined under the principles of subtitle A.

* * * * * * *

(4) Capital Gains and Losses.--For purposes of
paragraph (1) in determining capital gain net income

* * * * * * *

(C) Losses from sales or other
dispositions of property shall be allowed
only to the extent of gains from such sales
or other dispositions, and there shall be no
capital loss carryovers. [Emphasis added.]

However, section 4940 (Excise Tax Based on Investment

Income) is applicable to Subtitle D--Miscellaneous Excise Taxes,

Chapter 42A--Private Foundations and Other Certain Tax-exempt

Organizations. Here, we are dealing with income taxes on

individual taxpayers; i.e., Subtitle A--Income Taxes, rather than

an excise tax on a private foundation or tax-exempt organization.

In addition, there is no cross-reference between sections 4940

and 163(d) to make section 4940 applicable to this case.
 - 18 -

Furthermore, section 4940(c)(1) specifically provides that

“except to the extent inconsistent with the provisions of this

section, net investment income shall be determined under the

principles of subtitle A.” The rule under section 4940(c)(4)(C)

specifically excluding capital loss carryovers from the

calculation of capital gains and losses applies only to excise

taxes, and not to the present case. Consequently, section

4940(c)(4)(C) does not support petitioners’ interpretation of the

term “investment income” under section 163(d)(4)(B). As

pertinent to our inquiry, we rely on section 163(d)(4)(B) as the

controlling definition for the term “investment income” in

conjunction with sections 1212 and 1222.

We now turn to the amount of petitioners’ investment income.

Petitioners carried forward from 1996 a $141,621 long-term

capital loss. Sec. 1212(b)(1)(B). This carryover is treated as

a long-term capital loss for 1997. Sec. 1.1222-1(b)(2), Income

Tax Regs. Accordingly, the loss carryover is included in 1997

for purposes of calculating petitioners’ long-term capital loss,

net long-term capital loss, net capital loss, and capital loss

carryover to 1998. Sec. 1.1212-1(b)(1), Income Tax Regs. It

follows, then, that it is included in the calculation of net gain

and net capital gain in 1997 for purposes of section
 - 19 -

163(d)(4)(B)(ii). This gives petitioners a $75,90016 long-term

capital loss, and therefore, zero net capital gain. Net gain is

also equal to zero because total gains do not exceed total losses

($49,017 less $75,900). Therefore, petitioners have net

investment income of $5,044 and an allowable investment interest

expense deduction of $5,044.

Petitioners selectively chose to include the loss carryover

when it placed them in a better tax position. Thus, petitioners

included the loss carryover for purposes of calculating the

$3,000 capital loss deduction. If petitioners had not included

the loss carryover when calculating their overall capital loss,

they would have had an overall capital gain rather than a capital

loss.

We hold as a matter of law that petitioners’ loss carryover

is an integral part of the equation in calculating investment

income under section 163(d)(4)(B). Were the loss carryover not

included, petitioners would receive a double tax benefit. Under

petitioners’ approach, long-term capital gains would be offset by

the loss carryover and not subjected to taxation. Then, those

same capital gains that escaped taxation would be used to

increase investment income and, simultaneously, the investment

interest expense deduction. Essentially, petitioners would

16
This is the sum of Schedule D, lines 8, 9, and 14 (-$3,601
+$69,322 -$141,621).
 - 20 -

shelter noninvestment income with nontaxable income (e.g.,

capital gains offset by the loss carryover). This double tax

benefit is clearly not permitted by section 163(d).

D. Conclusion

We hold that investment income, as defined by section

163(d)(4)(B), requires inclusion of petitioners’ loss carryover

for purposes of calculating the section 163(d)(1) limitation on

the investment interest expense deduction. We hold further that

petitioners’ investment interest expense deduction is limited to

$5,044. In view of the foregoing, we sustain respondent’s

determination on the disputed issue.

We have considered all of the other arguments made by

petitioners and, to the extent that we have not specifically

addressed them, we find them to be without merit.

Reviewed and adopted as the report of the Small Tax Case

Division.

To reflect the foregoing,

Decision will be entered

for respondent.