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amount of rent was not excessive, as established by their expert
witness, and that the rental payments are deductible under
section 162.
Section 162(a)(3) generally provides that a taxpayer may
deduct rent paid in carrying on a trade or business. Section
162(a)(3) does not specifically limit deductions for rental
payments to a "reasonable allowance." Levenson & Klein, Inc. v.
Commissioner, 67 T.C. 694, 715 (1977). Nevertheless, if there is
a close relationship between the lessor and lessee, "an inquiry
into what constitutes reasonable rental is necessary to determine
whether the sum paid is in excess of what the lessee would have
been required to pay had he dealt at arm's length with a
stranger." Id. at 715 (quoting Place v. Commissioner, 17 T.C.
199, 203 (1951), affd. per curiam 199 F.2d 373 (6th Cir. 1952)).
A close relationship between lessor and lessee does not mean that
a valid lease agreement between them cannot exist. Feldman v.
Commissioner, 84 T.C. 1, 5 (1985), affd. 791 F.2d 781 (9th Cir.
1986); Kansas City S. Ry. v. Commissioner, 76 T.C. 1067, 1102
(1981). Therefore, we are required to examine the circumstances
surrounding the arrangement to determine whether the rent was in
excess of the amount which an unrelated lessee would have paid in
an arm's-length transaction. W.H. Braum Family Partnership v.
Commissioner, T.C. Memo. 1993-434; see also Harmon City, Inc. v.
United States, 733 F.2d 1381, 1383 (10th Cir. 1984).
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