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and tax-exempt interest beyond the mere fact that petitioners
reported tax-exempt interest while claiming deductions for
interest.
We also have credible testimony from petitioner that
petitioners’ only source of tax-exempt interest was from Mrs.
Burris’ inheritance. The record does not indicate that
petitioners used tax-exempt securities as collateral for the
indebtedness at issue, nor that petitioners incurred indebtedness
to purchase tax-exempt securities. Respondent improperly applied
section 265(a)(2), and we hold for petitioners on this issue.
3. Section 163(d)
Respondent argued at trial that part of the investment
interest deductions should be disallowed under section 163(d)(1).
Section 163(d)(1) provides that a deduction of investment
interest may not exceed net investment income. Net investment
income is defined as the excess of investment income over
investment expenses. See sec. 163(d)(4)(A). Investment income
includes gross income from property held for investment and any
net gain from the disposition of property held for investment.
See sec. 163(d)(4)(B). Property held for investment includes
property which produces income of a type described in section
469(e)(1). See sec. 163(d)(5)(A). Section 469(e)(1) property
includes gross income from interest, dividends, annuities, and
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