Epic Assocs. 84-Iii v. Comm'r

MEMORANDUM FINDINGS OF FACT AND OPINION

WHALEN, JUDGE: Respondent issued notices of final partnership administrative adjustment (notices of FPAA) in which respondent determined the following adjustments with respect to the partnership items reported by Epic Associates 83-XII (referred to herein as EA 83-XII):

                   1983     1984     1985

                   ____     ____     ____

Disallow interestand point      $ 483,029   $ 556,564   $ 576,848

 amortization deductions

Disallow depreciation         173,119    173,119    173,119

 deductions

Disallow claimed net investment    (341,010)    -0-      -0-

 loss

Disallow qualified investment      -0-     303,571    330,529

 income

Disallow qualified investment      -0-     908,960    909,831

 expenses

Disallow excess expenses from      10,859     -0-      -0-

 net lease*89 property

Disallow investment interest      66,366     -0-      -0-

 income

Disallow net investment income     29,306     -0-      -0-

Disallow investment income        -0-       90     1,262

Respondent issued notices of FPAA in which respondent determined the following adjustments with respect to the partnership items reported by Epic Associates 84-III (referred to herein as EA 84-III):

                   1983     1984      1985

                   ____     ____      ____

Disallow interestand point      $ 121,535   $ 536,280   $ 559,662

 amortization deductions

Disallow depreciation          56,910    170,742    170,742

 deductions

Disallow deductions in          -0-      -0-      44,219

 excess of income

Disallow claimed net         (141,142)    -0-      -0-

 investment loss

Disallow qualified investment      -0-     217,619    229,131

 income

Disallow qualified*90 investment      -0-     872,376    997,436

 expenses

Disallow net investment income     6,097      -0-      -0-

Disallow investment income        -0-      -0-       494

Among the adjustments summarized above, respondent disallowed all of the interest and depreciation claimed as deductions by each partnership. The principal issues in these cases are whether certain nonrecourse promissory notes issued by each partnership to purchase real estate constitute bona fide indebtedness and whether the activity of each partnership is an "activity not engaged in for profit", as that phrase is defined by section 183(c). Unless stated otherwise, all section references in this opinion are to the Internal Revenue Code as in effect during the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. EA 83-XII and EA 84-III are limited partnerships. At the time the instant petitions were filed on their behalf, each*91 partnership was doing business in the State of Virginia, and the tax matters partners of each partnership, William C. Griffith, Jr., and Dottie M. Griffith, resided in Atlanta, Georgia. Both limited partnerships reported income and expenses on a calendar year basis and used the accrual method of accounting.

EA 83-XII

EA 83-XII was formed on December 3, 1982, pursuant to the Uniform Limited Partnership Act of the Commonwealth of Virginia for a 10-year term ending on December 3, 1992. The Amended and Restated Certificate and Agreement of Limited Partnership dated June 1, 1983 (referred to herein as the 83 partnership agreement) describes the business of EA 83-XII in the following terms:

   Business of the Partnership

   The business of the Partnership shall be to acquire, directly or

   indirectly, and finance, fee interests in certain improved

   residential real properties and to operate, manage, lease or

   otherwise deal with such properties with the objective of

   distributing income generated thereby among the Partners as

   provided for herein; and to hold such properties for investment

   with the objective of capital appreciation*92 therein and to engage

   in and perform all acts and activities required in connection

   with or incident to the foregoing.

The partnership's sole general partner was Equity Programs Investment Corp. (EPIC), a corporation that was originally incorporated in Virginia in 1974 and was reincorporated in Maryland in 1983. EPIC's business involved the purchase, lease, and sale of residential houses and condominiums. We discuss EPIC at greater length below.

The 83 partnership agreement provides that EPIC's "interest shall be deemed to be a one-percent (1%) share in the Partnership's capital contributions for which it shall contribute" $ 10,580.81. In addition, the 83 partnership agreement authorizes two classes of limited partnership interests: 1 class A unit and 25 class B units. The class A unit was sold to four investors for an aggregate sum of $ 90,000. The purchasers of the class A unit made cash payments totaling $ 50,000 and executed recourse promissory notes totaling $ 40,000 that were payable to the partnership on July 1, 1983. These investors were admitted to the partnership on April 16, 1983.

EA 83-XII also sold 25 class B units of limited partnership interest for*93 $ 38,300 per unit or a total of $ 957,500. Approximately $ 3,300 of the amount paid for each class B unit was paid in cash and the balance of $ 35,000 was paid in the form of a recourse promissory note payable to EX 83-XII in 14 quarterly installments of $ 2,500 each with the last payment due on April 1, 1987.

Before selling the class B units in EA 83-XII, EPIC circulated a confidential private placement offering memorandum dated June 1, 1983 (referred to herein as the 83 offering memorandum). The 83 offering memorandum states that persons who purchased class B units would be admitted to EA 83-XII as limited partners commencing September 1, 1983.

The 83 offering memorandum states that the limited partners' contributions would be used primarily to fund operating deficits of the partnership. The 83 offering memorandum includes the following summary of EA 83-XII's anticipated sources and uses of the proceeds of the offering:

        Sources               Amount   Percent

        _______               ______   ______

Proceeds from sale of class A unit         $ 90,000   *94 1.66

Proceeds from sale of class B units         957,500   17.68

Capital contribution of general partner       10,581    0.19

First mortgage loans               3,706,150   68.38

Builder rebate [referred to herein         655,319   12.09

 as rental deficit contribution]         _________   ______

                        5,419,550   100.00

                        =========   ======

        Uses

        ____

Purchase price of homes            ¹ 3,901,550   71.98

Sales commissions to broker/dealers         83,800    1.55

 [8% of the price paid for each unit]

Escrows and prepaid insurance            20,370    0.38

First mortgage loan origination fees        148,246    2.73

Organization fee to general partner         41,900    0.77

 [4% of the price paid for each unit]

Estimated cash-flow deficits through

 April 15, 1983        *95            58,350    1.08

Available for cash-flow deficits         1,165,334   21.51

                        _________   ______

                        5,419,550   100.00

                        =========   ======

Note: Footnotes omitted.

As set forth above, it was anticipated that $ 58,350 of the proceeds of the offering would be offset by cash-flow deficits through April 15, 1983, and $ 1,165,334 of the offering proceeds would be available for cash-flow deficits after that date. The projected annual income and operating costs of EA 83-XII as set forth in the 83 offering memorandum show an annual operating deficit of $ 345,344 calculated as follows:

                          Percentage*96 of

    Projected Annual Income      Amount     Total Income

    _______________________      ______    _____________

Builder lease              $ 65,784      20.30

Rental income (less 20%

 vacancy & expense factor)        258,240      79.70

Total projected income          324,024      100.00

  Annual Operating Expenditures

Aggregate first mortgage

 principal & interest         $ 546,102      168.54

Real estate taxes             49,213      15.19

Insurance & homeowner's dues        21,500       6.64

Audit expenses               4,877       1.51

Property administration fee        30,600       9.44

Allowance for maintenance & repairs    17,076       5.27

                    ________      ______

 Total projected cash expenditures    669,368      206.59

                    ________      ______

Projected*97 operating deficit        345,344      106.59

                    ========      ======

The 83 offering memorandum also includes a cash-flow analysis for EA 83-XII from inception to June 30, 1987, as set forth in appendix A to this opinion.

In the 83 offering memorandum, it was contemplated that EPIC would finance the partnership's operating deficits by advancing funds to the partnership. The 83 partnership agreement provides that EA 83-XII would pay interest on all unsecured advances of funds by the general partner at the rate of 15 percent per annum. The 83 partnership agreement also permits the partnership to advance to the general partner any funds that were not distributed to the limited partners, and the agreement provides that the general partner would pay interest to EA 83-XII on such advances at the rate of 12 percent per annum.

The 83 partnership agreement provides that cash from operations is to be distributed in the following order of priority: (i) To EPIC to repay any unsecured advances made by EPIC to the partnership together with interest; (ii) to the partners in the ratio that the cumulative cash capital*98 contributions of each partner bear to the cumulative cash capital contributions of the partners until such amounts equal the partners' cumulative cash capital contributions; (iii) 25 percent to EPIC and 75 percent to the limited partners holding the class A and class B units.

The 83 partnership agreement further provides that cash from sales and from financings is to be distributed in the following order of priority: (i) To repay partnership debt secured by the property sold or refinanced and to pay the expenses of selling each property; (ii) to repay any unsecured advances made by EPIC to the partnership together with interest; (iii) to pay EPIC a disposition fee equal to 2.5 percent of the price for which any partnership properties are sold; (iv) to the partners in the ratio that each partner's total cash capital contributions bear to the cumulative cash capital contributions of all partners until such amounts equal the partners' cumulative cash capital contributions; and (v) 25 percent of any remaining amount to EPIC and 75 percent to the limited partners holding class A and class B units.

The partnership agreement specifies that EA 83-XII shall pay the following compensation*99 to EPIC:

   Compensations of the General Partner

               * * * * * * *

   (a) At the time of subscription, a Partnership Organization Fee,

   as detailed in the Confidential Private Offering Memorandum for

   the Partnership, being 4% of Limited Partners capital

   contribution upon admission to the Partnership or a maximum

   total payment of $ 41,900 for non-recurring services which may be

   incurred before or after formation of the Partnership, to

   include furnishing legal, financial, accounting and operational

   assistance review of rental schedules and expense forecasts and

   other services which do not give rise to the acquisition of

   specific properties or the obtaining of financing therefor;

   (b) During each full or partial month of the Partnership, the

   General Partner shall be paid an administration fee equal to

   Fifty and 00/100 ($ 50.00) for each Partnership property;

   (c) Such loan origination fees or service fees at commercially

   prevailing market rates that may derive from originating or

   servicing of any security*100 interests, including mortgages and

   deeds of trust, placed upon Partnership property;

   (d) Reimbursement of all carrying costs of the Partnership

   properties including, but not by way of limitation, interest on

   mortgage indebtedness encumbering the properties, incurred prior

   to the admission of the Limited Partners to the Partnership;

   (e) Two-and-one-half percent (2 1/2%) disposition fee on all

   resale of Partnership properties except in connection with an

   exchange with a builder for like kind property;

   (f) For all unsecured advances of funds to the Partnership, the

   General Partner shall be entitled to interest on all such funds

   advanced at the rate of 15% per annum; and

   (g) Any difference between costs incurred by the General Partner

   on pooled insurance policies for all partnerships sponsored by

   the General Partner and premiums charged to the Partnership for

   all risk insurance coverage (including fire and hazard) for each

   Partnership property plus the premium attributable to decreasing

   the deductible amount to $ 100 shall be the property*101 of the

   General Partner.

PURCHASE OF MODEL HOUSES IN CARROLLTON, TEXAS, FROM RALDON CORP.

EPIC executed a contract entitled Epic Model Home Purchase and Leaseback Agreement (purchase and leaseback agreement), dated December 9, 1982, under which it agreed to purchase five houses located in Carrollton, Texas, from Raldon Corp. (Raldon) for $ 485,995 and to lease the houses back to Raldon for use as model houses for an initial term of 18 months. For each of the five houses, there is a schedule attached to the agreement that lists the address; the base price; the "optional extras" included with the house, such as carpeting, wallpaper, and mirrored walls; the "marketing extras", such as drapes, sprinkler systems, built-ins, and landscaping; the price for each of the extras; and the "purchase price" of the house. The purchase price for each of the five houses was $ 8,000 to $ 10,000 more than the base price because of the "extras".

As one of the conditions of closing under the purchase and leaseback agreement, Raldon agreed to pay EPIC 6 percent of the purchase price of the properties. The agreement provides as follows:

     On the Closing Date, Seller [Raldon] *102 shall pay to Equity

   Programs Investment Corporation a sum equal to six percent (6%)

   of the Purchase Price of the Properties, and the execution of

   this Agreement by Seller shall constitute an irrevocable

   assignment to Equity Programs Investment Corporation from the

   sale proceeds of a sum sufficient to make the payment due under

   this Subparagraph 5.7.

We refer to the amount payable under the above provision as the builder fee.

Another condition under the purchase and leaseback agreement required Raldon to pay at closing the first full month's rent for each of the properties plus the pro rata portion of the monthly rent for the month of closing. The agreement provides as follows:

     Seller, as tenant, shall have * * * (ii) paid to Purchaser,

   as Landlord, the first full month's Adjusted Monthly Rental for

   each of the Properties plus the pro rata portion of the Adjusted

   Monthly Rental for the month during which the Closing Date

   occurs.

We refer to this amount as the rent advance.

Finally, as a condition to closing, the purchase and leaseback agreement required Raldon to supply to the purchaser*103 an appraisal that showed the value of the property and improvements equal to or greater than the purchase price. The agreement provides as follows:

   An appraisal of the Properties and improvements prepared by a

   FNMA/FHLMC qualified appraiser acceptable to Purchaser on a

   standard FNMA/FHLMC form which shall reflect a value of the

   Property and improvements equal to or greater than the Purchase

   Price.

EPIC made the following internal cash-flow analysis of the transaction with Raldon:

   Raldon Corp.         Year 1     Year 2     Year 3

   ____________         ______     ______     ______

Builder lease payments      $ 61,819    $ 30,909      -0-

Tax, ins., HOA reimburse       4,476     2,238      -0-

Tenant rental             -0-     17,489    $ 37,776

Rental deficit contribution      -0-      -0-      -0-

Interest income            -0-      -0-      -0-

                 _______    _______    _______

*104  Total revenue           66,295     50,636     37,776

First trust interest        -68,031    -68,031    -68,031

Tax, ins., HOA expense       -4,476     -4,476     -4,476

Repairs & maintenance         -0-     -1,215     -2,430

Property management fee       -2,100     -2,100     -2,100

Audit fee               -607      -607      -607

Interest on EPIC advances      -6,288     -6,288     -6,288

                 _______    _______    _______

 Total expenses          -81,502    -82,717    -83,932

Anticipated cash deficit      -15,207    -32,081    -46,156

As a percent of purchase      -3.13%     -6.60%     -9.50%

 price

             [Table continued]

   Raldon Corp.         Year 4      Total

   ____________         ______      _____

Builder lease payments        -0-     $ 92,728

Tax, ins., HOA*105 reimburse       -0-       6,714

Tenant rental           $ 40,798     96,063

Rental deficit contribution     -0-       -0-

Interest income           -0-       -0-

                 _______    ________

 Total revenue           40,798     195,505

First trust interest        -68,031    -272,124

Tax, ins., HOA expense       -4,476     -17,904

Repairs & maintenance        -2,430     -6,075

Property management fee       -2,100     -8,400

Audit fee               -607     -2,428

Interest on EPIC advances      -6,288     -25,152

                 _______    ________

 Total expenses          -83,932    -332,083

Anticipated cash deficit      -43,134    -136,578

As a percent of purchase      -8.88%     -28.10%

 price

According to the above analysis, EPIC projected a cash deficit from the transaction at the end of the fourth year of $ 136,578*106 or 28.10 percent of the original purchase price (viz $ 485,995). EPIC further projected that the following appreciation rates would be required to recoup the investment in the properties after sales expenses of 7 percent and a disposition fee of 2.5 percent to be paid to EPIC:

            Investment    Appreciation Rate

            __________    _________________

End of 2d year     ¹ $ 615,744        12.56

End of 3d year     1  678,408      1  11.76

End of 4th year    1  723,785      1  10.47

By instrument dated December 22, 1982, EPIC assigned to EA 83- XII EPIC's "right, title and interest" in the purchase and leaseback agreement with Raldon. On December 27, 1982, EA 83-XII closed the purchase of each of the five model houses from Raldon.

To finance its purchase of the*107 subject houses, EA 83-XII borrowed approximately 95 percent of the purchase price of each of the properties from EPIC Mortgage, Inc. (EMI), a corporation affiliated with EPIC. EMI's business was to originate mortgages for EPIC partnerships. At closing, EA 83-XII executed five nonrecourse promissory notes, in the aggregate principal amount of $ 461,675, payable to EMI in monthly installments of interest only on the unpaid principal balance for 5 years at the rate of 14.375 percent. The entire indebtedness under each note was due 5 years after the date of the first payment of interest required under the note.

Each nonrecourse promissory note was secured by a deed of trust bearing the date of closing and recorded on January 3, 1983, in the land records of Denton County, Texas. A mortgage insurance company, Ticor Mortgage Insurance (TMI), issued a commitment and certificate of insurance dated December 28, 1982, providing mortgage insurance for 25 percent of the first loss amount with respect to the mortgage on each of the five properties.

