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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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