Stukes v. Comm'r ( 2007 )


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  •                      T.C. Summary Opinion 2007-65
    UNITED STATES TAX COURT
    JOHN C. AND JOAN F. STUKES, Petitioners v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent
    Docket No. 16648-05S.             Filed April 26, 2007.
    John C. Stukes, pro se.
    David B. Mora, for respondent.
    JACOBS, 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.      Pursuant to section 7463(b),
    the decision to be entered is not reviewable by any other court,
    and this opinion shall not be treated as precedent for any other
    case.     Unless otherwise indicated, subsequent section references
    are to the Internal Revenue Code in effect for the year in issue,
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    and Rule references are to the Tax Court Rules of Practice and
    Procedure.
    Respondent determined a $7,908 deficiency in petitioners’
    2002 Federal income tax.   The issues for decision are:   (1) The
    amount of petitioners’ loss from farming; and (2) the amount of
    the excess unreimbursed employee and other miscellaneous expenses
    deduction1 to which petitioners are entitled.
    Background
    Some of the facts have been stipulated and are so found.
    The stipulation of facts and the attached exhibits are
    incorporated herein by this reference.   At the time they filed
    the petition, petitioners resided in Katy, Texas.
    Petitioners timely filed a joint Form 1040, U.S. Individual
    Income Tax Return, for 2002 in which they claimed:   (1) A loss
    from farming, and (2) itemized deductions for excess unreimbursed
    employee and other miscellaneous expenses.   Respondent determined
    that a portion of the amount claimed as a farm loss and the
    entire amount claimed as itemized deductions for excess
    unreimbursed employee and other miscellaneous expenses were not
    1
    The excess unreimbursed employee and other miscellaneous
    expenses deduction is claimed on Schedule A, Itemized Deductions.
    The amount of the deduction equals the sum of: (1) Unreimbursed
    employee expenses--job travel, union dues, job education, etc.;
    (2) tax preparation fees; and (3) other expenses--investment,
    safe deposit box, etc., less an amount equal to 2 percent (the 2-
    percent floor) of the taxpayer’s adjusted gross income. See sec.
    67(a).
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    allowable.   On the basis of those determinations, respondent
    calculated a deficiency in tax of $7,908 and on July 5, 2005,
    sent petitioners a notice of deficiency.    Petitioners timely
    petitioned this Court for a redetermination of the disallowed
    amounts.
    Discussion
    As a general rule, the Commissioner’s determinations in the
    notice of deficiency are presumed correct, and the burden of
    proving an error is on the taxpayer.   Rule 142(a); Welch v.
    Helvering, 
    290 U.S. 111
    , 115 (1933).   However, pursuant to
    section 7491(a), the burden of proof with respect to any factual
    issue relating to ascertaining the liability for tax shifts to
    the Commissioner if the taxpayer:   (1) Maintained adequate
    records; (2) satisfied the substantiation requirements; (3)
    cooperated with the Commissioner’s agents; and (4) during the
    Court proceeding introduced credible evidence with respect to the
    factual issue involved.   Except for the substantiation
    requirements for some items, discussed infra, we find that
    petitioners satisfied these requirements.
    Issue 1. Loss From Farming
    During 2002, petitioners owned a 45-acre farm in Williamson
    County, Texas.   In calculating their 2002 gross income,
    petitioners included a loss of $20,116, which was supported by
    Schedule F, Profit or Loss From Farming.    The Schedule F does not
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    report any farm income; the entire reported loss was due to
    claimed expenses.    The expenses petitioners reported on Schedule
    F were:   Car and truck expenses ($3,227), chemicals ($850),
    custom hire ($9,500), depreciation ($3,449), fertilizers ($550),
    gasoline ($350), insurance ($1,200), repairs and maintenance
    ($425), supplies purchased ($150), taxes ($250), and tractor
    repairs ($165).
    In the notice of deficiency, respondent determined that
    petitioners did not substantiate any of the items reported on
    Schedule F and therefore none were allowable.    At trial,
    respondent conceded petitioners’ entitlement to deduct $8,186 for
    custom hire, $1,850 for depreciation, $126.48 for taxes, and $350
    for gasoline, and petitioners conceded that $1,850 of claimed
    depreciation expense was not allowable.