Set out below is a list of each of the properties that EX 83-XII purchased from Raldon, the purchase price of each property, the builder fee, the rent*108 advance, and the amount borrowed with respect to each property:

           Purchase    Builder     Rent

 Raldon Corp.      Price      Fee     Advance     Loan

 ____________     ________    _______    _______     ____

2109 Avignon Dr.   $ 88,995   $ 5,339.70    $ 1,004    $ 84,525

2111 Avignon Dr.    89,500    5,370.00     1,009     85,025

2113 Avignon Dr.    100,500    6,030.00     1,134     95,475

2115 Avignon Dr.    100,500    6,030.00     1,134     95,475

2117 Avignon Dr.    106,500    6,390.00     1,201    101,175

           _______    _________     _____    _______

           485,995    29,159.70     5,482    461,675

A settlement statement was prepared for the sale of each house. Each statement shows the above purchase price as the contract sales price of the house and shows the builder fee and rent advance for each house as charges to the seller, Raldon, and, thus, as reductions of the amount due to Raldon. Each statement also shows*109 the total of the "amounts paid by/for" EA 83-XII, as consisting principally of the loan proceeds and the sum of the builder fees and rent advances. The total of these amounts exceeded the amount due from EA 83-XII. Set out below is a summary of the settlement statements showing that a total of $ 8,801.60 was due to the buyer, EA 83-XII, at closing:

  Raldon Corp.            Buyer          Seller

  ____________            _____          ______

Contract sales price       $ 485,995.00       $ 485,995.00

Settlement charges to buyer     2,132.60          -0-

Price adjustment            12.50           12.50

                ___________        ___________

Gross amount due          488,140.10        486,007.50

Principal amount of loans     461,675.00           -0-

Builder fee             29,159.70         29,159.70

Rent advance             5,482.00        *110  5,482.00

Rental deficit contribution       -0-            -0-

Other credits             625.00          625.00

Settlement charges to seller      -0-          5,835.04

                ___________        ___________

 Total credits          496,941.70         41,101.74

Amount due buyer           8,801.60           -0-

Amount due seller            -0-         444,905.76

According to the settlement sheets, the aggregate principal amount of the loans, $ 461,675, was credited as follows:

            Buyer     Seller    Others    Total

            _____     ______    ______    _____

Settlement charges

 to buyer         -0-      -0-    $ 2,132.60  $ 2,132.60

Amount due less loan $ -26,465.10    -0-      -0-    -26,465.10

Builder fee       29,159.70    -0-      -0-    29,159.70

Rent advance*111       5,482.00    -0-      -0-     5,482.00

Other credit        625.00    -0-      -0-      625.00

Settlement charges

 to seller        -0-      -0-     5,835.04   5,835.04

Amount due seller         $ 444,905.76    -0-    444,905.76

           ___________  ____________ _________  __________

            8,801.60   444,905.76   7,967.64  461,675.00

EMI assigned to Community Savings & Loan, Inc. (CSL), a savings and loan association affiliated with EPIC, its interest in each of the promissory notes and related deeds of trust that had been issued by EA 83-XII in connection with its purchase of the five properties from Raldon. EMI made the assignment in an Assignment of Deed of Trust dated March 30, 1983. In the same instrument, CSL further assigned its interest as holder of each promissory note under the related deed of trust to the North Jersey Savings & Loan Association. Thus, shortly after EA 83-XII purchased the subject properties from Raldon, North Jersey Savings & Loan Association purchased the promissory notes that*112 EA 83-XII had issued to EMI.

PURCHASE OF PRODUCTION HOUSES IN ODESSA, TEXAS

EPIC executed a Residential Rental Purchase Agreement (rental purchase agreement) dated December 18, 1982, under which it agreed to purchase seven houses located in the Hollywood View subdivision in Odessa, Texas, from Fox and Jacobs, Inc. (Fox & Jacobs), for $ 394,600. The rental purchase agreement had originally called for the purchase of eight properties for a total of $ 449,500 but was amended by deleting one house sometime before closing.

The rental purchase agreement includes an exhibit B for each of the seven properties that sets forth the base price of the property and the appliances and interior decorations included in the purchase price. This exhibit also lists an "estimated rental amount" for the property. Exhibit C to the rental purchase agreement gives EPIC the right to rent each of the properties and states that, for each property not leased as of the closing date, Fox & Jacobs agrees to pay to the purchaser on the closing date an amount equal to three times the monthly rent for that property as set forth on exhibit B. We refer to this amount as the rent advance.

Under the rental purchase*113 agreement, Fox & Jacobs agreed to pay to EPIC 6.8 percent of the purchase price of the properties. The rental purchase agreement provides for this payment as a condition to "the obligation of the Purchaser to purchase each of the Properties" in the following terms:

     On the Closing Date, Seller shall pay to Equity Programs

   Investment Corporation a sum equal to six and eight-tenths

   percent (6.8%) of the Purchase Price of the Properties, and the

   execution of this Agreement by Seller shall constitute an

   irrevocable assignment to Equity Programs Investment Corporation

   from the sale proceeds of a sum sufficient to make the payment

   due under Subparagraph 4.6.

We refer to this sum as the builder fee.

As a further condition to the purchaser's obligation under the rental purchase agreement, Fox & Jacobs agreed to pay to "the Purchaser a sum equal to the percentage as set forth on Exhibit 'A' hereof of the purchase price of each Property as a contribution towards rental deficits" (referred to herein as the rental deficit contribution). The percentages set forth on exhibit A attached to the rental purchase agreement range from*114 16.38 to 17.90 percent. We refer to this payment as the rental deficit contribution.

The rental purchase agreement also provided, as a condition to the purchaser's obligation to purchase the properties, that the "purchaser shall have obtained an appraisal of each of the Properties by a FNMA/FHLMC qualified appraiser * * * which shall reflect the value of each Property equal to or greater than the purchase price applicable to that Property".

EPIC made the following internal cash-flow analysis of the transaction with Fox & Jacobs:

  Fox & Jacobs, Inc.      Year 1     Year 2    Year 3

  __________________      ______     ______    ______

Builder lease payments       -0-       -0-      -0-

Tax, ins., HOA reimburse      -0-       -0-      -0-

Tenant rental          $ 48,740    $ 49,659   $ 53,632

Rental deficit contribution    69,190      -0-     -0-

Interest income           6,556      3,935     1,312

                _______     _______    _______

 Total*115 revenue          124,486     53,594    54,944

First trust interest       -62,922     -62,922    -62,922

Tax, ins., HOA expense       -7,920     -7,920    -7,920

Repairs & maintenance       -2,247     -2,247    -2,247

Property management fee       -562      -562     -562

Audit fee             -3,360     -3,360    -3,360

Interest on EPIC advances     -5,815     -5,815    -5,815

                _______     _______    _______

 Total expenses         -82,826     -82,826    -82,826

Anticipated cash deficit      41,660     -29,232    -27,882

As a percent of purchase       9.27      -6.5     -6.2

 price -- check Nos.

             [Table continued]

  Fox & Jacobs, Inc.      Year 4     Total

  __________________      ______     _____

Builder lease payments       -0-       -0-

Tax, ins., HOA reimburse   *116    -0-       -0-

Tenant rental          $ 57,922    $ 209,953

Rental deficit contribution     -0-      69,190

Interest income           -0-      11,803

                _______    ________

 Total revenue          57,922     290,946

First trust interest       -62,922    -251,688

Tax, ins., HOA expense       -7,920     -31,680

Repairs & maintenance       -2,247     -8,988

Property management fee       -562     -2,248

Audit fee             -3,360     -13,440

Interest on EPIC advances     -5,815     -23,260

                _______    ________

 Total expenses         -82,826    -331,304

Anticipated cash deficit     -24,904     -40,358

As a percent of purchase      -5.54      -8.98

 price -- check Nos.

The above analysis is based upon the original plan to purchase eight houses for $ 449,500. As shown above, EPIC projected a cash deficit from that transaction*117 at the end of the fourth year of $ 40,358 or 8.98 percent of the purchase price. EPIC further projected that the following appreciation rates would be required to recoup the investment in the properties after sales expenses of 7 percent and the disposition fee of 2.5 percent to be paid to EPIC:

                       Appreciation

               Investment      Rates

               __________    ____________

   End of 2d year      $ 507,668       6.27

   End of 3d year       541,663       6.41

   End of 4th year       572,185       6.22

EPIC's analysis of the transaction included a computation of the rental deficit contribution. First, EPIC personnel estimated that the project would generate a monthly deficit of $ 2,101, taking into account estimated monthly operating expenses of $ 7,961, tenant rentals of $ 4,600 (with a vacancy rate of 11.7 percent), and monthly contributions of investor capital of $ 1,798. According to the analysis, the present value of the monthly deficit*118 over 36 months discounted at 13 percent is $ 62,364. The analysis, which is reproduced below, designates this amount as the rental deficit contribution:

Operating expenses per month               $ 7,961

Tenant rental revenue                   -4,600

Rent-up factor                       0.883

Net tenant rental                     -4,062

Operating deficit                     3,899

Investor contribution

 purchase price        $ 449,500   x   0.004    -1,798

Net monthly deficit                    2,101

Present value of deficit

 over 36 mos. at 13%

 monthly deficit of         2,101  x  29.68    62,364 [sic]

Rental deficit contribution                62,364

As a percent of purchase price             0.1387408

The rental deficit contribution shown above was calculated using a

net borrowing cost, exclusive of servicing and private mortgage

insurance of 16.75 percent.

*119 The rental deficit contribution computed in the above analysis, $ 62,364, differs from the amount used in EPIC's cash-flow analysis for the project, $ 69,190, and differs from the rental deficit contribution finally negotiated with Fox & Jacobs, $ 67,643.

By instrument dated December 21, 1982, EPIC assigned to EA 83-XII "its entire right, title and interest, as purchaser and landlord" in the rental purchase agreement dated December 18, 1982, with Fox & Jacobs. On December 30, 1982, EA 83-XII closed the purchase of each of the properties.

To finance its purchase of the subject properties, EA 83- XII borrowed approximately 95 percent of the purchase price of each of the properties from EMI. On the closing date, EA 83-XII executed seven nonrecourse promissory notes, in the aggregate principal amount of $ 374,850, payable to EMI with monthly installments of interest only on the unpaid principal balance for 5 years at the rate of 14.375 percent. Thereafter, the notes required EA 83-XII to pay monthly installments of principal and interest for 5 years. The principal amount of each note was due at the end of 10 years, or January 1, 1993. On March 1, 1983, the parties executed an Allonge*120 to Note for each of the seven notes. The Allonge to Note states as follows:

     The Note shall bear interest at the rate computed as

   follows:  (a) the rate of interest for the first sixty (60) full

   calendar months of the loan term shall be Fourteen and 375/1000

   (14.375%) per annum; (b) thereafter, the rate of interest shall

   be adjusted annually, commencing with the sixty-first (61st)

   full calendar month of the loan term, to a rate per annum equal

   to the sum of the FNMA auction price in effect on the first day

   of the calendar month immediately preceding the month of such

   adjustment plus 237.5 basis points, payable as follows:

     Interest only on the unpaid principal balance, computed as

   set forth in (a) above, shall be payable on the first day of

   each month commencing April 1, 1983 and on the first day of each

   succeeding month through and including March 1, 1988.

   Thereafter, payments of monthly installments of principal and

   interest at the rate per annum as set forth in (b) above, shall

   be fully amortized over the remaining sixty (60) months*121 of the

   loan term, except that any remaining indebtedness, if not sooner

   paid, shall be due and payable in full on March 1, 1993.

Each nonrecourse promissory note was secured by a deed of trust bearing the closing date. The deeds of trust were recorded in the land records of Ector County, Texas, on January 14, 1983. Each deed of trust was amended on March 1, 1983, to reflect the changes made by the Allonge to Note. A mortgage insurance company, TMI, issued a Commitment and Certificate of Insurance dated January 7, 1983, providing mortgage insurance for 25 percent of the first loss amount with respect to the mortgage on each of the properties.

Set out below is a list of the seven houses that EA-XII purchased from Fox & Jacobs, Inc., together with the purchase price, the builder fee, the rental deficit contribution, the rent advance, and the amount borrowed with respect to each property:

                     Rental

                     Deficit

           Purchase   Builder   Contri-   Rent

Fox & Jacobs, Inc.   Price     Fee    bution   Advance*122    Loan

__________________   _______   _______   _______   _______    ____

1612 Hemphill Ave.  $ 57,400  $ 3,903.20 $ 10,039  $ 1,725   $ 54,525

1921 W. 17th St.    54,000   3,672.00   8,847   1,725    51,300

1716 Coronado Ave.   56,900   3,869.20   9,864   1,725    54,050

1720 Coronado Ave.   59,400   4,039.20   10,635   1,725    56,425

1728 Coronado Ave.   54,000   3,672.00   8,847   1,725    51,300

1700 Linda Ave.     56,900   3,869.20   9,864   1,725    54,050

1916 Hollywood Dr.   56,000   3,808.00   9,547   1,725    53,200

           _______   _________  ________  ______   _______

 Subtotal       394,600   26,832.80   67,643   12,075   374,850

A settlement statement was prepared for the sale of each property. In each case, the statement shows the above purchase price as the "contract sales price" of the property. Each statement also shows the builder fee, the rent advance, and the rental deficit contribution as charges to the seller, Fox & Jacobs, and, thus, as reductions of the amount due to Fox & Jacobs. Each statement*123 also shows the total of the "amounts paid by/for" EA 83-XII, as consisting principally of the loan proceeds and the sum of the builder fees, rent advances, and rental deficit contributions. The total of these amounts exceeded the amount due from EA 83-XII. Set out below is a summary of the settlement statements showing that a total of $ 92,331.55 had been overpaid by or on behalf of the buyer, EA 83-XII:

     Fox & Jacobs, Inc.       Buyer       Seller

     __________________       _____       ______

   Contract sales price      $ 394,600.00    $ 394,600.00

   Settlement charges to buyer    1,794.25

                  ___________     ___________

   Gross amount due         396,394.25     394,600.00

   Principal amount of loans    374,850.00

   Builder fee            26,832.80      26,832.80

   Rent advance           12,075.00      12,075.00

   Rental deficit contribution    67,643.00      67,643.00

   Other credits*124           7,325.00      7,325.00

   Settlement charges to seller             6,026.94

                   __________     __________

    Total credits         488,725.80     119,902.74

   Amount due buyer         92,331.55

   Amount due seller                 274,697.26

According to the settlement statements, the aggregate principal amount of the loans, $ 374,850, was credited as follows:

             Buyer     Seller    Others    Total

             _____     ______    ______    _____

Settlement charges

 to buyer          -0-      -0-   $ 1,794.25  $ 1,794.25

Amount due less loans  $ -21,544.25    -0-     -0-    -21,544.25

Builder fee        26,832.80    -0-     -0-    26,832.80

Rent advance        12,075      -0-     -0-    12,075.00

Rental deficit

 contribution       67,643.00   *125  -0-     -0-    67,643.00

Other credits        7,325.00    -0-     -0-     7,325.00

Settlement charges to

 seller           -0-      -0-    6,026.94   6,026.94

Amount due seller          $ 274,697.26       274,697.26

            __________  ___________  ________  __________

             92,331.55   274,697.26  7,821.19  374,850.00

EMI assigned to CSL its interest in each of the promissory notes and related deeds of trust that had been issued by EA 83-XII in connection with its purchase of the seven houses from Fox & Jacobs, Inc. EMI made the assignment in an Assignment of Deed of Trust dated March 31, 1983. In the same instrument, CSL further assigned its interest as holder of each promissory note under the related deed of trust to National Bank of Washington. Thus, shortly after EA 83-XII purchased the subject properties from Fox & Jacobs, National Bank of Washington purchased the promissory notes that EA 83-XII had issued to EMI. Ultimately, Westinghouse Credit Corp. acquired the deeds of trust related to the seven houses.

*126 PURCHASE OF 39 CONDOMINIUM UNITS IN PASEOS CASTELLANOS

EPIC executed a Residential Rental Purchase Agreement (rental purchase agreement) dated December 22, 1982, under which it agreed to purchase 39 condominium units located in the Paseos Castellanos condominium complex in Miami, Florida, from Babcock Co. (Babcock), a subsidiary of Weyerhaeuser, for $ 3,020,700. For each condominium unit covered by the rental purchase agreement, there is attached to the agreement an exhibit B which identifies the unit, its purchase price, and the monthly rent, and lists the appliances and interior decorations that are included in the purchase.

Paseos Castellanos was constructed in 1982. It consists of eight two-story buildings, with 8 units in each building for a total of 64 units. There is a garage for each unit. In each building, there are two one-story units on the second floor, over the garages; four two-story units in the center of the building; and two one-story units on the ground floor at the rear of the building.

The 39 units purchased by EA 83-XII are scattered among seven of the buildings. Seven are one-story units on the second floor, each with two bedrooms, 2-1/2 bathrooms, and 968*127 square feet of living space; 13 are two-story units in the center of the building, each with two bedrooms, 2-1/2 bathrooms, and 1,240 square feet; 12 are two-story units in the center of the building, each with three bedrooms, 1-1/2 bathrooms, and 1,240 square feet; and the remaining 7 are one-story units on the ground level, each with three bedrooms, two bathrooms, and 1,090 square feet.

The purchaser's obligation under the rental purchase agreement to purchase the subject properties was subject to the following condition:

   Rental of the Properties to individual tenants shall have been

   arranged, or shall be arranged, upon execution by Purchaser of

   this Agreement in accordance with the procedures set forth in

   Exhibit "C," attached hereto and by this reference made a part

   hereof.

According to exhibit C, in the event that EPIC had not leased all of the properties as of the closing date, then Babcock agreed to pay to the purchaser an amount equal to three times the monthly fair market rent of each property not leased as of the closing date as a nonrefundable contribution toward the expense of listing, showing, and leasing such property after*128 the closing date. We refer to this amount as the rent advance.

Under the rental purchase agreement, Babcock agreed to pay to EPIC 6.8 percent of the purchase price of each property on the closing date. We refer to this amount as the builder fee. The agreement further requires as a condition to the purchaser's obligation under the agreement that Babcock pay to the purchaser 19.455 percent of the purchase price of each property "as a contribution towards rental deficits (referred to as the Rental Deficit Contribution)." In this opinion, we refer to this payment as the rental deficit contribution. Finally, the rental purchase agreement provides, as a condition to the purchaser's obligation to purchase the properties, that the "purchaser shall have obtained an appraisal of each of the Properties by a FNMA/FHLMC qualified appraiser * * * which shall reflect the value of each Property equal to or greater than the purchase price applicable to that property".

