Jeffrey and Karen Winter - Page 7




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          Profit or Loss From Business, attached to their 1994 Form 1040,             
          U.S. Individual Income Tax Return, petitioners deducted $82,971             
          for legal and professional services and $17,712 for consulting.             
          These amounts included costs for legal counsel, accounting work,            
          and the appraisal.                                                          
               Respondent’s examination of petitioners’ 1994 return                   
          commenced in January 1997.  On March 3, 2000, respondent issued             
          petitioners a notice of deficiency determining that petitioners’            
          deductions for legal and consulting fees were not deductible                
          because the fees were incurred in connection with the                       
          establishment of the purchase price of the Truckee Hotel.                   
                                       OPINION                                        
               The issue for decision is whether legal and consulting fees            
          incurred in maintaining a lawsuit against a seller of property              
          are deductible as ordinary and necessary business expenses under            
          section 162.2  Respondent contends that the legal and consulting            
          fees must be capitalized pursuant to section 263(a) because they            
          arose out of, and were incurred in connection with, petitioners’            
          acquisition of the Truckee Hotel, a capital asset.3  Petitioners            
          argue that capitalization is not required because:  (1) The fees            
          were postacquisition expenditures not related to the purchase of            


               2Unless otherwise indicated, all section references are to             
          the Internal Revenue Code in effect for the year in issue.                  
               3Petitioners do not dispute that the Truckee Hotel was a               
          capital asset.                                                              





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