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$2,414. Petitioners did not report any gain or loss with respect
to the foreclosures on the ten parcels in their 1994 and 1995 tax
returns.
On January 11, 1994, Franz Huber and Nancy Huber (the
Hubers) and petitioners entered into a "Lease with Option to
Purchase" (lease). Pursuant to the lease, throughout the term of
the lease which began on March 1, 1994, and ended on February 28,
1997, the Hubers agreed to lease to petitioners, and petitioners
agreed to pay the Hubers monthly rent of $2,200 for, certain real
property located in Temecula, California, which petitioners used
as their personal residence (personal residence). The Hubers
also granted to petitioners in the lease the option to purchase
for $389,000 the personal residence, which petitioners could
exercise at any time during the period March 1, 1994, through
February 28, 1997, by giving 60 days' written notice to the
Hubers. Petitioners did not claim any mortgage loan interest
deductions with respect to the personal residence in their 1994
return.
In the notice of deficiency (notice) issued to petitioners
for 1994, respondent disallowed the expenses that they claimed in
their 1994 Schedule C because they did not establish that those
expenses were paid or incurred during 1994 and/or that they were
ordinary and necessary expenses within the meaning of section
162(a). Respondent further determined in the notice that the net
profit that petitioners reported in their 1994 Schedule C should
be increased by the amount of those disallowed expenses and that,
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