EPIC made the following internal cash-flow analysis of the transaction with Babcock:

  Paseos Castellanos       Year 1    Year 2     Year 3

  __________________       ______    ______  *129    ______

Builder lease payments       -0-      -0-      -0-

Tax, ins., HOA reimburse      -0-      -0-      -0-

Tenant rental          $ 243,873   $ 246,792   $ 266,536

Rental deficit contribution    659,929     -0-      -0-

Interest income           62,531    37,533     12,514

                ________   ________    ________

 Total revenue          966,333    284,325    279,050

First trust interest       -424,784   -424,784    -424,784

Tax, ins., HOA expense       -71,196    -71,196    -71,196

Repairs & maintenance       -15,173    -15,173    -15,173

Property management fee      -16,380    -16,380    -16,380

Audit fee              -3,793    -3,793     -3,793

Interest on EPIC advances     -39,259    -39,259    -39,259

                ________   ________    ________

 Total expenses         -570,585   -570,585*130    -570,585

Anticipated cash deficit      395,748   -286,260    -291,535

As a percent of purchase       13.04     -9.43     -9.61

 price

             [Table continued]

  Paseos Castellanos       Year 4     Total

  __________________       ______     _____

Builder lease payments        -0-      -0-

Tax, ins., HOA reimburse       -0-      -0-

Tenant rental          $ 287,858   $ 1,045,059

Rental deficit contribution     -0-      659,929

Interest income           -0-      112,578

                ________   __________

 Total revenue          287,858    1,817,566

First trust interest       -424,784   -1,699,136

Tax, ins., HOA expense       -71,196    -284,784

Repairs & maintenance       -15,173     -60,692

Property management fee      -16,380     -65,520

Audit fee              -3,793     -15,172

Interest on EPIC*131 advances     -39,259    -157,036

                ________   __________

 Total expenses         -570,585   -2,282,340

Anticipated cash deficit     -282,727    -464,774

As a percent of purchase       -9.32     -15.32

 price

As shown above, EPIC projected a cash deficit from the transaction at the end of the fourth year of $ 464,774, or 15.32 percent of the purchase price (viz $ 3,034,550). EPIC further projected that the following appreciation rates would be required to recoup the investment in the properties after sales expenses of 7 percent and a disposition fee of 2.5 percent to be paid to EPIC:

            Investment    Appreciation Rate

            __________    _________________

  End of 2d year     3405798        5.94

  End of 3d year     3755078        7.36

  End of 4th year    4094090        7.77

EPIC's analysis of the transaction included a computation of the rental deficit contribution. First, EPIC personnel estimated the monthly deficit from the project, *132 $ 22,235, taking into account estimated monthly operating expenses of $ 54,696, tenant rentals of $ 22,860 (with a vacancy rate of 11.1 percent), and a monthly contribution of investor capital of $ 12,138. According to the analysis, the present value of the monthly deficit, $ 22,235, discounted over 36 months at 13 percent, is $ 659,929. The analysis, which is reproduced below, designates this amount as the rental deficit contribution:

Operating expenses per month              $ 54,696

Tenant rental revenue                  -22,860

Rent-up factor                      0.889

Net tenant rental                    -20,323

Operating deficit                    34,373

Investor contribution

 purchase price        $ 3,034,550  x  0.004   -12,138

Net monthly deficit                   22,235

Present value of deficit

 over 36 mos. at 13%

 monthly deficit of        22,235  x  29.68   659,929 [sic]

Rental deficit contribution      *133          659,929

As a percent of purchase price            0.2174716

The rental deficit contribution shown above was calculated using a

net borrowing cost, exclusive of servicing and private mortgage

insurance of 16.75.

The rental deficit contribution computed in the above analysis differs from the amount finally negotiated with Babcock, $ 587,676.

By instrument dated December 29, 1982, EPIC assigned to EA 83-XII "all its right, title and interest" in the rental purchase agreement dated December 22, 1982, with Babcock. Thereafter, EA 83- XII closed the sale of each of the 39 condominium units as of December 30, 1982.

To finance its purchase of the condominium units in the Paseos Castellanos complex, EA 83-XII borrowed from EMI approximately 95 percent of the purchase price of each unit. On or about the closing date, EA 83-XII executed 39 nonrecourse promissory notes in the aggregate principal amount of $ 2,869,625 payable to EMI in monthly installments of interest only for 5 years at the rate of 14.375 percent. Thereafter, the notes required EA 83-XII to pay monthly installments of interest and principal for 5 years. The notes required*134 payment in full on January 1, 1993.

EA 83-XII executed an Allonge to Note dated March 1, 1983, for each of the 39 notes providing for a variable interest rate for the second 5-year term. The Allonge to Note extended the date for full payment of the indebtedness to March 1, 1993. EA 83-XII also executed a mortgage on the date of closing for each of the condominium units with EA 83-XII as the mortgagor and EMI as the mortgagee. The mortgages were modified on March 1, 1983, to reflect that the maturity date of the notes had changed from January 1, 1993, to March 1, 1993.

Set out below is a list of the 39 condominium units in the Paseos Castellanos complex that EA 83-XII purchased from Babcock, together with the purchase price, the builder fee, the rental deficit contribution, the rent advance, and the amount borrowed with respect to each condominium unit:

The Babcock

Co. Paseos   Contract  Builder   Rental Deficit   Rent

Castellanos    Price    Fee    Contribution   Advance   Loan

___________   ________  _______   ______________   _______   ____

  H 101    $ 82,000 $ 5,576.00    $ 15,953    $ 1,800   $ 77,900

  H 102   *135   80,000   5,440.00     15,564     1,800    76,000

  H 103     74,500   5,066.00     14,494     1,800    70,775

  H 105     80,000   5,440.00     15,564     1,800    76,000

  H 106     74,500   5,066.00     14,494     1,800    70,775

  H 107     82,000   5,576.00     15,953     1,800    77,900

  H 108     68,450   4,654.60     13,317     1,575    65,025

  B 105     79,450   5,402.60     15,457     1,800    75,475

  B 107     81,450   5,538.60     15,846     1,800    77,375

  D 101     81,450   5,538.60     15,846     1,800    77,375

  D 105     79,450   5,402.60     15,457     1,800    75,475

  D 107     81,450   5,538.60     15,846     1,800    77,375

  C 101     81,450   5,538.60     15,846     1,800    77,375

  C 102     79,450   5,402.60     15,457     1,800    75,475

  C 105     79,450   5,402.60     15,457     1,800    75,475

  C 107     81,450   5,538.60     15,846*136     1,800    77,375

  C 108     67,450   4,586.60     13,122     1,575    64,075

  E 101     82,000   5,576.00     15,953     1,800    77,900

  E 102     80,000   5,440.00     15,564     1,800    76,000

  E 103     74,500   5,066.00     14,494     1,800    70,775

  E 104     68,450   4,654.60     13,317     1,575    65,025

  E 105     80,000   5,440.00     15,564     1,800    76,000

  E 106     74,500   5,066.00     14,494     1,800    70,775

  E 107     82,000   5,576.00     15,953     1,800    77,900

  G 101     82,000   5,576.00     15,953     1,800    77,900

  G 102     80,000   5,440.00     15,564     1,800    76,000

  G 103     74,500   5,066.00     14,494     1,800    70,775

  G 104     68,450   4,654.60     13,317     1,575    65,025

  G 105     80,000   5,440.00     15,564     1,800    76,000

  G 106     74,500   5,066.00     14,494     1,800    70,775

  G 107*137     82,000   5,576.00     15,953     1,800    77,900

  G 108     68,450   4,654.60     13,317     1,575    65,025

  F 101     82,000   5,576.00     15,953     1,800    77,900

  F 102     80,000   5,440.00     15,564     1,800    76,000

  F 104     68,450   4,654.60     13,317     1,575    65,025

  F 105     80,000   5,440.00     15,564     1,800    76,000

  F 106     74,500   5,066.00     14,494     1,800    70,775

  F 107     82,000   5,576.00     15,953     1,800    77,900

  F 108     68,450   4,654.60     13,317     1,575    65,025

      _________ __________    _______    ______  _________

 Subtotal  3,020,700 205,407.60    587,676    68,625  2,869,625

A settlement statement was prepared for the sale of each condominium unit. Each statement shows the above purchase price as the contract sales price. The statements treat the builder fees, the rent advances, and the rental deficit contributions as charges to Babcock and, thus, as reductions of the amount*138 due to Babcock as seller. In the case of each of the subject condominium units, the "amounts paid by/for" EA 83-XII as shown on each settlement statement is the amount of the loan proceeds. Set out below is a summary of the settlement sheets for the purchase of the 39 condominium units in Paseos Castellanos:

   Paseos Castellanos        Buyer          Seller

   __________________        _____          ______

Contract sales price       $ 3,020,700.00     $ 3,020,700.00

Price adjustment             476.97         476.97

Other charges             30,934.87         -0-

Gross amount due          3,052,111.84      3,021,176.97

Principal amount of loans     2,869,625.00         -0-

Builder fee                        205,407.60

Rent advance              -0-          68,625.00

Rental deficit contribution      -0-          587,676.00

Other credits            *139  -0-          141,575.39

                 ____________      _____________

Amount due from buyer        182,486.84

Amount due to seller                   2,017,892.98

According to the settlement sheets, the aggregate principal amount of the loans, $ 2,869,625, was credited as follows:

           Buyer     Seller     Others     Total

           _____     ______     ______     _____

Settlement

 charges        -0-       -0-    $ 30,934.87   $ 30,934.87

Builder fee    $ 205,407.60     -0-      -0-     205,407.60

Rent advance     68,625.00     -0-      -0-     68,625.00

Rental deficit

 contribution    587,676.00     -0-      -0-     587,676.00

Other credits      -0-       -0-    141,575.39   141,575.39

Amount due from

 buyer       -182,486.84     -0-      -0-    -182,486.84

Amount due to

 seller        -0-    $ 2,017,892.98*140    -0-    2,017,892.98

         ___________  _____________ __________  ____________

          679,221.76   2,017,892.98 172,510.26  2,869,625.00

TMI issued a Commitment and Certificate of Insurance dated January 11, 1983, under which it committed to issue mortgage insurance for 25 percent of the first loss amount with respect to the mortgage on each condominium unit. Subsequently, EMI and CSL executed an Assignment of Mortgage dated March 31, 1983, for each condominium unit transferring their interest in each note to the National Bank of Washington. Thus, shortly after EA 83-XII purchased the subject properties from Babcock, National Bank of Washington purchased the promissory notes that EA 83-XII had issued to EMI. Ultimately, Westinghouse Credit acquired the notes.

In summary, the aggregate contract prices of the properties purchased by EA 83-XII, the aggregate rental deficit contributions attributable to those properties, and the aggregate amounts borrowed are as follows:

         Contract      Rent Deficit      Loan

          Price      Contribution      Amount

*141          ________      ____________      ______

Raldon       $ 485,995       -0-       $ 461,675

Fox & Jacobs     394,600      $ 67,643       374,850

Babcock      3,020,700      587,676      2,869,625

         _________      _______      _________

 Total      3,901,295      655,319      3,706,150

The 83 offering memorandum states that investors would break even if the real properties acquired by EA 83-XII appreciated at the annual rate of 7.99 percent over the 4-year period that the partnership planned to hold the properties.

FINANCIAL STATEMENTS FOR EA 83-XII

The general partner prepared and circulated to the limited partners quarterly statements for EA 83-XII entitled "Results of Operations and Taxable Income (Loss)." The record contains the statements for the nine quarters beginning April 16, 1983, and ending June 30, 1985. If the entries designated "current period" on the quarterly statements for a particular year are added, the totals for each year or part of a year during the period beginning April 16, 1983, and*142 ending June 30, 1985, are as follows:

                   4/16/83 to  1/1/84 to 1/1/85 to

                    12/31/83   12/31/84   6/30/85

                   __________  _________ _________

Revenue:

 Rental income            $ 265,635.60 $ 306,577 $ 158,108

 Interest income -- general partner   2,219.83     90    -0-

 Other income               274.10    -0-     -0-

                   ___________  ________  ________

 Total revenue             268,129.53   306,667   158,108

Expenses:

 Interest on first mortgage      386,821.70   546,197   273,062

 Additional mortgage interest       -0-     -0-     -0-

 Other interest expense          -0-     -0-     2,106

 Real estate taxes, insurance, HOA   54,204.89   72,927   39,391

 Audit fee                3,545.83    4,900    2,450

 Repairs and maintenance*143         1,940.72   32,412    7,260

 Property administration fee      21,675.00   30,778   15,300

 Interest expense -- general partner    -0-     7,147   10,459

 Rental commission           24,110.00   21,950    7,461

 Legal fees                725.75    7,915     730

 Other expenses               77.40    -0-      24

                   ___________  ________  ________

  Total expenses           493,101.29   724,226   358,243

Net results of operations       -224,971.76  -417,559  -200,135

Taxable income (loss):

 Net results of operations      -224,971.76  -417,559  -200,135

 Plus: mortgage amortization       -0-      -0-     -0-

 Less: depreciation          122,625.76   173,120   86,560

    Amortization of loan fees    11,808.84   16,672    8,336

    Amortization of refinancing    -0-      -0-     -0-

     costs

    Accrued*144 mortgage interest     -0-      -0-     -0-

                   ___________  ________  ________

Taxable income (loss)         -359,406.36  -607,351  -295,031

The above amounts can be compared with the cash-flow projection that was set out in the 83 offering memorandum and is reproduced as appendix A.

As shown above, one of the expenses recorded as having been paid on behalf of EA 83-XII during the quarters beginning April 16, 1983, and ending June 30, 1985, is "interest expense -- general partner" in the amount of zero during 1983, $ 7,147 during 1984, and $ 10,459 during 1985. Three of the quarterly statements contain the following note or words of similar import:

   Interest Expense -- GP:

   Cash advances by the General Partner necessary to sustain

   operations of the partnership continued to be greater than

   budget resulting in additional interest expense.

The quarterly statements also record "interest income -- general partner" during this period of $ 2,219.83, $ 90, and zero, respectively.

The record also contains audited financial statements of EX 83-XII for the years*145 ended December 31, 1983 and 1984, that were prepared by a firm of certified public accountants. Included in those financial statements is the following statement of operations and changes in partners' capital:

                   Year Ended December 31,

                   _______________________

                   1984        1983

                   ____        ____

Revenues:

 Rental income           $ 306,577      $ 287,640

 Interest income              90        9,344

 Other income              -0-          548

                   _______      ________

                   306,667       297,532

Expenses:

 Interest               539,893       532,724

 Depreciation             86,559       86,559

 Real estate taxes      *146      49,213       49,224

 Amortization             48,096       31,096

 Repairs and maintenance        30,866       20,620

 Property management fee        30,600       30,600

 Rental commissions          21,950       25,460

 Homeowner's association dues     20,620        5,624

 Insurance               16,438       27,744

 Professional fees           12,993        1,347

 Other expenses             2,722        1,952

                  ________      ________

                   859,950       812,950

                  ________      ________

Net loss               (553,283)      (515,418)

Partners' capital (deficit)      516,606       (10,974)

 at beginning of year

Partners' contributions         -0-       1,042,998

Partners'*147 distributions          (263)       -0-

                  ________      _________

Partners' capital (deficit)      (36,940)      516,606

 at end of year           ________      _________

One of the notes accompanying the financial statements deals with related-party transactions and states as follows:

   4. Related party transactions

    Equity Programs Investment Corporation (EPIC) is the sole

    general partner for EPIC Associates 83-XII. The general

    partner manages, controls and administers the business of the

    Partnership. The general partner is compensated for these

    services in accordance with the fee structure set forth in

    the Private Placement Offering Memorandum of the Partnership.

    The Partnership incurred $ 30,600 of cost per year to EPIC for

    these services during 1984 and 1983.

    Interest is charged or paid to the Partnership on the due

    to/from general partner balance in accordance with the rates

    prescribed in*148 the Private Placement Offering Memorandum. The

    Partnership incurred $ 7,057 and earned $ 9,344 of interest

    to/from EPIC and affiliates during 1984 and 1983,

    respectively. While not obligated to do so under the

    Partnership agreement, the general partner is anticipated to

    advance funds to cover cash flow deficits.

FEDERAL INCOME TAX RETURNS FILED ON BEHALF OF EA 83-XII

For Federal income tax purposes, EA 83-XII reported the following income and expenses for the years in issue:

EA 83-XII          1983      1984      1985

    _________          ____      ____      ____

Rent income           $ 287,640    $ 306,577   $ 331,743

Late charges              548      -0-      -0-

Interest income           9,344       90     1,262

Miscellaneous            -0-       -0-       883

                ________    ________    ________

 Total gross income   *149      297,532     306,667    333,888

Interest (noninvestment)      466,358     539,893    560,177

Commissions             25,460     21,950     24,846

Insurance              27,744     16,438     18,992

Legal and professional fee       726      8,093      574

Repairs               1,348     30,866     15,075

Taxes                49,224     49,213     45,962

Utilities               464      1,547      951

Homeowners dues           20,620     20,620     25,350

Audit fee              4,900      4,900     3,267

Points amortization         16,671     16,671     16,671

Property management         30,600     30,600     29,837

Real estate tax service       1,278      -0-      -0-

Miscellaneous             107      -0-       856

Depreciation     *150        173,119     173,119    173,119

Bad debts              -0-       1,174     -0-

Amortization org. expense      -0-       3,150     -0-

Recording fees            -0-       -0-        24

Service fee-EMI           -0-       -0-      3,413

                ________    ________    ________

 Total expenses          818,619     918,234    -919,114

Net rental income         -521,087    -611,567    -585,226

On its Schedule K, Partner's Share of Income Credits, Deductions, etc., for 1983, EA 83-XII reported an ordinary loss of $ 521,087, investment interest expense of $ 66,366, net investment income of $ 29,306, and excess expenses from "net lease property" of $ 10,859; and for purposes of allocating tax preference items to its partners, EA 83-XII reported a net investment loss of $ 341,010.

On its Schedules K for 1984 and 1985, EA 83-XII reported ordinary losses of $ 611,567 and $ 585,226, respectively, and investment income of $ 90*151 and $ 1,262, respectively; and for purposes of allocating tax preference items to its partners, EA 83-XII reported qualified investment income of $ 303,571 and $ 330,529, respectively, and qualified investment expenses of $ 908,960 and $ 909,831, respectively.

