John H. and Mary E. Douglas - Page 8

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          finding, that petitioners included in their gross income the                
          $21,900 of unpaid principal from the second deed.  Under the                
          installment reporting method, gain is not recognized until                  
          payments are received.  Sec. 453(c).  Since petitioners did not             
          receive payments and never would report gain which corresponded             
          to the $21,900 loss, petitioners never created a basis on which a           
          later bad debt deduction could be claimed.  See Lombard v.                  
          Commissioner, T.C. Memo. 1994-154, affd. per curiam without                 
          published opinion 57 F.3d 1066 (4th Cir. 1995).  They also did              
          not report as income the $9,160 in accrued interest and late fees           
          attributable to the second deed.  Since petitioners did not                 
          include in income any of the total amount of $31,060 in unpaid              
          principal, interest, and late fees from the second deed, they are           
          not entitled to a bad debt deduction under section 166.                     
                    (b) Legal Expenses in 1992                                        
               A deduction for a bad debt is limited to a bona fide debt.             
          Sec. 1.166-1(c), Income Tax Regs.  A taxpayer must establish the            
          validity of a debt before any portion of it may be deducted under           
          section 166.  American Offshore, Inc. v. Commissioner, 97 T.C.              
          579, 602 (1991); sec. 1.166-1(c), Income Tax Regs.  A bona fide             
          debt is defined as one which arises from a debtor-creditor                  
          relationship based upon a valid and enforceable obligation to pay           
          a fixed or determinable sum of money.  Sec. 1.166-1(c), Income              
          Tax Regs.                                                                   

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