                        T.C. Memo. 1998-79



                      UNITED STATES TAX COURT



          TRINITY MEADOWS RACEWAY, INC., JACK M. LENAVITT,
     A PERSON OTHER THAN THE TAX MATTERS PERSON, Petitioner
          v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 16315-96.              Filed February 25, 1998.



     Jack M. Lenavitt, pro se.

     Lynn M. Brimer, Trevor T. Wetherington, and Oksana O. Xenos,

for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:   Jack M. Lenavitt petitioned the Court to

readjust respondent's adjustments to subchapter S corporation

items reported by Trinity Meadows Raceway, Inc. (Trinity), for

1991.   On April 14, 1996, respondent issued a notice of final
                               - 2 -


S corporation administrative adjustment, stating, with respect to

1991, that respondent had increased Trinity's ordinary income by

$233,661 and disallowed its $2,028,750 casualty loss in full.

Following petitioner's concession of the correctness of

respondent's adjustment to Trinity's ordinary income, we must

decide whether Trinity may deduct the casualty loss.    We hold it

may not.   Unless otherwise stated, section references are to the

Internal Revenue Code in effect for the year in issue.    Rule

references are to the Tax Court Rules of Practice and Procedure.

                         FINDINGS OF FACT

     Some of the facts have been stipulated.   The stipulated

facts and the exhibits submitted therewith are incorporated

herein by this reference.   Trinity was incorporated in 1988 and

elected subchapter S status as of January 1, 1989.   It filed a

1991 Form 1120S, U.S. Income Tax Return for an S Corporation, on

September 15, 1992.   At all times relevant herein, its principal

place of business was on property (the Property) located at 130

Trinity Meadows Lane, Willow Park, Texas.   The Property consists

of four tracts of land measuring 99.916 acres, 33.597 acres, .6

acres, and 69.391 acres, respectively.   Two rivers run along or

through the Property's borders.

     Trinity's original shareholders purchased the Property on

March 6, 1987, intending to develop it for parimutuel racing,

which would later be legalized in the State of Texas.    At the
                                - 3 -


time of purchase, the Property contained an old, quarter horse

racetrack with dilapidated improvements, and the Property could

not be used for parimutuel racing.      Among other things, the

Property was located in a floodplain, and the racetrack was

partially situated in a floodway.    A floodway generally is the

riverbed of a stream that is designated by the Government as an

area of land susceptible to flooding, and that is limited by the

Government as to the types of improvements that may be built

thereon.    Land within a floodway cannot be reclaimed, but

building may occur on the land if the water level is not raised

by 1 foot or more, and no hazardous velocities of water are

created.    A floodplain generally is an area of land that is

adjacent to a floodway.    Land in a floodplain may be reclaimed,

in whole or in part, and used for certain designated purposes as

long as an engineering plan and design for the land meet Federal

standards and are approved by the appropriate governmental

agencies.    Land in a floodplain is reclaimed by strengthening the

land to lift it out of the floodplain.

     Trinity needed a special permit to develop the Property

because it was located in a floodplain.      On February 15, 1989,

Trinity applied to Willow Park for such a permit, and this permit

was later granted.    On June 19, 1989, the Texas Racing Commission

(TRC) granted Trinity a class 2 horse racing license, and,

shortly thereafter, Trinity began substantial development
                               - 4 -


activities and incurred major expenses to develop the Property

for horse racing under the license.

     Trinity retained the firm of F.P. Greenhaw, III, Inc.,

Engineers & Planners, to prepare and submit studies of the

Property in order to develop the plan that was required under the

applicable laws.   Trinity constructed a berm along a portion of

the Property to reclaim from the floodplain the area in which the

barns and grandstands were to be erected.   The land underneath

the barns and grandstands were removed from the floodplain, and

none of Trinity's racetrack was in a floodway.   Trinity made the

necessary land improvements to construct an oval track, parking

lots, bridges, ditches, banks, and other related items.

     In March 1991, Trinity retained a developer named Dennis

Moore to devise a plan to develop the track surface.   A racetrack

consists of three distinct and separate levels; namely, the sub-

base, the base, and the cushion.   The sub-base is the bottom

layer, and it consists of materials acquired from the underlying

excavation project.   The base is the middle layer, and it

provides a concretelike foundation for the top layer (the

cushion), which is a soft surface on which the horses race.     The

cushion consists of sand, silt, and clay, and these materials are

"fluffed up" daily.

     Trinity opened for business on May 29, 1991.   Shortly

thereafter, it became evident that the track's cushion had too
                               - 5 -


much clay in that clay was collecting at the bottom of the

cushion and on top of the base.    This problem created unsafe

conditions for the horses and the jockeys, and, in early

September 1991, the guild of jockeys boycotted the track for fear

for their safety.   In response to this boycott, the TRC asked Mr.

Moore to inspect the track to ascertain whether it was safe.