For depreciation purposes, EA 83-XII treated the aggregate contract price of its 51 properties, $ 3,901,295, less the aggregate rental deficit contribution, $ 655,319, as its aggregate basis in the real estate; viz $ 3,245,976. EA 83-XII allocated 20 percent of that amount to land; viz $ 649,195, and 80 percent to buildings; viz $ 2,596,781. EA 83-XII depreciated the latter amount on a straight- line basis over 15 years and claimed depreciation of $ 173,119 in each of the years in issue.

For each of the years in issue, EA 83-XII was obligated under the promissory notes that it had issued to EMI to pay interest on the aggregate principal amount of the notes, $ 3,706,150, at the annual rate of 14.375 percent. Thus, EA 83-XII was obligated to pay interest to EMI in the aggregate amount of $ 532,759 during each of the years in issue (i.e., $ 3,706,150 x 14.375 percent).

EA 83-XII was also obligated under the 83 partnership agreement*152 to pay interest at the annual rate of 15 percent to compensate the general partner for unsecured advances of funds to the partnership. The returns filed on behalf of EA 83-XII for the years in issue report the following liabilities to the general partner on Schedule L, Balance Sheets:

     Year Ended    Amount of Advances    Accrued Interest

     __________    __________________    ________________

     12/31/83       $ 2,991          -0-

     12/31/84       104,754         $ 7,147

     12/31/85       57,567         12,929

EA 83-XII reported the following interest expense on its returns for the years in issue:

                  1983      1984      1985

                  ____      ____      ____

  Interest (noninvestment)    $ 466,358   $ 539,893   $ 560,177

  Investment interest income    66,366      -0-      -0-

                 ________    ________  *153   ________

   Total             532,724    539,893    560,177

The difference between the above amounts and the interest paid or incurred with respect to the partnership's first mortgage notes is as follows:

                   1983      1984      1985

                   ____      ____      ____

Total interest expense reported   $ 532,724   $ 539,893   $ 560,177

Interest on first mortgage notes   532,759    532,759    532,759

                  ________    ________    ________

 Difference               (35)     7,134     27,418

The record of this case does not explain the above differences.

EA 83-XII paid loan origination fees to EMI in the aggregate amount of $ 148,246 equal to 4 percent of the principal amount of the first mortgage loans (i.e., $ 3,706,150 x 4 percent). This amount was amortized over the life of the loans. For each of the years in issue, EA 83-XII reported "points amortization" expense of $ 16,671 on each of the subject*154 returns.

EA 84-III

EPIC formed EA 84-III on September 14, 1983, pursuant to the Uniform Limited Partnership Act of the Commonwealth of Virginia for a 10-year term ending on September 14, 1993. EPIC was the sole general partner. The Certificate and Agreement of Limited Partnership was amended by the execution and filing of an Amended and Restated Certificate and Agreement of Limited Partnership dated October 1, 1983, which was recorded on December 20, 1983, among the limited partnership records maintained by the clerk of the court of Fairfax County, Virginia. The Certificate and Agreement of Limited Partnership of EA 84-III was amended for a second time on April 1, 1985. The Second Amended and Restated Certificate and Agreement of Limited Partnership (84 partnership agreement) describes the business of EA 84-III in the following terms:

   Business of the Partnership

   The business of the Partnership has been and shall be to

   acquire, directly or indirectly, own and finance fee interests

   in certain improved residential real properties and to hold such

   properties for investment with the objective of attaining

   maximum capital appreciation*155 therein and to engage in and

   perform all necessary and proper acts and activities in

   connection therewith including, but not limited to, operating,

   managing, maintaining, leasing, mortgaging, selling, exchanging

   or otherwise dealing with such properties with the objective of

   distributing income generated thereby among the Partners as

   provided for herein.

The 84 partnership agreement provides that EPIC's "interest shall be deemed to be a one-percent (1%) share in the partnership's capital contributions for which it shall contribute" $ 12,267. In addition, the 84 partnership agreement authorizes five enumerated classes of limited partnership interest, classes A through E, and such additional classes as are authorized by the general partner.

The 84 partnership agreement states that one class A unit, representing an aggregate capital contribution of $ 132,918.89, was sold to four investors, one class B unit, representing a capital contribution of $ 56,900, was sold to one investor, and one class C unit, representing an aggregate capital contribution of $ 208,750, was sold to three investors. It also appears that thereafter two investors*156 made an aggregate capital contribution of $ 51,381.

According to the partnership agreement, if the need for additional equity arose, the general partner could authorize any number of additional classes of limited partnership interest. Purchasers of the additional classes would be admitted to the limited partnership starting on July 1, 1986. The agreement also states that the general partner, in its sole discretion, may authorize future class units from January 1, 1988, through and until the termination of the partnership.

Before offering class D and class E units of limited partnership interest in EA 84-III for sale, EPIC circulated a confidential private placement offering memorandum (84 offering memorandum) dated April 1, 1985. The 84 offering memorandum states that the class A, B, C, D, and E limited partners' contributions would be used primarily to fund operating deficits of EA 84-III. The 84 offering memorandum contains a chart summarizing EA 84-III's anticipated sources and uses of the proceeds of the offering as follows:

       Sources               Amount    Percent

       _______          *157      ______    _______

Proceeds from sale of class A unit       $ 132,918     2.32

Proceeds from sale of class B unit         56,900     1.00

Proceeds from sale of class C unit        208,750     3.64

Proceeds from sale of class D unit         75,000     1.31

Proceeds from sale of class E unit        290,850     5.07

Proceeds from sale of additional class(es)    450,000     7.85

Capital contributions of general partner      12,266     0.21

First mortgage loans              3,453,450    60.24

Builder rebates                  755,287    13.17

General partner advances             297,400     5.19

                       _________   _______

 Total                     5,732,821    100.00

        Uses

        ____

Purchase price of homes             3,956,700    69.02

Sales commissions to broker/dealers  *158       97,153     1.70

Escrows and prepaid insurance           18,070     .32

First mortgage loan origination fees       138,138     2.40

Organizational fee to general partner       85,009     1.48

Estimated cash-flow deficits

 through September 30, 1984           473,417     8.26

Available for cash-flow deficits         964,334    16.82

                       _________    ______

  Total                    5,732,821    100.00

                       =========    ======

As set forth above, it was anticipated that $ 473,417 of the proceeds of the offering would be offset by cash-flow deficits through September 30, 1984, and $ 964,334 of the offering proceeds would be available for cash-flow deficits after that date.

The projected annual income and operating costs of EA 84- III as set forth in the 84 offering memorandum shows an annual operating deficit of $ 431,115 calculated as follows:

         *159                 Percentage of

   Projected Annual Income       Amount    Total Income

   _______________________       ______   _____________

   Rental income (less 20%

    vacancy & expense factor)    $ 231,293     100.00

                    ________     ______

    Total projected income       231,293     100.00

                    ________     ______

   Annual Operating Expenditures

   Aggregate first mortgage

    principal & interest        502,217     217.14

   Real estate taxes           72,617     31.40

   Insurance & homeowner's

    association dues          12,511      5.41

   Audit expenses             4,945      2.14

   Property administration fee      33,000     14.27

   Allowance for maintenance

    & repairs              19,783      8.55

   Additional interest     *160      17,335      7.49

                    _______     ______

   Total projected cash

    expenditures            662,408     286.40

                    _______     ______

   Projected operating deficits     431,115     186.40

                    _______     ______

The 84 offering memorandum also includes a cash-flow analysis for EA 84-III from October 1, 1983, through December 31, 1987, as set forth in appendix B to this opinion.

In the 84 offering memorandum, it was contemplated that EPIC would finance the partnership's operating deficits by advancing funds to the partnership. The 84 partnership agreement provides that EA 84-III would pay interest on all unsecured advances of funds by the general partner at the rate of 15 percent per annum. The 84 partnership agreement permits the partnership to advance to the general partner any funds that were not distributed to the limited partners, and the agreement provides that the general partner would pay interest to EA 84-III on such advances*161 at the rate of 12 percent per annum.

The 84 partnership agreement provides that cash from operations is to be distributed generally in the following order of priority: (i) To EPIC to repay any unsecured advances made by EPIC to the partnership together with interest; (ii) to the partners in the ratio that the cumulative cash capital contributions of each partner bear to the cumulative cash capital contributions of the partners until such amounts equal the partners' cumulative cash capital contributions; (iii) 25 percent to EPIC and 75 percent to the limited partners holding the class A, B, C, D, E, and additional class units.

The partnership agreement further provides that cash from sales not associated with a liquidation and/or financings is to be distributed generally in the following order of priority: (i) To repay the partnership debt secured by the property sold or refinanced; (ii) to repay general creditors of the partnership, including EPIC, any advances with interest; (iii) to establish such reserves as the general partner deems necessary; (iv) to the partners in the ratio that the cumulative cash capital contributions of each partner bear to the cumulative cash capital contributions*162 of the partners up to the amounts which equal the partners' cumulative cash capital contributions; and (v) 25 percent to EPIC and 75 percent to the limited partners.

The 84 partnership agreement states that EA 84-III shall compensate EPIC as follows:

   Compensation of the General Partner and Affiliates

               * * * * * * *

   (a) At the time of subscription, the General Partner shall

   receive seven percent (7%) of each Class A, Class B, Class C,

   Class D, Class E and any Additional Class or Classes Limited

   Partner's full contribution to the Partnership as a Partnership

   organization fee, as defined in the Confidential Private

   Offering Memorandum for the Partnership, or a maximum total

   payment of eighty-five thousand nine and 32/100 dollars

   ($ 85,009.32) for nonrecurring services which may be incurred

   before or after formation of the Partnership, including the

   furnishing of legal, financial, accounting and operational

   assistance, reviewing rental schedules and expense forecasts and

   providing other services which do not give rise to the

*163    acquisition or leasing of specific properties or the obtaining

   of financing therefor.

   (b) At the time of subscription to Future Class Units authorized

   pursuant to section 8(k), the General Partner, in its sole

   discretion, shall receive up to seven percent (7%) of the

   proceeds of the full contribution of each holder of a Future

   Class Unit for nonrecurring services which may be performed

   before or after authorization and sale of such Future Class

   Units, which may include furnishing legal, financial, accounting

   and operational assistance, reviewing and analyzing the

   Partnership's condition and determining the need for an amount

   of such additional capital to be raised by the sale of such

   Future Class Units.

   (c) During each full or partial month of the Partnership, the

   General Partner shall be paid a Property Administration Fee

   equal to fifty dollars ($ 50) per month for each Partnership

   property.

               * * * * * * *

   (d) Such loan origination fees or service fees as may derive

   from originating*164 or servicing any security interests, including

   mortgages and deeds of trust, placed upon Partnership property.

   (e) Reimbursement of all carrying costs of the Partnership

   properties, including, but not limited to, interest on mortgage

   indebtedness encumbering the properties incurred prior to the

   admission to the Partnership of the Limited Partners.

   (f) On all Advances of funds to the Partnership made by the

   General Partner pursuant to section 8(a)(xiv), the General

   Partner shall be entitled to interest at the rate of fifteen

   percent (15%) per annum.

               * * * * * * *

   (i) Any item of Partnership expense or cost may be paid to an

   entity or person affiliated directly or indirectly with the

   General Partner, subject only to the requirement that such

   affiliated or related person or entity perform such service as

   is contracted for or requested in consideration for such cost or

   expense.

PURCHASE OF PRODUCTION HOUSES IN TEXAS AND ARIZONA

EPIC entered into a Residential Rental Purchase Agreement (rental purchase agreement), *165 dated September 16, 1983, under which it agreed to purchase 142 residential properties from U.S. Home Corp. (U.S. Home) for an aggregate purchase price of $ 8,767,850. The location and purchase price of each property is set forth in exhibit A to the rental purchase agreement.

As a condition to the purchaser's obligation under the rental purchase agreement, U.S. Home agreed to pay to EPIC 6.8 percent of the purchase price of each property on the closing date. The rental purchase agreement provides for this payment in the following language:

     On the Closing Date, Seller shall pay to Equity Programs

   Investment Corporation a sum equal to six and eight-tenths

   (6.8%) of the Purchase Price of the Properties, and the

   execution of this Agreement by Seller shall constitute an

   irrevocable assignment to Equity Programs Investment Corporation

   from the sale proceeds of a sum sufficient to make the payment

   due under this Subparagraph 4.6.

We refer to this amount as the builder fee.

The rental purchase agreement also requires U.S. Home to pay to the purchaser 3 months' rent for each property under certain conditions. That provision*166 states as follows:

   On the Closing Date, Seller shall pay to Purchaser a sum equal

   to the total estimated rent for three (3) months, as shown on

   Exhibit A for each of the Properties (the "Reserve"). At such

   time as all of the Properties have been rented at least once, or

   upon the expiration of seven (7) months from the Closing Date,

   whichever shall first occur, Purchaser shall refund the Reserve

   to Seller, less the product of the rent, as shown in Exhibit A,

   times the period of vacancy for each Property since the Closing

   Date. For seven (7) full months after the Closing Date,

   Purchaser shall furnish Seller written monthly reports detailing

   occupancy and rents.In this opinion, we refer to the payment required under the above provision as the rent advance.

The agreement further obligated U.S. Home to pay to the purchaser "a sum equal to the amount as set forth on Exhibit 'A' hereof of the purchase price of each Property as a contribution towards rental deficits (rental deficit contribution)." We refer to this amount as the rental deficit contribution. Finally, the rental purchase agreement conditioned*167 the purchaser's obligation under the agreement on the acquisition of "an appraisal of each of the Properties by a FNMA/FHLMC qualified appraiser on a standard FNMA/FHLMC form which shall reflect the value of each Property equal to or greater than the purchase price applicable to that Property".

EPIC assigned its right, title, and interest as purchaser under the rental purchase agreement with U.S. Home to various limited partnerships of which it was general partner. EPIC assigned its right to purchase 15 of the 142 properties to EA 84-III. On September 19, 1982, EA 84-III purchased the 15 properties it had been assigned for an aggregate purchase price of $ 908,700.

To finance its purchase of the 15 properties, EA 84-III borrowed $ 863,250, approximately 95 percent of the purchase price, from EMI. On the closing date, EA 84-III executed 15 nonrecourse promissory notes in the aggregate principal amount of $ 863,250, payable to EMI with monthly installments of interest only for 5 years at the annual rate of 14.625 percent. Thereafter, the notes required EA 84-III to pay monthly installments of principal and interest for 5 years. The full indebtedness was due and payable on October 1, 1993.

*168 Each nonrecourse promissory note was secured by a deed of trust dated on the closing date. Most of the deeds of trust were recorded either in the land records of Harris County or Bexar County, Texas, or Pima County, Arizona. A mortgage insurance company, Republic Mortgage Insurance Co. (RMIC), issued a commitment and certificate of insurance providing mortgage insurance for 25 percent of the first loss amount with respect to the mortgage on each of the properties.

Set out below is a list of the 15 properties, together with the purchase price, the builder fee, the rental deficit contribution, the rent advance, and the amount borrowed with respect to each property:

                              Rental                  Purchase    Builder    Deficit   Houses and Condominiums     Price      Fee     Contrib.   _______________________     ________    _______    ________

5419 Heronwood Dr.        $ 54,000    $ 3,672.00   $ 6,189 5411 Heronwood Dr.         65,000     4,420.00    9,610 3518 Tower Hill Lane*169        63,750     4,335.00    8,959 12347 Northcliff Manor Dr.     58,500     3,978.00    7,326 13066 Clarewood Dr.        57,000     3,876.00    8,169 6351 S. Briar Bayou Dr.      61,500     4,182.00    8,914 12103 Kingslake Forest Dr.     60,500     4,012.00    8,341 12107 Kingslake Forest Dr.     50,500     3,434.00    5,231 12111 Kingslake Forest Dr.     56,000     3,808.00    6,549 12115 Kingslake Forest Dr.     64,000     4,352.00    9,037 12231 Carola Forest Dr.      59,000     4,114.00    7,482 4850 West Ferret Dr.        71,000     4,828.00    9,905 4107 Medical Dr. (Condo.)     59,950     4,076.60    7,777 13739 Earlywood Dr.        64,000     4,352.00    9,692 6402 Ridgecreek Dr.        64,000     4,352.00    9,692                  _______    _________   _______   Total              908,700    61,791.60   122,873

             [Table*170 continued]

                 Rent   Houses and Condominiums     Advance      Loan   _______________________     _______      ____

5419 Heronwood Dr.        $ 1,395     $ 51,300 5411 Heronwood Dr.         1,395      61,750 3518 Tower Hill Lane        1,425      60,550 12347 Northcliff Manor Dr.     1,425      55,575 13066 Clarewood Dr.         1,275      54,150 6351 S. Briar Bayou Dr.       1,350      58,425 12103 Kingslake Forest Dr.     1,380      57,475 12107 Kingslake Forest Dr.     1,380      47,975 12111 Kingslake Forest Dr.     1,425      53,200 12115 Kingslake Forest Dr.     1,425      60,800 12231 Carola Forest Dr.       1,425      56,050 4850 West Ferret Dr.        1,575      67,450 4107 Medical Dr. (Condo.)      1,425      56,950 13739 Earlywood Dr.         1,350      60,800 6402 Ridgecreek Dr.         1,350      60,800           *171        _______     _______   Total              21,000     863,250

The sale of each property to EA 84-III is reflected on a settlement statement executed on the date of closing that shows the purchase price listed above as the contract sales price. For each of the properties, the total of the "amounts paid by/for" EA 84-III, consisting principally of the loan proceeds and the sum of the builder fee, rent advance, and rental deficit contribution, exceeded the gross amount due from EA 84-III. Set out below is a summary of the settlement statements showing that a total of approximately $ 142,658.49 had been overpaid by or behalf of the buyer, EA 84-III:

   U.S. Home Corp.           Buyer        Seller

   _______________           _____        ______

Contract sales price         $ 908,700.00     $ 908,700.00

Settlement charges to buyer       18,600.95       -0-

Price adjustment              830.16        830.16

                  ___________     ___________

*172                    928,131.11      909,530.16

Principal amount of loans       863,250.00       -0-

Builder fee               61,791.60      61,791.60

Rent advance              21,000.00      21,000.00

Rental deficit contribution      122,873.00      122,873.00

Other credits              1,875.00       1,875.00

Settlement charges to seller        -0-        11,320.94

                  ____________     ___________

                  1,070,789.60      218,860.54

Amount due to buyer         ¹ 142,658.49

Amount due to seller                   690,669.62

*173 According to the settlement statements, the aggregate principal amount of the loans, $ 863,250, was credited as follows:

 U.S. Home Corp.     Buyer    Seller    Others     Total

 _______________     _____    ______    ______     _____

Settlement charges

 to buyer         -0-      -0-   $ 18,600.95 $ 18,600.95

Amount due less loan $ -64,881.11    -0-      -0-    -64,881.11

Builder fee       61,791.60    -0-      -0-    61,791.60

Rent advance       21,000.00    -0-      -0-    21,000.00

Rental deficit

 contribution     122,873.00    -0-      -0-    122,873.00

Other credits       1,875.00    -0-      -0-     1,875.00

Settlement charges

 to seller        -0-      -0-    11,320.94   11,320.94

Amount due seller     -0-    $ 690,669.62    -0-    690,669.62

           __________  ___________  _________  __________

           142,658.49   690,669.62  29,921.89  863,250.00

In passing, *174 we note that the parties stipulated that U.S. Home sold to EA 84-III the two houses at 5411 and 5419 Heronwood Drive, and the four houses at 12103, 12107, 12111, and 12115 Kingslake Forest Drive. These six properties are listed among the properties covered by the Residential Rental Purchase Agreement dated September 16, 1983, between EPIC and U.S. Home. Furthermore, the settlement statement for the sale of five of those properties lists the seller as U.S. Homes. The record does not contain the settlement statement for the sale of 12103 Kingslake Forest Drive.