    A taxpayer who is carrying on a trade or business generally
    may deduct ordinary and necessary expenses paid or incurred in
    connection with the operation of the business.    Sec. 162(a); see
    also Commissioner v. Lincoln Sav. & Loan Association, 
    403 U.S. 345
    , 352 (1971); FMR Corp. & Subs. v. Commissioner, 
    110 T.C. 402
    ,
    414 (1998).    Respondent does not dispute that petitioners’
    farming activity qualifies as a trade or business and that the
    expenses from this activity, if incurred, were ordinary and
    necessary.    Thus, we need address only whether the claimed
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    expenses were incurred, and if so, through substantiation, the
    amounts paid and hence allowable as deductions.
    When a taxpayer establishes that he/she has incurred
    deductible expenses but is unable to establish the exact amounts,
    we can estimate the deductible amounts, but only if the taxpayer
    presents sufficient evidence to establish a rational basis for
    making the estimates.    See Cohan v. Commissioner, 
    39 F.2d 540
    ,
    543-544 (2d Cir. 1930); Vanicek v. Commissioner, 
    85 T.C. 731
    ,
    742-743 (1985).   In estimating the amount allowable, we bear
    heavily on the taxpayer whose inexactitude in substantiating the
    amount of the expense is of his own making.    See Cohan v.
    Commissioner, supra at 544.    However, without a rational basis
    for making the estimate, any allowance we make would amount to
    unguided largesse.     Williams v. United States, 
    245 F.2d 559
    , 560-
    561 (5th Cir. 1957).
    In the case of expenses paid or incurred with respect to
    certain listed property, section 274 overrides the Cohan
    doctrine, and those expenses are deductible only if the taxpayer
    meets the stringent substantiation requirements of section
    274(d).   Sanford v. Commissioner, 
    50 T.C. 823
    , 827-828 (1968),
    affd. per curiam 
    412 F.2d 201
    (2d Cir. 1969).
    Section 274 contemplates that no deduction may be allowed
    for specified expenses on the basis of any approximation or the
    unsupported testimony of the taxpayer.    Sec. 1.274-5T(a),
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    Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).
    At a minimum, the taxpayer must substantiate:    (1) The amount of
    the expense; (2) the time and place the expense was incurred; and
    (3) the business purpose for which the expense was incurred.
    The strict substantiation requirements of section 274 apply
    to deductions with respect to “any listed property (as defined in
    section 280F(d)(4))”.   Section 280F(d)(4)(A)(i), in turn,
    includes “passenger automobile” in the definition of listed
    property.   Further, section 1.274-5T(b)(6)(i)(A), Temporary
    Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985), includes the
    cost of maintenance and repairs for listed property as subject to
    the section 274 substantiation rules.
    Petitioners claimed automobile expenses of $3,227; these
    expenses related to petitioners’ pickup truck.   Mr. Stukes
    testified that some substantiating documents pertaining to the
    automobile mileage were lost when petitioners moved.   However, he
    introduced a truck mileage log (the mileage log) with 24 entries.
    The mileage log, which shows that petitioners drove the truck
    6,684 miles for farm-related business, was not prepared
    contemporaneously with the incurrence of the claimed expenses but
    rather was a reconstruction by petitioners of their use of the
    truck.   The mileage log shows the date of each use and the
    specific destination (such as Home Depot, Wal-Mart, farm
    equipment vendors, gas stations, and truck supplies vendors).
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    The mileage log is supplemented by bank records which show
    purchases from the retail establishments or vendors on specific
    dates.   The date claimed for the business use of the truck in the
    mileage log does not correspond in every instance to the date of
    the related purchase shown on the bank records.   Further, neither
    the mileage log nor the bank records show the specific
    merchandise purchased from each seller, and it is possible that
    petitioners purchased items for their personal consumption as
    well as for their farm when they made these excursions using the
    truck.   It is equally possible that petitioners made additional
    trips to acquire farm equipment or supplies but did not actually
    make a purchase, so that there might have been additional mileage
    costs that do not appear in the mileage log.   In any event, Mr.