     Mr. Moore and his assistant, Joe Fallwell, inspected the

track in September 1991, and they concluded that soft spots in

the track made the track unsafe.    During their inspection,

Messrs. Moore and Fallwell pulled back the track's cushion and

found that clay was breaking away from the base and rising into

the cushion.   The consultants recommended that the entire cushion

be "peeled back" and screened to remove most of the clay.      This

was done.   The entire cushion was peeled back and run through a

screening process, and, after fresh sand was added to the

cushion, the newly filtered cushion was layered back onto the

track.   After this process was complete, the track was considered

safe for racing, and Trinity resumed its racing activities

shortly thereafter.

     Beginning on or about December 18, 1991, and continuing for

approximately the next 4 days, heavy rains fell in Willow Park,

and significant portions of the Property were inundated by a

major flood that spewed raging water onto it and damaged the
                               - 6 -


Property extensively.1   The damage was attributable mainly to the

flooding of the parking lots, racetrack, paddock area, ditches,

banks, driveways, and other related areas, including the ground

surrounding the barns.   The racetrack was significantly damaged

by the flood, and the flood washed out portions of the back side

of the embankment and created other problems with respect to the

existing land improvements.   Little, if any, damage was done to

the buildings.

     Trinity was forced to cancel races on December 20, 21, and

22, 1991.   The cushion problems that had been remedied during the

fall of 1991 were considerably different from the more serious

damage to the cushion occasioned by the flood.    The flood washed

away or redistributed the entire cushion material and caused a

major new problem to the base in that the base was now wet and

spongy.   The banking areas of the track and the sub-base eroded

on account of water damage.   The base was damaged directly by the

flood and indirectly by the impact of the flood on the sub-base.

The base no longer had the rigidity to hold up.

     The land immediately adjacent to the barns where the horses

had to walk also was damaged by the flood.   Significant amounts

of silt were washed into that area, and a good portion of the

area adjacent to the barn area was rendered useless until

     1
       In view of the extensive flooding in and around Willow
Park, President Bush declared the area a qualified Federal
disaster area.
                                        - 7 -


extensive silt could be removed.             The paddock area was eroded

significantly.

      Trinity claimed a $2,028,750 casualty loss on its 1991 tax

return for damage caused by the flood, attributing the loss to

the following assets:
                                               Fair           Fair
                                 Adjusted    Market Value   Market Value
Casualty
                                   Basis     Before Flood   After Flood       Loss
Land improvements &             $3,102,000   $8,378,713      $7,137,913    $1,240,800
  site preparation
Track, etc.                        613,500      1,657,105     1,403,792       253,313
Paddock                            563,000      1,520,701     1,379,951       140,750
Barns and surrounding area       1,456,800      3,934,916     3,541,029       393,887
  Total                                                                     2,028,750

Respondent disallowed the loss in full.

                                      OPINION

      We must decide whether Trinity may deduct the casualty loss

reported on its return.          Respondent determined that it could not

deduct any of this loss, and petitioner must prove respondent's

determination wrong.          Rule 142(a); Welch v. Helvering, 290 U.S.

111 (1933).     Petitioner also must prove Trinity's right to the

claimed deduction.           Deductions are a matter of legislative grace.

New Colonial Ice Co. v. Helvering, 292 U.S. 435 (1934).

      The parties' dispute centers on section 165 and the

regulations thereunder.

      Section 165 provides in part:

      SEC. 165. LOSSES.

           (a) General Rule.--There shall be allowed as a
      deduction any loss sustained during the taxable year
      and not compensated for by insurance or otherwise.
                              - 8 -


          (b) Amount of Deduction.--For purposes of
     subsection (a), the basis for determining the amount of
     the deduction for any loss shall be the adjusted basis
     provided in section 1011 for determining the loss from
     the sale or other disposition of property.

          (c) Limitation of Losses of Individuals.--In the
     case of an individual, the deduction under subsection
     (a) shall be limited to--

               (1) losses incurred in a trade or
          business;

               (2) losses incurred in any transaction
          entered into for profit, though not connected
          with a trade or business; and

               (3) * * * losses of property not
          connected with a trade or business or a
          transaction entered into for profit, if such
          losses arise from fire, storm, shipwreck, or
          other casualty, or from theft.

Section 1.165-7, Income Tax Regs., provides in part:

          §1.165-7. Casualty losses.--(a) In general--(1)
     Allowance of deduction. * * * any loss arising from
     fire, storm, shipwreck, or other casualty is allowable
     as a deduction under section 165(a) for the taxable
     year in which the loss is sustained. * * * The amount
     of a casualty loss shall be determined in accordance
     with paragraph (b) of this section. * * *

               (2) Method of Valuation. (i) In
          determining the amount of loss deductible
          under this section, the fair market value of
          the property immediately before and
          immediately after the casualty shall
          generally be ascertained by competent
          appraisal. This appraisal must recognize the
          effects of any general market decline
          affecting undamaged as well as damaged
          property which may occur simultaneously with
          the casualty, in order that any deduction
          under this section shall be limited to the
          actual loss resulting from damage to the
          property.
                         - 9 -