At trial, respondent introduced warranty deeds that show that on or about June 1, 1982, the two properties on Heronwood Drive were transferred by U.S. Home to Tanmis Models, Inc., and on or about August 26, 1983, were transferred by Tanmis Models, Inc., to EA 84- III. Respondent also introduced warranty deeds that show that on or about September 1, 1981, the four properties on Kingslake Forest Drive were transferred by U.S. Home to Dyblof Models, Inc., and on or about August 26, 1983, were transferred by Dyblof Models, Inc., to EA 84-III.

Apparently, these six properties were models that EPIC acquired from U.S. Home through*175 companies affiliated with EPIC, Tanmis Models, Inc., and Dyblof Models, Inc., and leased back to U.S. Home. Under its agreement with EPIC, U.S. Home had the right to buy each property back at the original purchase price at the end of the lease term.

EMI assigned to CSL its interest in each of the promissory notes and related deeds of trust that had been The 16th promissory note and the related deed of trust are similar to the others, except they refer to unit 101 of The Reflections condominium complex, described below.

PURCHASE OF 40 CONDOMINIUMS UNITS IN THE REFLECTIONS

EPIC executed a Residential Rental Purchase Agreement (rental purchase agreement), dated August 3, 1983, under which it agreed to purchase a condominium complex located in San Antonio, Texas, known as the Reflections from Pitman Properties, Inc., and Japhet Properties, Inc. (herein Pitman & Japhet), for $ 3,048,000. For each condominium unit, there is attached to the agreement an exhibit B that identifies the unit, lists the appliances and furnishings included in the purchase price, and states the estimated monthly rent for the unit.

The Reflections is a 40-unit condominium complex which was new at the time of*176 this transaction in 1983. The complex is composed of seven buildings with a total of 40,356.85 square feet of net rentable living area located on 2.233 acres. The units have fireplaces, parking spaces, 1,135 square feet of storage space, and patios, porches and balconies. There is a pool and exterior landscaping, and one side of the complex faces a man-made lake.

Under the rental purchase agreement, Pitman & Japhet agreed as a condition to closing to pay to EPIC 6.8 percent of the purchase price of each unit. We refer to this amount as the builder fee. As a further condition to closing, Pitman & Japhet agreed to pay to the purchaser a sum equal to the percentage of the purchase price of each unit that is set forth on exhibit A to the agreement as a contribution towards rental deficits (rental deficit contribution). The percentages set forth on exhibit A range from 20.30 percent to 21.39 percent. We refer to this amount as the rental deficit contribution.

As a further condition to EPIC's obligation, the agreement provides:

   Rental of the Properties to individual tenants shall have been

   arranged, or shall be arranged, upon execution by Purchaser of

   the Agreement*177 in accordance with the procedures set forth in

   Exhibit "C", attached hereto and by this reference made a part

   hereof.

Pursuant to exhibit C, in the event that any of the properties were not leased as of 7 days before closing, Pitman & Japhet agreed to pay to the purchaser, in addition to the rental deficit contribution, an amount equal to three times the monthly rent set forth for each unit that was not rented as of the closing date. We refer to this payment as the rent advance.

The purchaser's obligations under the rental purchase agreement were also subject to the condition that the purchaser shall have obtained "an appraisal of each of the Properties prepared by a FNMA/FHLMC qualified appraiser on a standard FHMA/FHLMC form which shall reflect the value of each Property equal to or greater than the purchase price".

It appears that EPIC assigned to EA 84-III its rights as purchaser under the rental purchase agreement dated August 3, 1983, with Pitman & Japhet. The record does not contain an instrument of assignment. In any event, on September 30, 1983, EA 84-III purchased the 40 condominium units at the Reflections.

To finance its purchase of the condominiums,*178 EA 84-III borrowed $ 2,590,200, approximately 85 percent of the aggregate purchase price, from EMI. EA 84-III executed 40 nonrecourse promissory notes in the aggregate principal amount of $ 2,590,200, that were each payable to EMI with monthly installments of interest at the annual rate of 14.125 percent. The record does not contain any of the 40 promissory notes, but their terms are summarized in the 84 offering memorandum as follows:

   Thirty-five month interest only, thirteen months amortizing on

   the leases [sic] of a thirty year amortization schedule, six

   year level pay fully amortizing, with no adjustments in the

   interest rate during the life of the loan.

Each promissory note was secured by a deed of trust and was covered by a private mortgage insurance policy. The record does not contain the deeds of trust or documents relating to the private mortgage insurance. At some time, Philadelphia Savings Fund of Philadelphia acquired the promissory notes that EA 84-III had issued to EMI and EMI assigned each of the 40 deeds of trust to Philadelphia Savings Fund of Philadelphia.

Set out below is a list of the 40 condominiums that EA 84- III purchased*179 together with the purchase price, rental deficit contribution, rent advance, and loan amount:

                   Rental

      Purchase    Builder    Deficit    Rent

Unit     Price      Fee     Contrib.   Advance    Loan

____     ________    _______    ________   _______    ____

A 101    $ 91,900    $ 6,249.20   $ 19,661   $ 1,800    $ 78,100

A 102     97,900     6,657.20    20,596    1,950     83,200

A 103     97,900     6,657.20    20,596    1,950     83,200

A 104     91,900     6,249.20    19,661    1,800     78,100

B 201     91,900     6,249.20    19,661    1,800     78,100

B 202     97,900     6,657.20    20,597    1,950     83,200

B 203     97,900     6,657.20    20,597    1,950     83,200

B 204     91,900     6,249.20    19,661    1,800     78,100

C 301     91,900     6,249.20    19,661    1,800     78,100

C 302     97,900     6,657.20    20,597    1,950   *180   83,200

C 303     97,900     6,657.20    20,597    1,950     83,200

C 304     91,900     6,249.20    19,661    1,800     78,100

D 401     75,900     5,161.20    15,616    1,575     64,500

D 402     75,900     5,161.20    15,616    1,575     64,500

D 403     75,900     5,161.20    15,616    1,575     64,500

D 404     75,900     5,161.20    15,616    1,575     64,500

E 501     75,900     5,161.20    15,616    1,575     64,500

E 502     57,900     3,937.20    11,751    1,245     49,200

E 503     75,900     5,161.20    15,616    1,575     64,500

E 504     57,900     3,937.20    11,751    1,245     49,200

E 505     57,900     3,937.20    11,751    1,245     49,200

E 506     75,900     5,161.20    15,616    1,575     64,500

E 507     57,900     3,937.20    11,751    1,245     49,200

E 508     75,900     5,161.20    15,616    1,575     64,500

F 601     75,900     5,161.20  *181   15,616    1,575     64,500

F 602     57,900     3,937.20    11,751    1,245     49,200

F 603     75,900     5,161.20    15,616    1,575     64,500

F 604     57,900     3,937.20    11,751    1,245     49,200

F 605     57,900     3,937.20    11,751    1,245     49,200

F 606     57,900     3,937.20    11,751    1,245     49,200

F 607     57,900     3,937.20    11,751    1,245     49,200

F 608     57,900     3,937.20    11,751    1,245     49,200

F 609     57,900     3,937.20    11,751    1,245     49,200

F 610     75,900     5,161.20    15,616    1,575     64,500

F 611     57,900     3,937.20    11,751    1,245     49,200

F 612     75,900     5,161.20    15,616    1,575     64,500

G 701     75,900     5,161.20    15,616    1,575     64,500

G 702     75,900     5,161.20    15,616    1,575     64,500

G 703     75,900     5,161.20    15,616    1,575     64,500

G 704    *182 75,900     5,161.20    15,616    1,575     64,500

     _________    __________   _______   ______   _________

 Total  3,048,000    207,264.00   632,414   62,640   2,590,200

The sale of each condominium to EA 84-III is reflected on a settlement statement executed on the date of closing that shows the purchase price listed above as the "contract sales price". On each settlement statement, the builder fee, rent advance, and rental deficit contribution are treated as charges to Pitman & Japhet, reducing the amount due Pitman & Japhet. These amounts are also treated as credits to EA 84-III. Set out below is a summary of the settlement statements showing that the aggregate amounts paid by or on behalf of the buyer, EA 84-III, exceeded the aggregate amount due from the buyer by $ 441,356.12:

Pitman & Japhet Properties      Buyer          Seller

__________________________      _____          ______

Contract sales price       $ 3,048,000.00      $ 3,048,000.00

Settlement charges to buyer      16,018.38         -0-

       *183          _____________      _____________

                 3,064,018.38       3,048,000.00

Principal amount of loans     2,590,200.00         -0-

Builder fee             207,264.00        207,264.00

Rent advance             62,640.00        62,640.00

Rental deficit contribution     632,414.00        632,414.00

Adjustments              1,756.50         1,756.00

Other credits             11,100.00        11,100.00

Payoff loans              -0-         1,548,548.53

Settlement charges to seller      -0-          132,833.00

                _____________      ______________

                 3,505,374.50       2,596,556.03

Amount due buyer           441,356.12

Amount due seller                      451,443.97

According to the settlement*184 statements, the aggregate principal amount of the loans, $ 2,590,200, was credited as follows:

Pitman & Japhet

Properties       Buyer     Seller     Others     Total

_______________     _____     ______     ______     _____

Settlement charges

 to buyer        -0-      -0-    $ 16,018.38   $ 16,018.38

Amount due less

 loans       $ -473,818.38    -0-      -0-    -473,818.38

Builder fee      207,264.00    -0-      -0-     207,264.00

Rent advance      62,640.00    -0-      -0-     62,640.00

Rental deficit

 contribution     632,414.00    -0-      -0-     632,414.00

Adjustments       1,756.50    -0-      -0-      1,756.50

Other credits      11,100.00    -0-      -0-     11,100.00

Payoff loans        -0-     -0-    1,548,548.53 1,548,548.53

Settlement charges

 to seller        -0-     -0-     132,833.00   132,833.00

Amount due seller     -0-   $ 451,443.97    -0-  *185    451,443.97

           __________ ___________ ____________ ____________

           441,356.12  451,443.97 1,697,399.91 2,590,200.00

In summary, the aggregate contract prices of the properties purchased by EA 84-III, the aggregate rental deficit contributions attributable to those properties, and the aggregate amounts borrowed are as follows:

           Contract    Rental Deficit     Loan

            Price     Contribution     Amount

           ________    ______________     ______

U.S. Home       $ 908,700     $ 122,873      $ 863,250

Pitman & Japhet    3,048,000      632,414      2,590,200

          _________     ________      _________

   Total      3,956,700      755,287      3,453,450

The 84 offering memorandum states that investors would break even if the real properties acquired by EA 84-III appreciated at the annual rate of 9.15 percent over the 4-year period that the partnership planned to hold the properties.

FINANCIAL STATEMENTS*186 FOR EA 84-III

The general partner prepared and circulated to the limited partners quarterly statements for EA 84-III entitled "Results of Operations and Tax Income (Loss)". The record contains the statements for the eight quarters beginning September 19, 1983, and ending June 30, 1985. If the entries designated "current period" on the quarterly statements for a particular year are added, the totals for each entry for each year or part of a year during the period beginning September 16, 1983, and ending June 30, 1985, are as follows:

                   9/19/83 to  1/1/84 to 1/1/85 to

EA 84-III          12/31/83   12/31/84   6/30/85

       _________         __________  _________ _________

Revenue:

 Rental income            $ 76,790.36 $ 228,516 $ 107,858

 Interest income -- general partner   6,097.26    -0-     -0-

 Other income                -0-     -0-     2,866

                   __________  ________  ________

 Total revenue        *187      82,887.62   228,516   110,724

Expenses:

 Interest on first mortgage      118,081.87   504,391   250,902

 Additional mortgage interest       -0-     -0-     -0-

 Other interest expense          -0-     -0-     5,000

 Real estate taxes, insurance, HOA   26,480.69   83,110   45,240

 Audit fee                5,000.00    5,000    2,500

 Repairs and maintenance        10,225.44   120,032   30,811

 Property administration fee       8,250.00   33,000   16,500

 Interest expense -- general partner    -0-     28,175   18,680

 Rental commission            5,305.42   23,198   10,118

 Legal fees                 15.00     687     167

 Other expenses              140.81    -0-      90

                   __________  ________  ________

  Total expenses           173,499.23   797,593   380,008

Net results of operations      *188   -90,611.61  -569,077  -269,284

Taxable income (loss):

 Net results of operations       -90,611.61  -569,077  -269,284

 Plus: mortgage amortization        -0-     -0-     -0-

 Less: depreciation           42,685.50   170,742   85,372

    Amortization of loan fees     3,454.45   13,812    6,906

    Amortization of refinancing

     costs               -0-     -0-     -0-

    Accrued mortgage interest      -0-     -0-     -0-

    Misc. expenses           -0-       28     -5

                   ___________  ________  ________

Taxable income (loss)         -136,750.56  -753,659  -361,557

The above amounts can be compared with the cash-flow projection that was set out in the 84 offering memorandum and is reproduced as appendix B.

As shown above, one of the expenses recorded as having been paid on behalf of EA 84-III during the period beginning September 19, 1983, and ending June 30, 1985, is interest expense -- general*189 partner of zero during 1983, $ 28,175 during 1984, and $ 18,680 during 1985. Three of the statements contain the following note or words of similar import:

   Interest Expense -- GP:

   Cash advances by the General Partner necessary to sustain

   operations of the partnership continued to be greater than

   budget resulting in additional interest expense.

The quarterly statements also record that EA 84-III received interest income -- general partner of $ 6,097.26 during 1983.

The record contains audited financial statements of EA 84-III for the period beginning September 14 (inception) to December 31, 1983, that were prepared by a firm of certified public accountants. Included therein is the following statement of operations and changes in partners' capital:

    Revenues:

     Rental income                $ 76,790

     Interest income                 2,756

                           _______

                           79,546

    Expenses:

    *190 Interest                   118,082

     Depreciation                  21,343

     Real estate taxes               18,123

     Amortization                  3,804

     Property management fee             8,250

     Rental commission                5,305

     Insurance                    5,480

     Repairs and maintenance             8,500

     Other                      9,759

                           _______

                           198,646

    Loss from operations              (119,100)

    Partners' capital contributions         134,334

                          ________

   Partners' capital at end of year        *191  15,234

                          ========

One of the accompanying notes deals with related-party transactions and states as follows:

   4. Related party transactions

    Equity Programs Investment Corporation (EPIC) is the sole

    general partner for EPIC Associates 84-III. The general

    partner manages, controls and administers the business of the

    Partnership. The general partner is compensated for these

    services in accordance with the fee structure set forth in

    the Private Placement Offering Memorandum of the Partnership.

    The Partnership incurred $ 8,250 of cost to EPIC for these

    services during 1983. In addition the partnership paid

    organization fees to EPIC of $ 83,755.

    Interest is charged or paid to the Partnership on the due

    to/from general partners balance in accordance with the rates

    prescribed in the Private Placement Offering Memorandum. The

    Partnership earned $ 2,756 of interest net from EPIC during

    1983. While not obligated to do*192 so under the Partnership

    agreement, the general partner is anticipated to advance

    funds for any cash flow deficits.

    The Partnership paid loan origination fees of $ 138,138 to

    EPIC Mortgage, Inc., an affiliate of the general partner.