    Stukes testified that the trips shown on the mileage log were
    made for the purpose of acquiring farm equipment or supplies, and
    we found that testimony credible.   Therefore, we find that
    petitioners have met the substantiation requirements of section
    274 with respect to trips on dates for which there is a
    corresponding purchase from a vendor of farm equipment or
    supplies.   Consequently, we hold that petitioners are entitled to
    deduct the cost of using their truck on those occasions.
    Of the 44 occasions on which petitioners claim to have used
    their truck for the purpose of acquiring farm supplies or
    equipment, there are records which confirm farm-related purchases
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    on 22 of those occasions (or within a day or two of the claimed
    date for those occasions).2    The total number of miles
    petitioners drove the truck for the purpose of acquiring farm
    equipment or supplies on those 22 occasions was 2,368.
    Petitioners did not present receipts for the actual cost of this
    use, but we may apply the standard mileage rate to determine the
    allowable deduction.3    The standard mileage rate for 2002 was
    36.5 cents per mile.    Accordingly, the total allowable expense
    for farm-related use of the truck amounted to $864.32.
    Petitioners’ mileage log contains three entries pertaining
    to automobile maintenance and repair that are corroborated by
    bank records, showing purchases of $224.99.4    In addition,
    petitioners submitted a credit card receipt for $100 of repairs
    to the truck.
    2
    The dates of use   that are matched by substantiating
    purchases are: Feb. 2    and 18; Mar. 3, 13, 16, and 18; May 6, 7,
    and 24; July 5 and 17;   Aug. 5, 14 (two purchases on Aug. 14), and
    31; Sept. 1, 2, 3 (two   purchases on Sept. 3), 16, and 21; Oct. 1
    and 10; and Nov. 29.
    3
    The standard mileage rate is a matter of administrative
    convenience by which a taxpayer may compute the amount of
    deductible automobile expenses using a standard rate rather than
    separately establishing the amount of an expenditure for travel
    or transportation. Sec. 1.274-5(j), Income Tax Regs., in part,
    grants the Commissioner the authority to establish a method under
    which a taxpayer may use mileage rates to substantiate, for
    purposes of sec. 274(d), the expense of using a vehicle for
    business purposes. See Rev. Proc. 2001-54, 2001-2 C.B. 530.
    4
    These dates are: Mar. 13, Mar. 16, and Nov. 29. The
    corresponding claimed expenses are $141.79, $69.20, and $14.
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    Thus, petitioners have substantiated that they spent $324.99 for
    maintenance and repair of the truck.
    The deduction for automobile expenses based on the standard
    rate may be used only in lieu of all operating and fixed costs of
    the automobile allocable to business purposes such as
    depreciation, maintenance and repairs, tires, gasoline (including
    all taxes thereon), oil, insurance, and license and registration
    fees.   See sec. 1.274-5(j)(2), Income Tax Regs.; Rev. Proc. 2001-
    54, 2001-2 C.B. 530.    As stated previously, petitioners are
    entitled to a deduction based on the standard rate.    This amount
    ($864.32) exceeds the amount of the deduction to which
    petitioners would be entitled for the corroborated maintenance
    and repair of the truck ($324.99).
    On Schedule F of their 2002 return, petitioners claimed $850
    of expenses for purchase of chemicals for use on their farm.
    Petitioners’ mileage log, 
    described supra
    , indicates that
    petitioners purchased chemicals from Home Depot on various
    occasions in 2002.    Petitioners’ bank records establish that
    payment was made to Home Depot at or near the date indicated by
    petitioners on nine occasions.    The total amount of these
    purchases was $491.    Consequently, we hold that petitioners are
    entitled to a deduction of $491 for farm chemicals.
    Other amounts petitioners claimed as deductible farm
    expenses and disallowed by respondent include custom hire
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    ($1,314), depreciation ($1,599), fertilizers ($550), insurance
    ($1,200), supplies purchased ($150), and taxes ($123.52).   Of
    these amounts, we find substantiation for $39.87 for supplies.5
    In addition, we accept Mr. Stukes’s testimony that petitioners
    paid $1,200 for farm insurance for 2002.   We therefore hold that
    these amounts are allowable deductions.
