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expenses that petitioners deducted as a bad debt in 1992 was not
a bona fide debt and, therefore, not deductible as a business bad
debt. Finally, respondent determined that the $2,500 in legal
expenses deducted in tax year 1992 and the $3,171 in legal
expenses deducted in tax year 1993 are nonbusiness expenses
properly allowable as miscellaneous itemized deductions.
Discussion
1. Bad Debt Deduction
(a) Second Deed
Section 166(a) generally allows a deduction for any bona
fide debt that becomes worthless during the taxable year. Bad
debts may be characterized as either business bad debts or
nonbusiness bad debts. Sec. 166(d). A taxpayer is not entitled
to a deduction for a worthless debt under section 166 in
connection with an income item unless it has been included in the
taxpayer's gross income for Federal income tax purposes either
for the year for which the deduction is claimed or for a prior
year. Gertz v. Commissioner, 64 T.C. 598, 600 (1975); O'Meara v.
Commissioner, 8 T.C. 622, 633 (1947); sec. 1.166-1(e), Income Tax
Regs. This principle also applies to interest owed to a taxpayer
but never reported as income. W.L. Moody Cotton Co. v.
Commissioner, 2 T.C. 347, 353-357 (1943), affd. 143 F.2d 712 (5th
Cir. 1944).
Petitioners sold the Fort Washington property in 1989.
Petitioners do not contend, nor does the record support a
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