On the basis of the above, it appears that EA 84-III realized interest income from EPIC in 1983 and paid or incurred interest expense on unsecured advances from EPIC in 1984 and 1985 in the following amounts:

                     1983     1984    1985

                     ____     ____    ____

Interest income -- general partner   $ 6,097.26    -0-     -0-

Interest expense -- general partner    -0-    $ 28,175  $ 18,680

                   _________   _______   _______

                    6,097.26   (28,175)  (18,680)

FEDERAL INCOME TAX RETURNS FILED ON BEHALF OF EA 84-III

For Federal income tax purposes, EA 84-III reported the following income and expenses for the years in issue:

  EA*193 84-III            1983      1984      1985

  _________            ____      ____      ____

Rent income           $ 80,124    $ 228,516   $ 230,130

Interest              -0-       -0-       494

 Total gross income        80,124     228,516    230,624

Interest (noninvestment)     118,082     522,466    545,848

Commissions             5,305     23,198     19,403

Insurance              5,480     16,663     19,894

Legal and professional fee     6,895       687     1,008

Repairs               8,500     19,782    108,459

Taxes               18,123     72,554     72,617

Utilities              1,726     33,555     1,830

Homeowners dues            998      3,993     12,353

Property management fee       8,250     33,000     32,175

Points amortization*194         3,453     13,814     13,814

Miscellaneous             141       606      574

Audit fee              -0-      5,000     3,333

Service fee             -0-       -0-      3,197

Depreciation            56,910     170,742    170,742

                ________     ________   _________

 Total expenses         233,863     916,060   1,005,247

Net rental income        -153,739     -687,544   -774,623

On its Schedule K, Partner's Share of Income, Credits, Deductions, etc., for 1983, EA 84-III reported an ordinary loss of $ 153,739, a net investment loss of $ 141,142 for purposes of allocating tax preference items to its partners, and net investment income of $ 6,097 for purposes of computing investment interest. On its Schedules K for 1984 and 1985, EA 84-III reported ordinary losses of $ 687,544 and $ 774,623, respectively, and investment income of zero and $ 494, respectively; and for purposes of allocating tax preference items*195 to its partners, EA 84-III reported qualified investment income of $ 217,619 and $ 229,131, respectively, and qualified investment expenses of $ 872,376 and $ 997,436, respectively.

For depreciation purposes, EA 84-III treated the aggregate contract price of its 55 properties, $ 3,956,700, less the aggregate rental deficit contributions, $ 755,287, as its aggregate basis in the real estate; viz $ 3,201,413. EA 84-III allocated 20 percent of that amount to land; viz $ 640,283, and 80 percent to buildings; viz $ 2,561,130. EA 84-III depreciated the later amount on a straight-line basis over 15 years and claimed deprecation at the annual rate of $ 170,742 in each of the years in issue. EA 84-III claimed a depreciation allowance for 4 months on its 1983 return, $ 56,910, and a depreciation allowance for 12 months on its 1984 and 1985 returns.

For each of the years in issue, EA 84-III was obligated under the promissory notes that it had issued to EMI to pay interest on the aggregate principal amount of the notes, $ 3,453,450. EA 84-III was obligated to pay interest at the annual rate of 14.625 percent on the notes issued to purchase the 15 properties from U.S. Home and was obligated to*196 pay interest at the annual rate of 14.125 percent on the notes issued to purchase the 40 condominium units from Pitman & Japhet. Thus, EA 84-III was obligated to pay interest to EMI in the total amount of $ 492,116.06 during each of the years 1984 and 1985 computed as follows:

                 Loan     Rate    Annual Interest

                 ____     ____    _______________

U.S. Home properties      $ 863,250    14.625    $ 126,250.31

Pitman & Japhet properties   2,590,200    14.125     365,865.75

               _________          ___________

 Total             3,453,450          492,116.06

EA 84-III was also obligated under the 84 partnership agreement to pay interest at the annual rate of 15 percent to compensate the general partner for unsecured advances of funds to the partnership. The returns filed on behalf of EA 84-III for the years in issue report the following liabilities to the general partner on Schedule L:

               Due to

Taxable*197 Year Ended    General Partner    Accrued Interest -- G/P

__________________    _______________    _______________________

  12/31/83          -0-            -0-

  12/31/84        $ 165,481         $ 28,174

  12/31/85         373,705          42,750

EA 84-III reported noninvestment interest expense on its returns for the years in issue of $ 118,082, $ 552,466, and $ 545,848, respectively. The difference between these amounts and the interest paid or incurred with respect to the partnership's first mortgage notes is as follows:

                    1983     1984     1985

                    ____     ____     ____

Total interest expense reported    $ 118,082   $ 522,466   $ 545,848

Interest on first mortgage notes   ¹ 123,029    492,116    492,116

                   ________    _______   ________

Difference                (4,947)    30,350    53,732

*198 The record of this case does not fully explain the above differences.

EA 84-III paid loan origination fees to EMI in the aggregate amount of $ 138,138 equal to 4 percent of the principal amount of the first mortgage loans (i.e., $ 3,453,450 x 4 percent). On the subject returns, EA 84-III claimed a deduction for "amount of points" of $ 3,453, $ 13,814, and $ 13,814, respectively.

EPIC

As mentioned above, EPIC, the general partner of EA 83-XII and EA 84-III, was incorporated in 1974 for the purpose of acquiring residential real properties and providing various services in connection with the acquisition, syndication, management, and disposition of the properties. Between 1975 and 1985, EPIC formed approximately 357 limited partnerships with more than 6,000 limited partners. EPIC was the general partner of each limited partnership. These partnerships owned approximately 17,600 residential dwelling units located throughout the United States and issued approximately 20,500 mortgages totaling approximately $ 1,435,000,000.

When EPIC began its real estate syndication business, it contracted to purchase properties from developers of residential real estate and to lease the properties*199 back to the developers for use as models. Typically, the developers were willing to pay to EPIC a commission, referred to as the builder's fee, of approximately 6 percent of the purchase price of each property and were willing to pay rent on each property for some period in advance.

EPIC would form a limited partnership for the purpose of buying the models. EPIC would assign its rights to purchase the properties to the limited partnership, and the limited partnership would purchase the properties with equity capital contributed by the limited partners. The early limited partnerships financed 75 or 80 percent of the purchase of the properties. These loans were recourse. The limited partnership would lease the models back to the developer on a triple net lease basis during completion of the project, a period ranging from 18 to 24 months.

Typically, the rental income from the properties exceeded the amount needed to service the debt, and the partnership realized a positive cash-flow during the lease term. The plan called for the limited partnership to sell the properties for a profit at the end of the developers' lease term. These early limited partnerships were referred to by EPIC's*200 management as income partnerships.

EPIC's success and the success of its partnerships depended upon the appreciation of the real properties that were purchased by the partnerships. The sales of real estate by EPIC partnerships before 1980, as shown in exhibits to the 83 and 84 offering memoranda, reveal high annual appreciation.

During 1980, mortgage interest rates increased to historic levels, and the real estate market began to deteriorate as a result. The higher interest rates significantly increased the costs of selling properties and reduced profits realized by the partnerships on the sale of properties. Accordingly, in 1980, EPIC's management made the decision to stop selling properties until interest rates fell. EPIC's management believed that, as an interim measure, the company could carry the limited partnerships until interest rates decreased and profit margins returned to normal.

Notwithstanding the cessation of sales, EPIC continued to syndicate real estate partnerships. This was EPIC's core business. EPIC's management did not consider shutting down that business when interest rates increased in 1980 because EPIC's management believed that the company could purchase*201 properties that would appreciate and could be sold for a profit when interest rates declined.

At this time, EPIC's management undertook to revise certain characteristics of the limited partnerships that were syndicated. EPIC's management had realized that if an income partnership held properties after the developer's lease expired, the partnership would realize cash deficits, and it had no mechanism to fund such deficits. EPIC's management wanted greater flexibility in the period of time that a partnership could hold its properties. In order to permit a longer holding period, the partnerships would have to lease properties to individual tenants, and, as a result, the rental stream would decrease substantially because lease rates paid by individual tenants are much lower than the commercial rates paid by developers. However, EPIC found that developers would discount the price of the properties by an amount roughly equivalent to the present value of the difference in rental rates. EPIC referred to this discount as the rental deficit contribution.

Because of the longer holding period, EPIC's management also wanted to increase the loan-to-value ratio of its mortgages to 95 percent in*202 order to help carry the properties. For the same reason, EPIC's management wanted the loans to be nonrecourse.

EPIC found that lenders in the secondary mortgage market would purchase such loans if the lender's risk, taking private mortgage insurance into account, was no greater than 72 percent of the loan. Thus, in the case of a 95-percent loan, for example, a secondary lender would require mortgage insurance of at least 25 percent. In the case of a 90-percent loan, a secondary lender would require mortgage insurance of at least 20 percent, and so on. Through negotiation, EPIC found that private mortgage insurance companies were willing to insure nonrecourse mortgages on residential properties. As a result of negotiations with secondary lenders and private mortgage insurers, EPIC's management found that it could obtain 95-percent nonrecourse financing on single-family houses and condominiums owned by its investment partnerships. Finally, EPIC's management found that investors were willing to purchase interests in the new partnerships for roughly one-half of the anticipated tax losses; i.e., a 2-to-1 ratio. The new partnerships were known internally to EPIC's management as "tax partnerships"*203 to distinguish them from the earlier "income partnerships".

During the period after 1980, EPIC's management also experimented with resyndicating properties from older partnerships and with expandable partnerships. EPIC's management also formed EPIC Residential Network, Inc. (ERNI), to act as a real estate broker to be in position to sell properties when interest rates declined and the real estate market recovered.

Thus, beginning in 1981 or 1982, EPIC expanded its business by entering into agreements to purchase properties that it intended to rent to the public, rather than to the developer. After this change, EPIC did not limit itself to models in a particular project but contracted to buy production houses. This meant that, in some cases, EPIC acquired a substantial inventory of unsold houses in a single project and facilitated the developer's completion of the project.

Under this business plan, EPIC intended to syndicate the properties to limited partnerships which would rent the properties for 4 years before selling them. EPIC calculated the capital contributions of the limited partners to equal one-half of the anticipated tax losses, resulting in a "two-to-one tax write-off. *204 "

For cash management purposes, EPIC "swept" all funds from all of the partnerships' accounts daily and deposited the funds into a master account maintained by EPIC. EPIC then advanced funds to pay the debts of any of its partnerships that needed funds. The amounts borrowed from each partnership and the amounts advanced to each partnership were accounted for in the books and records of the appropriate partnerships. Interest was credited to partnerships to which EPIC owed money and was charged to partnerships which owed money to EPIC (net borrowers and net lenders). Among the funds swept from the accounts of individual partnerships were the funds received by partnerships upon the acquisition of real properties. EPIC management believed that a default by any of its partnerships would have an adverse impact on the entire EPIC enterprise, and EPIC never permitted any limited partnership to default on a payment until August 1985 when all of the limited partnerships sought protection under the bankruptcy laws.

During the time it was in existence, EPIC formed or acquired a number of subsidiaries and affiliated companies to engage in different aspects of the real estate business. For example, *205 as mentioned above, EMI originated mortgage loans on behalf of EPIC limited partnerships and received fees for doing so. EMI obtained the funds to originate loans through "warehouse" or interim lines of credit from CSL, an affiliated savings and loan association, and other financial institutions. EPIC sold interests in passthrough certificates or whole loans in the secondary market to other financial institutions. All of the purchase money promissory notes at issue in these cases were sold in the secondary market in one form or another.

Another affiliate, ERSI, managed the properties that were owned by EPIC limited partnerships, other than properties leased back to the developers on net leases. ERSI leased the properties, reviewed tenant applications, collected and accounted for rental income, secured insurance and arranged maintenance and repairs. EPIC paid ERSI a monthly fee of $ 35 of the $ 50 it received for managing each property.

Another affiliate, ERNI, acted as a real estate broker to sell properties. Generally, ERNI received a real estate commission of 6 percent of the sale price of each unit sold.

Another affiliate, Continental Appraisal Group, Inc. (CAG), appraised the*206 residential properties purchased by EPIC partnerships. The appraisals were made either by a member of the CAG staff or by an outside appraiser and reviewed by a staff appraiser. CAG also appraised properties for unrelated lenders. Another company, EPIC Securities, Inc., wholesaled the limited partnership interests in EPIC partnerships and received a percentage of the capital contributions as a commission. Finally, in October 1983, EPIC or one of its affiliates acquired Community Savings & Loan, a Maryland- chartered savings and loan association.

PRIVATE MORTGAGE INSURANCE

While EMI originated the loans at issue, each of the loans was insured by a private mortgage insurance company for 25 percent of the first loss amount. Tricor Mortgage Insurance Co. and Republic Mortgage Insurance Co. (RMIC) issued mortgage insurance covering the first mortgage loans at issue in the instant cases. In addition, EPIC dealt with other mortgage insurance companies, including Mortgage Guarantee Insurance Corp. (MGIC) and Commonwealth Mortgage Assurance Corp. (CMAC).

The private mortgage insurance companies thoroughly investigated the risks presented by EPIC's business. For example, in June 1982, after*207 EPIC had changed the nature of its limited partnerships, representatives of MGIC's appraisal department and underwriting evaluation department made a risk management study of EPIC. The study sets forth a detailed description of EPIC's business and the underwriting risks presented to MGIC from that business. As part of the study, MGIC had conducted spot checks of EPIC's appraisals and had found "inflated property values". The report states as follows:

   Based on our spot checks Epic's appraisals had inflated property

   values. The value estimates made 2 or 3 years ago by Epic's

   appraisers are higher than the value estimates as of the date of

   contract and the current value estimates of the properties. It

   is not known if Epic Mortgage is aware of this over-valuing in

   as much [sic] as they do not have an appraisal department to

   review the appraisals.

               * * * * * * *

   Based on MGIC's 25 spot checks there is overvaluing by Epic that

   has resulted in inflated property values and 14 properties with

   loan to value ratios in excess of 95%, up to 112%.

  *208 a. We can only speculate at the reason for the overvaluing

    because Epic Mortgage utilizes independent fee appraisers.

    The appraisers might be influenced by the builder's indicated

    cost and are finding higher priced comparable sales to

    justify this cost rather than carefully studying the

    marketplace.

   b. The higher value estimates by Epic's appraisers are a result

    of using higher priced comparable sales, higher land value

    estimates which do not accurately indicate the subject

    property's true market value and model upgrade. The model

    "upgrades" increase the sales price of the home and typically

    make it the highest priced home in the subdivision with the

    cost not typically recognized by the end purchaser.

   c. Epic should have the same concerns with overvaluing as MGIC

    because of losses to the partnership. Epic's expertise may be

    in syndication and marketing not property valuation. This

    would explain why they are only now setting up an appraisal

    review department.

Representatives*209 of MGIC met with EPIC's management on two occasions to discuss possible overvaluation of properties. Circa 1983, MGIC ceased insuring EPIC mortgages. The principal reason given for this action was the concentration of risk represented by EPIC's business and the fact that EPIC had switched from syndicating model properties to production properties. Nevertheless, MGIC wished to retain the renewal business for existing EPIC insurance policies.

Similarly, beginning in December 1983, before agreeing to insure any mortgage loans to an EPIC partnership, Mr. James C. Miller, president of Commonwealth Mortgage Assurance Co. (CMAC), and his staff met on several occasions with representatives of EPIC's management to discuss EPIC's business and the risks that CMAC would face in writing mortgage insurance on mortgage loans issued by EPIC partnerships. A memorandum dated February 24, 1984, written by Mr. Miller before any mortgage insurance was written describes EPIC's business and the risks presented by that business. The memorandum describes the risks as follows:

   Risks

   They described their program as unique, and it is certainly

   entirely different from the normal*210 owner-occupied situation. To

   hear them tell it, there is virtually no chance of borrower

   default. Their track record of selling to high-income investors

   and obtaining the note payments from them has been very good to

   date.

   The next major risk is that the real estate projects themselves

   do not work out. Deprived of rental income, the pool's cash flow

   would be negatively impacted. EPIC minimizes this risk by wide

   diversification of the properties -- geographically, price and

   style. They showed us one sample pool in which the

   diversification seemed to be excellent.

   There's always the possibility that the general partner, EPIC,

   will fail; the most likely form of failure would be a series of

   projects that did not rent out adequately. We can review their

   project plans to verify that they have adequate margins built in

   to minimize this risk. We can also constantly monitor the

   financial position of the general partner.

   Another risk is that the EPIC property management company will

   fail. If the manager is collecting the rents and does not

*211    promptly forward all of the rent to the general partner, the

   entire enterprise is in jeopardy. Of course, this is virtually

   the entire business of EPIC. Therefore, it is highly improbable

   that the property management company would fail alone.

   Ultimately, we have the property to look to. Of course, the

   critical question is whether or not the property investors are

   acquiring the property at a bargain price, or whether EPIC is

   overcharging the investors. Presumably, this is what our

   underwriting is intended to guard against. We'll have to look at

   it carefully to satisfy ourselves that the value is probably

   there if we need it. However, I believe that we should be

   concerned only with the entire pool because there is no way that

   an individual property will go into default -- unless the

   general partner can decide to stop making payments on one

   individual mortgage.

   The rates may be standard, owner-occupied rates on the primary

   insurance. Frank Bossle agreed to send me copies of the current

   rates of the other PMI companies. He says he is not*212 looking for

   a bargain rate, because the cost of the mortgage insurance is

   passed on to the customer anyway.

   He also says that they do not believe in requiring an insurer to

   take property that the insurer doesn't want. They like all their

   business relationships to be based upon cooperation and mutual

   trust and profitability.

As noted above, one of the risks that Mr. Miller identified related to the value of the property; i.e., "whether or not the property investors are acquiring the property at a bargain price, or whether EPIC is overcharging the investors."

In a later memorandum dated August 24, 1984, after CMAC had written mortgage insurance on a small amount of EPIC's business, Mr. Miller focused on the risk "that the overall market for investment property could become saturated, and/or the EPIC Management might overextend themselves by paying too much for their properties." Mr. Miller instructed his staff to order spot-check appraisals of the EPIC property. The spot-check appraisals did not support the values suggested by EPIC's appraisals, and CMAC was not able to reconcile the differences. Shortly thereafter, in a letter dated*213 August 5, 1985, CMAC ended its business relationship with EPIC.