    The amounts for custom hire and depreciation were
    unsubstantiated.   The amounts claimed as deductions for
    fertilizers and taxes were also unsubstantiated.   As there is no
    rational basis upon which we can estimate the amounts of these
    expenses, we hold that they are not deductible.
    Issue 2. Schedule A Deductions
    We now turn to the amount of the excess unreimbursed
    employee and other miscellaneous expenses deduction to which
    petitioners are entitled.   On Schedule A of their 2002 return,
    petitioners reported itemized deductions of $72,921.   Respondent
    disallowed $39,048 of this amount, which consisted of claimed
    unreimbursed employee business expenses of $7,930, attorney’s and
    accountant’s fees of $32,610, and tax preparation fees of $20,
    reduced by 2 percent of petitioners’ adjusted gross income.6
    5
    Petitioners’ mileage records and corresponding bank records
    show purchases of supplies on Sept. 3 and Oct. 1.
    6
    See supra note 1.
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    The unreimbursed employee business expenses consisted of job
    search expenses incurred by Mr. Stukes.    Mr. Stukes worked in the
    computer industry, and during part of 2002 had been employed in
    Austin, Texas, as a software development manager for a company
    that produced energy software.   In 2002, he was involuntarily
    terminated from that job, which led him to file a complaint with
    the Equal Employment Opportunity Commission (EEOC), alleging that
    his termination was the result of age discrimination.      While that
    matter was pending, Mr. Stukes commenced an intensive search for
    a new job and succeeded in finding employment in January of 2003.
    During his search for employment, Mr. Stukes provided his
    attorney with documentation to assist with the preparation of the
    EEOC proceeding.   He testified that this documentation had
    subsequently been destroyed.
    Job search expenses are deductible under section 162(a) to
    the extent they are incurred in searching for new employment in
    the employee’s same trade or business.    See Primuth v.
    Commissioner, 
    54 T.C. 374
    , 377-378 (1970).   However, if the
    employee is seeking a job in a new trade or business, the
    expenses are not deductible under section 162(a).   See Frank v.
    Commissioner, 
    20 T.C. 511
    , 513-514 (1953).   Job search expenses
    include preparation expenses, postage, and travel and
    transportation expenses.   See Murata v. Commissioner, T.C. Memo.
    1996-321.
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    Petitioners’ claimed deduction for job search expenses of
    $7,930 consisted of:   The cost of transportation to job
    interviews, the cost of retaining a search firm to assist with
    the search, and the cost of preparing and printing Mr. Stukes’s
    calling cards, résumé, and envelopes.   Respondent does not
    dispute that petitioners would be entitled to deduct these
    expenses if they substantiated them adequately, but respondent
    maintains that they failed to do so.
    As discussed supra, section 274, which imposes strict
    substantiation requirements, applies to transportation expenses
    involving a “passenger automobile”.    In order to establish the
    number of miles Mr. Stukes drove pursuant to his job search,
    petitioners submitted a log captioned “Job Search Mileage
    Expenses/Deductions” (petitioners’ job search mileage log) which
    was not prepared contemporaneously with the interviews but rather
    was prepared on the basis of contemporaneous calendar records and
    bank statements that show costs incurred on specific dates.
    It appears from the record that Mr. Stukes was terminated
    from his employment in June 2002.   We find that petitioners’ job
    search mileage log, taken together with the calendar, bank
    records, and Mr. Stukes’s credible testimony, substantiates the
    transportation expense in search of a job between June and
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    December 2002, to the extent of 1,137 miles.7      The standard
    mileage rate for 2002 was 36.5 cents per mile.8      Consequently, the
    total allowable mileage expense is $415.
    Petitioners incurred expenses in retaining a search firm to
    help Mr. Stukes with his job search.       We find that petitioners’
    records and Mr. Stukes’s testimony substantiate these expenses to
    the extent of $1,300.
    Petitioners also incurred expenses in preparing and printing
    Mr. Stukes’s calling cards, résumé, and envelopes.       We find that
    petitioners’ records and Mr. Stukes’s testimony substantiate
    these expenses to the extent of $1,100.
    On Schedule A of their 2002 return, petitioners reported
    attorney’s fees and accountant’s fees of $32,610, all of which
    was disallowed by respondent.       The attorney’s fees stem from a
    controversy involving the sale of real property in May of 2001.
