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life savings, in a "lock box". Petitioners bought and sold tax-
free municipal bonds through their account at Merrill Lynch,
investing approximately $10,000 in 1983, $60,000 in 1984, and
$40,000 in 1985. In addition, during 1984, petitioners purchased
City of Brooksville bonds for $20,277.50 and New Jersey Economic
Development Authority bonds for $41,191.67 through Jay Milton
Newton, Inc., which they later transferred to their Merrill
Lynch account.
Petitioners purchased a 56' sailboat on April 17, 1985, for
$125,000. They purchased two warehouses on April 29, 1986, for
$372,000. Petitioners paid for the sailboat and the warehouses
without the use of financing; their Merrill Lynch account served
as the conduit for the funds. Petitioners sold nearly all of the
bonds in the Merrill Lynch account to help fund the purchase of
the warehouses on April 29, 1986.
Tax Returns and Audits
Petitioners did not file income tax returns for the taxable
years 1979 through 1983. Petitioners filed joint income tax
returns for 1984 through 1986, which they prepared themselves.
Attached to each of the 1984 through 1986 tax returns were
Schedules C (Profit or (Loss) from Business or Profession),
wherein petitioners reported income and expenses on the cash
method of accounting from the manufacture and sale of marine air
conditioners operating under the name of DJM Enterprises. The
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