EPIC's FINANCIAL STATEMENTS

The record contains EPIC's financial statements for 1981, 1982, and 1983. These statements show the following revenue and expenses:

                       Year Ended

                ______________________________________

                12/31/81    12/31/82    12/31/83

                __________  ___________   ____________

Revenues:

 Builder Fees         $ 8,960,780 $ 15,895,234  $ 18,905,034

 Interest income and

  loan service fees      3,910,907   8,871,358    8,233,739

Rental income           1,613,598   1,219,852      -0-

Property management fees      972,077   1,357,220     941,616

Partnership organization fees    474,220   4,882,669    9,403,021

Loan origination fees        177,031   2,790,098    7,580,544

Other income            298,442    698,480     443,087

      *214           __________   __________   ___________

 Total revenue         16,407,055   35,714,911   45,507,041

Costs and Expenses:

 Interest expense        4,149,063   7,629,826    3,270,713

 Payroll & fringe benefits    3,969,457   8,696,684    8,430,324

 Commissions            339,277   3,319,496    8,483,881

 Partnership rental expenses   2,799,960   1,916,887     -0-

 Other operating expenses    2,411,917   3,991,804   10,000,887

                __________   __________   __________

 Total expenses         13,669,674   25,554,697   30,185,805

Income from operations      2,737,381   10,160,214   15,321,236

EA 83-XII AND EA 84-III's BANKRUPTCY

In 1985, the Governor of Maryland shut down the State's savings and loan system, and the State required all savings and loan associations subject to Maryland regulation to liquidate their assets or to obtain Federal deposit insurance from the Federal Home Loan Bank Board (FHLBB). CSL, a nonfederally insured Maryland savings and loan, applied*215 for deposit insurance issued by the Federal Savings & Loan Insurance Corp. (FSLIC).

In July 1985, the FHLBB informed CSL that it would not approve CSL's application for FSLIC insurance. As a result, EPIC and its real estate partnerships, including EA 84-III and EA 83-XII, could no longer use CSL as a source of funds necessary for their operations. By August 15, 1985, EA 83-XII and EA 84-III defaulted on their respective obligations under the mortgages and deeds of trust on the properties. Shortly thereafter, EA 83-XII and EA 84-III filed petitions in the U.S. Bankruptcy Court for the Eastern District of Virginia.

NOTICES OF FPAA ISSUED TO EA 83-XII

In the notices of FPAA issued to EA 83-XII for 1983, 1984, and 1985, respondent adjusted the ordinary income reported by the partnership as shown below in the second column for each year:

EA 83-XII          1983           1984

    _________      ___________________   ____________________

Rent income        $ 287,640 $ 287,640   $ 306,577   $ 306,577

Late charges           548     548     -0-      -0-

Interest income*216        9,344    9,344      90      90

Miscellaneous         -0-     -0-      -0-      -0-

             ________   ________   ________   ________

 Total gross income     297,532   297,532    306,667    306,667

Interest (noninvestment)   466,358    -0-    539,893     -0-

Commissions          25,460   25,460    21,950    21,950

Insurance           27,744   27,744    16,438    16,438

Legal and professional fee    726     726     8,093     8,093

Repairs            1,348    1,348    30,866    30,866

Taxes             49,224   49,224    49,213    49,213

Utilities            464     464     1,547     1,547

Homeowner dues        20,620   20,620    20,620    20,620

Audit fee           4,900    4,900     4,900     4,900

Points amortization      16,671    -0-     16,671     -0-

Property management*217      30,600   30,600    30,600     30,600

Real estate tax service    1,278    1,278     -0-      -0-

Miscellaneous          107     107     -0-      -0-

Depreciation         173,119    -0-     173,119     -0-

Bad debts           -0-     -0-      1,l74     1,174

Amortization organization

 expense           -0-     -0-      3,150     3,150

Recording fees         -0-     -0-      -0-      -0-

Service fee-EMI        -0-     -0-      -0-      -0-

             ________   _______   ________   ________

 Total expenses       818,619   162,471    918,234    188,551

 Total rent income     -521,087   135,061   -611,567    118,116

             [Table continued]

EA 83-XII             1985

    _________        _____________________

Rent income          $ 331,743   $ 331,743

Late*218 charges            -0-      -0-

Interest income          1,262     1,162

Miscellaneous            883      883

               ________    ________

 Total gross income       333,888    333,888

Interest (noninvestment)     560,177     -0-

Commissions            24,846     24,846

Insurance             18,992     18,992

Legal and professional fee      574      574

Repairs              15,075     15,075

Taxes               45,962     45,962

Utilities              951      951

Homeowner dues          25,350     25,350

Audit fee             3,267     3,267

Points amortization        16,671      -0-

Property management        29,837     29,837

Real estate tax service      -0-       -0-

Miscellaneous            856      856

Depreciation    *219        173,119      -0-

Bad debts             -0-       -0-

Amortization organization

 expense             -0-       -0-

Recording fees            24       24

Service fee-EMI          3,413     3,413

               ________    _______

 Total expenses         919,114    169,147

 Total rent income       -585,226    164,741

Respondent also disallowed the investment interest expense of $ 66,366 claimed on the 1983 return.

The "explanation of items" attached to the notice of FPAA for 1983 gives the following explanation of these adjustments:

INTEREST EXPENSE AND POINT AMORTIZATION

               * * * * * * *

   The deductions shown on your return as interest are not

   deductible because it has not been established that the amounts

   were for interest on a bona fide debt. Consequently, the

   partnership's taxable income is increased.

               * * * * * * *

*220    In the event that it is determined that there was an actual

   investment associated with the acquisition of the property or

   that there was genuine indebtedness on the property, then with

   respect to EPIC Associates 83-XII partnership for the taxable

   year 1983, this activity was not engaged in for profit and the

   allowability of interest expenses incurred is limited to the

   investment income of the taxpayer for the taxable year.

   Consequently, all interest expenses relative to this activity

   are not allowable as deductions against ordinary income, but are

   separately stated items subject to the investment interest

   limitations.

DEPRECIATION

   The deductions shown on your return as depreciation are not

   deductible because it has not been established that a bona fide

   investment in depreciable property was made. Consequently, the

   partnership's taxable income is increased.

   In the event that it is determined that there was an actual

   investment associated with the acquisition of the property or

   that there was genuine indebtedness on the property, *221 then with

   respect to the EPIC Associates 83-XII partnership for the

   taxable year 1983 [1984 and 1985], this activity was not engaged

   in for profit and only the following deductions are allowable:

     (1) The deductions which would be allowable for the taxable

     year without regard to whether or not such activity is

     engaged in for profit, and

     (2) a deduction equal to the amount of the deductions which

     would be allowable for the taxable year year [sic] only if

     such activity were engaged in for profit, but only to the

     extent that the gross income derived from such activity of

     the taxable year exceeds the deductions allowable by reason

     of paragraph (1) above.

The notices of FPAA for 1984 and 1985 are virtually identical.

Respondent made other adjustments to EA 83-XII's returns for 1983, 1984, and 1985. For taxable year 1983, respondent disallowed the net investment loss of $ 341,010 reported for purposes of allocating tax preference items to its partners, and respondent disallowed the excess expenses from net lease*222 property of $ 10,859 and the investment interest income of $ 29,306. For taxable years 1984 and 1985, respondent disallowed the qualified investment income of $ 303,571 and $ 330,529, respectively, the qualified investment expenses of $ 908,960 and $ 909,831, respectively, and the investment interest income of $ 90 and $ 1,262, respectively. In support of these other adjustments, the notices of FPAA issued to EA 83-XII state that "it has not been established that there was an actual investment associated with the acquisition of the property or that there was genuine indebtedness on the property." In further support of these other adjustments, the notices state that the activity of EA 83-XII for 1983, 1984, 1985, and 1986 "was not engaged in for profit."

NOTICES OF FPAA ISSUED TO EA 84-III

In the notices of FPAA issued to EA 84-III for 1983, 1984, and 1985, respondent adjusted the ordinary income reported by the partnership as shown below in the second column for each year:

EA 84-III         1983           1984

    _________     ___________________   ____________________

Rent income        $ 80,124*223   $ 80,124   $ 228,516   $ 228,516

Interest           -0-     -0-      -0-      -0-

             ________   _______   ________   ________

 Total gross income     80,124    80,124    228,516    228,516

Interest (noninvestment)  118,082    -0-     522,466     -0-

Commissions          5,305    5,305    23,198    23,198

Insurance           5,480    5,480    16,663    16,663

Legal & professional fee   6,895    6,895      687      687

Repairs            8,500    8,500    19,782    19,782

Taxes            18,123    18,123    72,554    72,554

Utilities           1,726    1,726    33,555    33,555

Homeowner dues         998     998     3,993     3,993

Property management fee    8,250    8,250    33,000    33,000

Points amortization      3,453    -0-     13,814     -0-

Miscellaneous          141    *224  141      606      606

Audit fee           -0-     -0-      5,000     5,000

Service fee          -0-     -0-      -0-     -0-

Depreciation         56,910    -0-     170,742     -0-

             ________    ______   ________    _______

 Total expenses      233,863    55,418    916,060    209,038

Net rental income     -153,739    24,706   -687,544    19,478

EA 84-III          1985

    _________     _____________________

Rent income        $ 230,130   $ 230,130

Interest            494      494

             ________    ________

 Total gross income    230,624    230,624

Interest (noninvestment)  545,848     -0-

Commissions         19,403     19,403

Insurance          19,894     19,894

Legal & professional fee   1,008     1,008

Repairs           108,459    108,459

Taxes   *225          72,617     72,617

Utilities           1,830     1,830

Homeowner dues        12,353     12,353

Property management fee   32,175     32,175

Points amortization     13,814     -0-

Miscellaneous          574      574

Audit fee           3,333     3,333

Service fee          3,197     3,197

Depreciation        170,742     -0-

            _________    ________

 Total expenses     1,005,247    274,843

Net rental income     -774,623    -44,219

The explanation of the above adjustments is virtually identical to the explanation in the notices of FPAA issued to EA 83-III, quoted above.

Respondent made a number of other adjustments to EA 84- III's returns for 1983, 1984, and 1985. Respondent disallowed the net investment loss of $ 141,142 and investment interest income of $ 6,097 claimed in 1983. Respondent disallowed qualified investment income of $ 217,619 and qualified investment expenses of $ 872,376 claimed in 1984. Respondent disallowed qualified*226 investment income of $ 229,131, qualified investment expenses of $ 997,436, and investment interest income of $ 494 claimed in 1985. In support of these other adjustments, the notices of FPAA state that "it has not been established that there was an actual investment associated with the acquisition of the property or that there was genuine indebtedness in the property." In further support of the other adjustments, the notices state that the activity of EA 84-III for 1983, 1984, 1985, and 1986 "was not engaged in for profit."

OPINION

In the subject notices of FPAA, respondent disallowed the interest and depreciation deductions that each partnership claimed on its tax returns for 1983, 1984, and 1985. According to the notices of FPAA, the interest deductions are disallowed because "it has not been established that the amounts were for interest on a bonafide [sic] debt." Similarly, according to the notices of FPAA, the depreciation deductions are disallowed because "it has not been established that a bona fide investment in depreciable property was made."

The interest deductions at issue consist principally, but not entirely, of amounts paid or accrued with respect to the nonrecourse*227 promissory notes issued by each partnership for the purchase of the residential properties described above. We sometimes refer to the subject promissory notices as first mortgage notes. The depreciation deductions are based entirely on the portion of the subject promissory notes that each partnership claims as a basis in the residential properties purchased with the notes.

If none of the promissory notes constitutes a bona fide debt, as determined by the notices of FPAA, it follows, as discussed below, that no amount paid or accrued with respect to any of the notes is deductible as interest under section 163(a). Furthermore, if none of the promissory notes constitutes a bona fide debt, it also follows that neither partnership incurred a cost in issuing the notes and neither partnership obtained a basis in any of the properties for depreciation purposes. Thus, the first issue for decision in these cases is whether any of the nonrecourse promissory notes issued by either partnership constitutes a bona fide debt.

A portion of the interest deducted by both partnerships was for "points amortization". These deductions are based upon the loan origination fees paid by both partnerships to*228 EMI. The partnerships treated these fees as additional interest on the first mortgage notes and amortized them over the life of the loans. The second issue for decision in these cases is whether the partnerships are entitled to these deductions for points amortization.

The notices of FPAA also take the position that the activity of each partnership for each of the tax years in issue, 1983, 1984, and 1985, is an "activity not engaged in for profit" within the meaning of section 183(c). The notices of FPAA state: "the allowability of interest expenses incurred is limited to the investment income of the taxpayer for the taxable year." Thus, according to the notices of FPAA, if section 183 applies, then the interest expenses of each partnership must be treated as investment interest subject to limitation under section 163(d). On that basis, the adjustments to the subject returns would be similar in amount to the adjustments determined under the theory, described above, that neither partnership had entered into a bona fide indebtedness during any of the years in issue.

The application of section 183 is not just an alternative theory. The notice of FPAA issued to EA 84-III for 1985 relies*229 on section 183 to disallow net operating expenses of $ 44,219. This is the amount by which the deductions claimed by EA 84-III exceed the partnership's gross income, after the deductions for interest and depreciation are disallowed under the non-bona fide indebtedness theory, described above. Thus, we must consider the application of section 183 no matter how we decide the other issues. This is the third issue for decision in these cases.

It appears that each partnership also deducted, as interest, amounts paid or accrued during the years in issue with respect to certain funds advanced to it by EPIC, as general partner. By implication, the notices of FPAA take the position that any such unsecured advance made by EPIC to either partnership did not create a bona fide indebtedness of the partnership to EPIC and any amount paid or accrued with respect to any such advance is not deductible under section 163(a). This is the fourth issue for decision in these cases.

It also appears that EA 84-III deducted, as interest, amounts paid or accrued during 1985 with respect to 16 promissory notes issued to CSL. Each of those promissory notes was secured by a deed of trust on one of the properties*230 that had been purchased by EA 84-III in 1983. As mentioned above, the notices of FPAA disallow all of the interest deductions claimed by the partnerships on the ground that the amounts deducted were not shown to have been paid as interest on a bona fide debt. Thus, the fifth issue for decision in these cases is whether any of the 16 promissory notes issued by EA 84-III to CSL constitutes a bona fide debt.

NONRECOURSE PROMISSORY NOTES

Generally, a taxpayer is allowed to deduct an amount as interest under section 163(a) if the amount was paid or incurred during the taxable year with respect to genuine indebtedness. See, e.g., Knetsch v. United States, 364 U.S. 361, 5 L. Ed. 2d 128, 81 S. Ct. 132 (1960); Lukens v. Commissioner, 945 F.2d 92, 97 (5th Cir. 1991), affg. T.C. Memo 1990-87; Fox v. Commissioner, 80 T.C. 972, 1019 (1983), affd. sub nom. Barnard v. Commissioner, 731 F.2d 230 (4th Cir. 1984); Hager v. Commissioner, 76 T.C. 759, 773 (1981). Similarly, a taxpayer is allowed to include purchase money indebtedness in the basis of an asset for purposes of computing the allowance for depreciation under section 167 if the indebtedness*231 is genuine indebtedness and represents an actual investment in property. See, e.g., Brannen v. Commissioner, 722 F.2d 695, 701 (11th Cir. 1984), affg. 78 T.C. 471 (1982); Siegel v. Commissioner, 78 T.C. 659, 684 (1982).

Indebtedness is not considered genuine, that is, a true loan, if the facts show that the parties to the loan did not intend the principal amount of the indebtedness to be repaid in full. See, e.g., Siegel v. Commissioner, supra at 688. In the case of nonrecourse indebtedness, such as that involved in the instant cases, the indebtedness is a lien that the debtor must satisfy according to its terms in order to retain possession and use of the encumbered property, but there is no fixed, unconditional obligation of the debtor to pay. See, e.g., Waddell v. Commissioner, 86 T.C. 848, 898 (1986), affd. 841 F.2d 264 (9th Cir. 1988). However, the lack of personal liability of the debtor, by itself, does not mean that nonrecourse indebtedness will not be repaid, nor does it disqualify the nonrecourse indebtedness from being considered genuine. See, e.g., Hager v. Commissioner, supra at 773;*232 Mayerson v. Commissioner, 47 T.C. 340, 351-352 (1966). A nonrecourse mortgage can be found to be genuine indebtedness for tax purposes "on the assumption that the mortgage will be repaid in full." Commissioner v. Tufts, 461 U.S. 300, 308, 75 L. Ed. 2d 863, 103 S. Ct. 1826 (1983).

We have previously summarized the approaches taken by the courts in determining whether a purported nonrecourse liability is to be treated as true debt for Federal tax purposes. See, e.g., Waddell v. Commissioner, 86 T.C. at 900-902; Fox v. Commissioner, 80 T.C. at 1019-1021. In Fox v. Commissioner, 80 T.C. at 1019-1021, we described these approaches as follows:

     There are various approaches which may be taken in

   establishing whether a purchaser may treat a nonrecourse

   liability as a bona fide debt. One, originating in Estate of

  Franklin v. Commissioner, 544 F.2d 1045 (9th Cir. 1976), affg.

  64 T.C. 752 (1975), indicates that when the amount of the

   aggregate purchase price unreasonably exceeds the value of the

   property securing the note (or when the principal amount of the

   note unreasonably*233 exceeds the value of the property securing the

   note), the debt will not be recognized. In such instance, the

   purchaser acquires no equity in the property by making payments

   and, therefore, would have no economic incentive to pay off the

   note. Estate of Franklin v. Commissioner, 544 F.2d at 1048-1049.

The Estate of Franklin analysis, comparing the purchase price

   and size of the note to the fair market value of the property at

   the time of purchase, originated in real estate transactions

   (see Estate of Franklin v. Commissioner, supra; Narver v. Commissioner, 75 T.C. 53 (1980), affd. per curiam 670 F.2d 855

   (9th Cir. 1982); Beck v. Commissioner, 74 T.C. 1534 (1980),

   affd. 678 F.2d 818 (9th Cir. 1982)), but has also been applied

   to the purchase of cattle (see Hager v. Commissioner, supra),

   and, more recently, to movies (see Wildman v. Commissioner,

   supra; Siegel v. Commissioner, supra; Brannen v. Commissioner,

   supra).