          *    *    *    *       *   *   *

     (b) Amount deductible--(1) General rule. In the
case of any casualty loss whether or not incurred in a
trade or business or in any transaction entered into
for profit, the amount of loss to be taken into account
for purposes of section 165(a) shall be the lesser of
either--

               (i) The amount which is equal
          to the fair market value of the
          property immediately before the
          casualty reduced by the fair market
          value of the property immediately
          after the casualty; or

               (ii) The amount of the
          adjusted basis prescribed in
          §1.1011-1 for determining the loss
          from the sale or other disposition
          of the property involved. However,
          if the property used in a trade or
          business or held for the production
          of income is totally destroyed by
          casualty, and if the fair market
          value of such property immediately
          before the casualty is less than
          the adjusted basis of such
          property, the amount of the
          adjusted basis of such property
          shall be treated as the amount of
          the loss for purposes of section
          165(a).

          (2) Aggregation of property for
     computing loss. (i) A loss incurred in a
     trade or business or in any transaction
     entered into for profit shall be determined
     under subparagraph (1) of this paragraph by
     reference to the single, identifiable
     property damaged or destroyed. Thus, for
     example, in determining the fair market value
     of the property before and after the casualty
     in a case where damage by casualty has
     occurred to a building and ornamental or
     fruit trees used in a trade or business, the
     decrease in value shall be measured by taking
     the building and trees into account
                                - 10 -


          separately, and not together as an integral
          part of the realty, and separate losses shall
          be determined for such building and trees.

     From the text of section 165 and the regulations thereunder,

we discern that Trinity may deduct a casualty loss for the

taxable year in which it suffers a "casualty" resulting in a loss

from the damage or destruction of property.   We also discern that

the amount of the loss equals the diminution in value2 of each

single, identifiable piece of property, as measured before and

after the casualty, and that this loss is deductible to the

extent that it is not greater than the property's adjusted basis.

To the extent that this loss is greater than the property's

adjusted basis, the deductible loss is limited to the property's

adjusted basis.   See also Helvering v. Owens, 305 U.S. 468

(1939); Carloate Indus., Inc. v. United States, 354 F.2d 814, 817

(5th Cir. 1966); Lamphere v. Commissioner, 70 T.C. 391, 395

(1978); Millsap v. Commissioner, 46 T.C. 751, 759 (1966), affd.

387 F.2d 420 (8th Cir. 1968).

     Respondent, citing Lamphere v. Commissioner, supra at 395,

observes that damage caused by a flood may be a casualty under

section 165, and we find under the facts herein that the subject

     2
       We use the term "value" throughout this opinion as a
shorthand for the term "fair market value". For a discussion of
the rules used to determine "fair market value" for Federal
income tax purposes, see Estate of Scanlan v. Commissioner, T.C.
Memo. 1996-331, affd. without published opinion 116 F.3d 1476
(5th Cir. 1997), and Estate of Proios v. Commissioner, T.C. Memo.
1994-442.
                              - 11 -


flood was such a casualty.   See also Ferguson v. Commissioner,

23 B.T.A. 364 (1931), remanded on other grounds 59 F.2d 893 (10th

Cir. 1932).   See generally Rev. Rul. 76-134, 1976-1 C.B. 54.   The

parties generally lock horns on the adjusted basis of each

single, identifiable property that was damaged by the flood and

the value of each of these assets both before and after the

flood.

     Turning first to the need to identify each separate piece of

property damaged by the flood, we find that the record does not

allow us to do so.   Although petitioner presented an expert at

trial who testified on the amount of the casualty loss that the

Property suffered as a whole, the expert did not identify each

separate piece of property that he believed suffered a loss.

The need to know each piece of property damaged by the flood is

essential to our determination because Trinity's deduction of any

loss caused by the flood's damage or destruction of property is

limited by that property's adjusted basis.   Carloate Indus., Inc.

v. United States, supra at 817; see also United States v.

Koshland, 208 F.2d 636, 639-640 (9th Cir. 1953); Keefer v.

Commissioner, 63 T.C. 596 (1975).

     Nor can we determine the basis or diminution in value of any

single, identifiable property.   The regulations require that

petitioner identify each separate piece of property not only to

isolate the basis in that asset, but to determine the diminution
                               - 12 -


in the value of that asset on account of the flood.   Trinity may

not deduct a diminution in the value of undamaged property, even

if that diminution is indirectly related to the damage caused to

other property.   See Thornton v. Commissioner, 47 T.C. 1, 6

(1966).   Petitioner has not proven the diminution in value of the

Property as a whole, let alone the diminution in value of any of

the separate parts thereof.3

     We hold for respondent.   To the extent that petitioner

argues for a contrary holding, we have considered all his

arguments and, to the extent not discussed above, find them to be

irrelevant or without merit.

     To reflect the foregoing,


                                         Decision will be entered

                                    for respondent.




     3
       In this regard, we are unpersuaded by the testimony of
petitioner's expert on the diminution in the value of the
Property as a whole. We are not required to adopt that
testimony, Helvering v. National Grocery Co., 304 U.S. 282, 294-
295 (1938), and we do not.
