- 43 -
the expense, even if made, does not qualify as a de-
ductible expense under well-settled legal principles or
when no substantial legal argument can be made to
support its deductibility. Ordinarily, a deduction
having no basis in fact or in law can be described as
frivolous, fraudulent, or, to use the word of the
committee report, phony. [Fn. ref. omitted.]
That a deduction is disallowed does not necessarily mean that it
has no basis in fact or in law within the meaning of section
6013(e)(2)(B). See id. at 763.
Ms. Gordon concedes that Mr. Gordon's 1986 net trading loss
to which the claimed 1988 NOL deduction is attributable was, in
fact, sustained by Mr. Gordon during 1986. She argues, however,
that the claimed 1988 NOL deduction is grossly erroneous because,
pursuant to section 1256(a)(3), Mr. Gordon's 1986 net trading
loss to which that deduction is attributable is a capital loss,
and, consequently, that loss is not a net operating loss that the
Gordons are entitled to carry over to years after 1986. Respon-
dent counters that the claimed 1988 NOL deduction is not grossly
erroneous because it is not frivolous, fraudulent, or phony.
We note initially that Ms. Gordon is wrong in claiming that
section 1256(a)(3) mandates capital loss treatment for Mr.
Gordon's 1986 net trading loss. It is section 1256(f)(3)(A), and
not section 1256(a)(3), that requires that any gain or loss from
trading of section 1256 contracts be treated as gain or loss from
the sale or exchange of a capital asset, unless the hedging
exception in section 1256(f)(3)(B) applies. Section 1256(a)(3)
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