    Petitioners had acquired the property (the Lakeshore property) in
    2000.       At the time of acquisition, petitioners intended to
    renovate the Lakeshore property and resell it at a profit.
    Petitioners were successful, and they reported $7,633 of capital
    7
    In reaching this amount, we excluded miles driven before
    Mr. Stukes was terminated from his job, miles driven in pursuit
    of the Equal Employment Opportunity Commission (EEOC) claim, and
    miles for which there is no corresponding bank record or calendar
    entry.
    8
    See supra note 3.
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    gain from the sale of the Lakeshore property on their 2001
    Federal income tax return.
    Difficulty arose at the time of closing the sale of the
    Lakeshore property in 2001.   Petitioners believed that the real
    estate agent who had organized the sale had damaged the Lakeshore
    property and the contents of the house, consisting of
    furnishings, appliances, and other personal property.9
    Petitioners therefore refused to pay the realtor’s commission and
    instead placed an amount equal to the realtor’s commission in an
    escrow account.   When negotiation and mediation attempts failed,
    the realtor brought suit against petitioners in the District
    Court of Llano County, Texas, seeking payment of the commission
    as well as recovery of attorney’s fees.   Petitioners
    counterclaimed, alleging negligence, conversion, breach of
    contract, and violation of the Texas Deceptive Trade Practices-
    Consumer Protection Act set forth in Tex. Bus. & Com. Code Ann.
    secs. 17.41-17.63 (Vernon, 2002).   Specifically, petitioners
    alleged that they had been deprived of personal property
    consisting of household furnishings and appliances that had been
    in the Lakeshore property.    The realtor prevailed in the district
    court proceeding, and the amount of the realtor’s commission was
    released from the escrow account.   The realtor was also awarded
    9
    At the trial of this case, Mr. Stukes testified that the
    personal property was already in the house when petitioners
    bought it.
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    his attorney’s fees of $12,750, which petitioners paid in
    September of 2002.   During 2002, petitioners paid their attorney10
    for services in connection with the lawsuit brought by the
    realtor and paid $250 for mediation services.   We are unable to
    determine the exact amount that petitioners paid their attorney
    because although petitioners submitted bank records which show
    that such payments were made, they redacted the amounts.
    Respondent contends that petitioners have not shown that the
    Lakeshore property was other than their second home, for which
    Schedule A itemized deductions are not available.   Further,
    respondent contends that even if Schedule A itemized deductions
    were appropriate in connection with the lawsuit involving the
    Lakeshore property, petitioners have not shown the extent to
    which the litigation costs were related to the realtor’s demand
    for the commission on the sale of the property as opposed to
    petitioners’ counterclaims with respect to damage to their
    personal property.
    Payment of litigation costs may result in a tax benefit in
    one of three ways.   Section 162(a) governs the deductibility of
    litigation costs as a business expense.   Section 162(a) allows an
    individual to deduct all of the ordinary and necessary expenses
    of carrying on his trade or business.   Closely related to this
    10
    At trial, petitioners conceded that they had erroneously
    included in the Schedule A amount some payments to their attorney
    that had been made in 2001.
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    provision is section 212, which allows an individual to deduct
    all of the ordinary and necessary expenses paid or incurred in:
    (1) Producing income, (2) managing, conserving, or maintaining
    property held for the production of income, or (3) determining,
    collecting, or refunding a tax.   Sections 162(a) and 212 are
    considered in pari materia, except the income-producing activity
    of section 162(a) is a trade or business whereas the income-
    producing activity of section 212 is a pursuit of investing or
    other profit-making that lacks the regularity and continuity of a
    business.   Guill v. Commissioner, 
    112 T.C. 325
    , 328 (1999).      A
    deduction under 162(a) reduces gross income to arrive at adjusted
    gross income, while a deduction under section 212 reduces
    adjusted gross income to arrive at taxable income.11
    Id. Neither party contends
    that the Lakeshore property was property used in a
    trade or business under section 162.
    A third possible treatment of litigation costs that may
    confer a tax benefit is as a capital expenditure.    See sec. 1221;
    Woodward v. Commissioner, 
    397 U.S. 572
    , 575 (1970).    Litigating
    costs that are incurred in connection with the sale of a capital
    asset are capital expenditures.   Sec. 1211(b)(1).    A capital
    asset is property held by the taxpayer and not specifically
    excluded from capital asset status by section 1221.    Sec.
    11
    The sec. 212 deduction is reported on Schedule A and is
    subject to the 2-percent floor. See supra note 1.
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    1221(a).   The regulations under section 1221 provide that
    “Property held for the production of income, but not used in a
    trade or business of the taxpayer, is not excluded from the term
    ‘capital assets’”.   Sec. 1.1221-1(b), Income Tax Regs.
    The Lakeshore property was a capital asset in petitioners’
    hands, and petitioners properly reported the gain on the sale of
    the Lakeshore property as capital gain in 2001.   Petitioners’
    expenditures for the legal fees and expenses arose in connection
    with the disposition of the Lakeshore property, rather than with
    its conservation or maintenance, and are therefore capital
    expenditures.
    Respondent contends that the legal costs borne by
    petitioners did not relate to the sale of the Lakeshore property
    but rather, at least in part, to petitioners’ counterclaim
    against the realtor for damages with respect to petitioners’
    personal property.   Consequently, according to respondent, the
    legal costs are personal items which under section 262 are not
    deductible.
    The proper characterization of legal fees and expenses is
    governed by the “origin of the claim” test.    Woodward v.
    Commissioner, supra at 577-578.   The object of the “origin of the
    claim” test is to find the transaction or activity from which the
    taxable event proximately resulted.    United States v. Gilmore,
    
    372 U.S. 39
    , 47 (1963).   The origin is determined by analyzing
    - 18 -
    the facts and determining the nature of the transaction.       Keller
    St. Dev. Co. v. Commissioner, 
    688 F.2d 675
    , 681 (9th Cir. 1982),
    affg. T.C. Memo. 1978-350.
    Petitioners do not dispute that commissions are generally
    payable to a realtor in connection with the sale of property.
    Petitioners believed that the commission they owed the realtor
    should have been reduced or entirely offset by damages due to
    them from the realtor.   Petitioners withheld the realtor’s
    commission in an attempt to ensure that they would be compensated
    for the loss allegedly caused by the realtor.     A lawsuit ensued,
    and petitioners incurred legal fees in defending their actions.
    But for the sale of the Lakeshore property, petitioners
    would not have incurred realtor’s commission.     Had they not
    disputed the realtor’s commission, petitioners would not have
    incurred the legal fees at issue.    Thus, the origin of the
    realtor’s claim and the proximate cause of all of petitioners’
    legal fees was the sale of the Lakeshore property, a capital
    asset in the hands of petitioners.     Therefore, we hold that
    petitioners’ payment of legal fees in 2002 constituted a capital
    expenditure.12
    12
    Petitioners showed that they paid $21.64 for the purchase
    of tax preparation software. This expense might be deductible
    but for the fact that it appears to have been incurred and paid
    in 2003. Therefore, respondent properly disallowed this amount
    for 2002.
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    Petitioners may offset any capital gains they had in 2002
    with their capital losses, and they are allowed an additional
    capital loss deduction of up to $3,000 per year for the excess
    losses that cannot be offset by capital gains.   Sec. 1211(b).
    Petitioners’ excess capital losses may be carried over to
    subsequent years.   Sec. 1212(b).
    On their 2002 return, petitioners reported a capital loss
    carryover of $38,427 from 2001 as well as a short-term capital
    loss from 2002.   The expenses petitioners incurred in 2002
    relating to the sale of the Lakeshore property in 2001 should be
    aggregated with (and increase) the capital loss carryover
    petitioners already reported for 2002.
    Petitioners realized no tax benefit in 2002 from the payment
    of attorney’s fees relating to the disposition of their capital
    asset in 2001.    However, those expenditures may be beneficial in
    future periods.   Only the year 2002 is before us; we do not
    address the treatment of petitioners’ capital losses in
    subsequent years.
    To reflect the foregoing and concessions by the parties,
    Decision will be entered
    under Rule 155.