 Another line of cases, in many ways complimentary*234 to the

   above, more closely addresses the problem of bona fide loans

   where the sole security for such loans is a speculative asset

   with an undeterminable value at the time of purchase. This line

   of decisions holds that highly contingent or speculative

   obligations are not recognized for tax purposes until the

   uncertainty surrounding them is resolved. CRC Corp. v. Commissioner, 693 F.2d 281 (3d Cir. 1982), revg. and remanding

   on other grounds Brountas v. Commissioner, 73 T.C. 491 (1979);

  Brountas v. Commissioner, 692 F.2d 152, 157 (1st Cir. 1982),

   vacating and remanding on other grounds 73 T.C. 491 (1979);

  Gibson Products Co. v. United States, 637 F.2d 1041 (5th Cir.

   1981); Denver & Rio Grande Western R.R. Co. v. United States, 205 Ct. Cl. 597, 505 F.2d 1266 (1974); Lemery v. Commissioner,

  52 T.C. 367, 377-378 (1969), affd. on another issue 451 F.2d 173

   (9th Cir. 1971); Inter-City Television Film Corp. v. Commissioner, 43 T.C. 270, 287 (1964); Albany Car Wheel Co. v.

*235 Commissioner, 40 T.C. 831 (1963), affd. per curiam 333 F.2d 653

   (2d Cir. 1964). For example, in Lemery v. Commissioner, supra,

   we held that an obligation to pay $ 444,335.17 of the $ 1,131,000

   stated purchase price of a business only out of future "net

   profits" was too contingent to be included in the purchaser's

   amortizable basis. [Fn. refs. omitted.]

Respondent takes the position in the instant cases that none of the first mortgage notes issued by EA 83-XII or EA 84-III is a bona fide debt because the aggregate principal amount of the notes issued by each partnership exceeds the aggregate fair market value of the property securing the notes and, for that reason, neither partnership had an incentive to repay the notes. See, e.g., Estate of Franklin v. Commissioner, 544 F.2d 1045 (9th Cir. 1976), affg. 64 T.C. 752 (1975). Respondent does not rely on a disparity between the purchase price of the properties and their value, and neither respondent nor petitioners address the question whether the value comparison required under the Estate of Franklin line of cases should be based upon the purchase prices*236 of the properties as opposed to the principal amounts of the notes. See Brannen v. Commissioner, 722 F.2d at 701 (Chabot, J., concurring). Therefore, as framed by the parties, the first issue in these cases is whether the principal amount of the first mortgage notes issued by each partnership unreasonably exceeds the value of the properties securing the notes.

Petitioners argue that "the fair market value of the properties [purchased by each partnership] was at least equal to the amount of the debt at the time it was incurred." They argue that the fair market value of each of the subject properties is its contract price, as established by a contemporaneous appraisal that was made by an independent, unrelated appraiser. The appraisals reflect the sale of each property to an individual buyer, rather than the bulk sale of all of the properties to a single buyer. Petitioners argue that the promissory note issued to purchase each of the properties, based upon 85 to 95 percent of the contract price, is bona fide indebtedness.

Petitioners emphasize that "each of the nonrecourse mortgages in the partnerships was insured by an unrelated mortgage insurance company" and "was*237 purchased by an unrelated lender shortly after the loan was funded". According to petitioners, the unrelated mortgage insurers and the lenders who acquired the loans in the secondary market each "had the incentive to ascertain that the value of the properties was at least equal to the debt" and the fact that they undertook to participate in the transactions is "evidence that the fair market value of the properties was at least equal to the amount of the debt at the time it was incurred." Petitioners argue that "the unrelated lenders and insurers did due diligence" and, in fact "would have exercised special caution with respect to such loans" because of the unusual nature of the loans. They further argue that the facts show "that there was no attempt by EPIC to conceal the facts."

Petitioners acknowledge that the partnerships purchased the properties with substantial discounts and that the partnerships did not pay the contract price for any of the properties purchased. As stated in their posttrial brief: "common sense suggests that a large and astute investor [such as EPIC] would demand price concessions." Thus, petitioners acknowledge that the prices paid by each partnership reflected*238 the discounts or price concessions that a large buyer would expect when buying "in bulk". In fact, as discussed above, EPIC negotiated with the sellers of the properties various "discounts" in the aggregate amount of approximately 20 percent of the contract price of the properties. Furthermore, the tax returns filed on behalf of each partnership compute the partnership's cost basis for each property under section 1012 as the contract price of the property less the rental deficit contribution for that property and claim depreciation on the portion of the cost that was allocated to the improvements. Petitioners argue that the value of each of the subject properties is equal to the contract price notwithstanding the fact that each partnership paid a price that reflected discounts from the contract price. Petitioners argue that such discounts "do not reduce the underlying value of any one item purchased".

Finally, petitioners argue that respondent's evidence relating to the fair market value of the properties is "rife with errors in assumptions and/or judgement and/or application of concepts". Petitioners ask the Court to conclude that respondent's evidence is biased and not worthy of*239 consideration.

Respondent argues that the 106 promissory notes issued by EA 83-XII and EA 84-III should be disregarded for tax purposes "because the debt substantially exceeded the fair market value of the underlying property and lacked economic substance." According to respondent's posttrial brief:

     Respondent's appraisals reflect that the nonrecourse debt

   by EMI exceeds the actual values of EA83-XII's properties by

   39.40% and the actual values of EA84-III's properties by 19.53%

   and that EA83-XII and EA84-III "overmortgaged" the 106

   properties to support nominal purchase prices that permitted

   Epic to receive substantial builder fees, rental deficit

   contributions, and rental advances.

Respondent explains the computation of the above percentages as

follows:

   Respondent's appraisals reflecting values totalling

  $ 2,658,600.00 for the properties acquired by EA83-XII

   demonstrate that the nonrecourse debt totalling $ 3,706,150.00

   originated by EMI exceeds the actual values by $ 1,047,550.00, or

   39.40%. Respondent's appraisals reflecting values totalling

  $ 2,889,150.00*240 for the properties acquired by EA84-III

   demonstrate that the nonrecourse debt totalling $ 3,453,450.00

   originated by EMI exceeds the actual values by $ 564,300.00, or

   19.53%.

According to respondent, EA 83-XII and EA 84-III "overmortgaged" the 106 properties in order "to generate substantial builder fees, rental deficit contributions, and rental advances necessary to feed EPIC's ravenous appetite for fees to enlarge and maintain EPIC's real estate empire." As an essential element of the "scheme", respondent alleges that "EPIC secured inflated, faulty appraisals to support the nonrecourse debt originated by EMI to acquire the 106 properties." In this connection, respondent asserts that EPIC, through CAG "encouraged outside appraisers to inflate values on properties acquired by the partnerships", such as "by requesting appraisers to value multiple properties purchased in bulk sales as if purchased separately by different individuals." As a result, respondent argues, the nonrecourse debt issued by EA 83-XII and EA 84-III to acquire the properties exceeded the value of the properties. Thus, respondent asserts: "there was no incentive to repay the debt and the debt*241 lacked economic substance."

Respondent also argues that the instant transactions did not "involve unrelated parties and independent appraisers establishing purchase prices." Respondent argues that the transactions "involved related parties" and notes that EPIC, acting through its subsidiary, EMI, "originated, serviced each nonrecourse loan, and was primarily responsible for any due diligence related to the loans." Respondent claims that for at least six properties acquired by EA 84-XII, EPIC, through two subsidiaries "was both the seller and purchaser". Respondent argues that the outside appraisers were not independent because EPIC "influenced their appraisals with guidelines and requests that precluded the use of bulk sale methods in purchases of multiple units." According to respondent, "EPIC, through CAG, influenced the inflated appraisals related to the properties and determined the stated purchase price."

Respondent also argues that the participation of secondary lenders and mortgage insurers does not establish that the value of the properties approximated the debt because there is no evidence that they engaged in due diligence. According to respondent: "the lack of due diligence*242 by secondary lenders and mortgage insurers demonstrates that [the] lenders ignored or did not understand the realities of the EPIC transactions." At the same time, respondent notes the fact that some mortgage insurers refused to insure "newly- created debt on EPIC properties."

The following is a list of the 51 properties purchased by EA 83-XII (viz 12 single-family residences and 39 condominium units) together with the amount of each loan, the value of each property as determined by respondent's appraisers, and the loan to value ratio for each property, computed using respondent's value:

EA 83-XII

                     Respondent's

   Address        Loan Amount     Value    Loan / Value

   _______        ___________   ____________   ____________

1612 Hemphill Ave.      $ 54,525     $ 57,400      94.99

1921 West 17th St.       51,300      54,000      95.00

1728 Coronado Ave.       51,300      54,000      95.00

1700 Linda Ave.        54,050      56,900      94.99

1716 Coronado*243 Ave.       54,050     ¹ 53,900     100.28

1916 Hollywood Dr.       53,200      56,000      95.00

1720 Coronado Ave.       56,425      59,400      94.99

2109 Avignon Dr.        84,525      84,000     100.63

2111 Avignon Dr.        85,025      85,000     100.03

2113 Avignon Dr.        95,475      91,000     104.92

2115 Avignon Dr.        95,475      100,500      95.00

2117 Avignon Dr.       101,175      106,500      95.00

Paseos Castellanos    ² 2,869,625   2 1,800,000     159.42

(39 units)        __________   _____________    ________

    Total        3,706,150    2,658,600     139.40

*244 Respondent's position is that the promissory notes issued by EA 83- XII, comprising 51 of the 106 notes mentioned above, should be disregarded for tax purposes because the aggregate nonrecourse debt represented by those notes exceeds the value of the properties by 39.40 percent.

Similarly, the following is a list of the 55 properties purchased by EA 84-III (viz 14 single-family residences and 41 condominium units) together with the amount of each loan, the value of each property as determined by respondent's appraisers, and the loan to value ratio for each property, computed using respondent's value:

EA 84-III

                       Respondent's

  Address           Loan Amount     Value   Loan/Value

  _______           ___________   ____________ ___________

5419 Heronwood Dr.        $ 51,300     $ 58,000    88.45

5411 Heronwood Dr.         61,750      65,000    95.00

3518 Tower Hill La.         60,550      55,000    110.09

12347 Northcliffe Manor Dr.     55,575      45,000   *245 123.50

13066 Clarewood Dr.         54,150      48,000    112.81

6351 S. Briar Bayou Dr.       58,425      47,000    124.31

12103 Kingslake Forest Dr.     57,475      46,000    124.95

12107 Kingslake Forest Dr.     47,975      38,000    126.25

12111 Kingslake Forest Dr.     53,200      40,000    133.00

12115 Kingslake Forest Dr.     60,800      52,000    116.92

12231 Carola Forest Dr.       56,050      54,000    103.80

4850 W. Ferret           67,450      71,200    94.73

4107 Medical Dr. (Condo.)      56,950      56,400    100.98

13739 Earlywood Dr.         60,800      57,600    105.56

6402 Ridgecreek Dr.         60,800      55,950    108.67

Reflections Condos      ¹ 2,590,200   1 2,100,000    123.34

(40 Units)           _________    _________   _______

  Total             3,453,450    2,889,150   119.530

*246 Respondent's position is that the promissory notes issued by EA 84- III, comprising 55 of the 106 notes mentioned above, should be disregarded for tax purposes because the aggregate nonrecourse debt represented by those notes exceeds the value of the properties by 19.53 percent.

The above schedules show that respondent tests whether the principal amount of the indebtedness exceeds the value of the property securing it in the aggregate, rather than loan by loan. If the value comparison were made loan by loan, most of the loans issued with respect to the single-family residences would approximate the value of the property securing the loan, even using respondent's values. For example, in the case of the 12 single-family residences acquired by EA 83-XII, as shown in the schedule above, none of the loans issued by the partnership materially exceeds the value of the related property, as determined by respondent's appraisers. Similarly, in the case of the properties acquired by EA 84-III, other than the Reflections condominium units, 7 of the 15 loans issued by the partnership are 110 percent or less of the value of the related property, as determined by respondent's appraisers. Nevertheless, *247 respondent determined that all of the loans issued by both partnerships are not bona fide because the aggregate principal amount of the loans issued by each partnership exceeds the aggregate value of the properties by 39.4 percent in the case of EA 83-XII and 19.53 percent in the case of EA 84-III. Petitioners do not take issue with this aspect of respondent's approach and the parties do not address the issue whether the value comparison should be made in the aggregate or loan by loan.

In these cases, we must determine whether the fair market value of the properties acquired by each partnership is more or less than the principal amount of the debt that was incurred by the partnership in purchasing the properties. For purposes of making this comparison, we must determine the fair market value of the properties as of the time they were acquired by each partnership. See, e.g., Bailey v. Commissioner, 993 F.2d 288, 293 (2d Cir. 1993), affg. T.C. Memo 1992-72; Lebowitz v. Commissioner, 917 F.2d 1314, 1318 (2d Cir. 1990), revg. and remanding T.C. Memo 1989-178. In the case of EA 83- XII, we must determine the fair market values of the*248 properties as of December 1982; and, in the case of EA 84-III, we must determined the fair market values of the properties as of September 1983.

The fair market value of an item of property is "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts." E.g., United States v. Cartwright, 411 U.S. 546, 551, 36 L. Ed. 2d 528, 93 S. Ct. 1713 (1973); Narver v. Commissioner, 75 T.C. 53, 96 (1980), affd. per curiam 670 F.2d 855 (9th Cir. 1982); McShain v. Commissioner, 71 T.C. 998, 1004 (1979); see sec. 1.170A-1(c)(2), Income Tax Regs.; sec. 20.2031-1(b), Estate Tax Regs.; sec. 25.2512-1, Gift Tax Regs. This is a question of fact to be determined from an examination of the entire record. See, e.g., Lio v. Commissioner, 85 T.C. 56, 66 (1985), affd. sub nom. Orth v. Commissioner, 813 F.2d 837 (7th Cir. 1987); McShain v. Commissioner, supra at 1004.

The fair market value of real property is based on the highest and best use to which the property could be put on*249 the date of valuation. See, e.g., Frazee v. Commissioner, 98 T.C. 554, 563 (1992); Symington v. Commissioner, 87 T.C. 892, 896 (1986); Stanley Works v. Commissioner, 87 T.C. 389, 400 (1986). Generally, the highest and best use of a parcel of property is the reasonable and probable use of the property that supports the highest present value. See Frazee v. Commissioner, supra at 563; Symington v. Commissioner, supra 87 T.C. at 896-897. In determining the highest and best use of the property, it is necessary to consider the realistic, objective potential uses for which the property is adaptable and needed or likely to be needed in the foreseeable future. See Stanley Works v. Commissioner, supra at 400. See generally Olson v. United States, 292 U.S. 246, 255-256, 78 L. Ed. 1236, 54 S. Ct. 704 (1934).

In the process of establishing the fair market value of an item of property on the basis of its highest and best use, it is sometimes necessary to consider the most appropriate market through which the property would change hands from a willing seller to a willing buyer. See, e.g., Akers v. Commissioner, 799 F.2d 243 (6th Cir. 1986),*250 affg. T.C. Memo 1984-490; Anselmo v. Commissioner, 757 F.2d 1208 (11th Cir. 1985), affg. 80 T.C. 872 (1983); cf. United States v. Cartwright, supra 411 U.S. at 551-552. In identifying what market to use in estimating the value of an item of property, we have looked to the regulations promulgated under the estate and gift taxes, see sec. 20.2031-1(b), Estate Tax Regs.; sec. 25.2512-1, Gift Tax Regs., which provide that the fair market value of an item of property is the sales price of the item in the market in which such item is "most commonly sold to the public." See, e.g., Goldstein v. Commissioner, 89 T.C. 535, 544 (1987); Lio v. Commissioner, supra at 66; Orth v. Commissioner, 813 F.2d 837 (7th Cir. 1987); Skripak v. Commissioner, 84 T.C. 285, 321-322 (1985); Anselmo v. Commissioner, 80 T.C. at 881-882.

In applying the estate and gift tax regulations to ascertain the fair market value of an item of property for purposes of computing the amount of a charitable contribution deduction, the Court of Appeals in Anselmo v. Commissioner, 757 F.2d at 1214, noted the*251 following:

     Rules governing valuations for charitable contributions of

   property are distinguishable from valuations in the estate and

   gift context because the taxpayer has the opposite incentives in

   the two situations: the taxpayer wants to reduce the value of

   property for estate and gift tax purposes but, as here, the

   taxpayer wishes to inflate the value of property for charitable

   donation purposes. The estate and gift tax regulations are aimed

   at preventing abusive undervaluation of property; the

   regulations governing charitable contributions are not. In the

   usual case, however, there should be no distinction between the

   measure of fair market value for estate and gift tax and

   charitable contribution purposes. Cf. Champion v. Commissioner,

  303 F.2d 887, 892-93 (5th Cir. 1962). * * *

Thus, the Court of Appeals noted that the estate and gift tax regulations were not a perfect fit in considering the charitable deduction in that case because the taxpayers had an incentive to inflate the value of the property, whereas "the estate and gift tax regulations are*252 aimed at preventing abusive undervaluation of property". Id. The same is true in the instant cases. Nevertheless, we also agree with the Court of Appeals that "there should be no distinction between the measure of fair market value". Id.; see also United States v. Parker, 376 F.2d 402, 408 (5th Cir. 1967); Skripak v. Commissioner, supra at 322 n. 30. Finally, we agree with the Court of Appeals that selection of the proper market for valuation purposes is a question of fact. See Anselmo v. Commissioner, 757 F.2d at 1213.

A sale to the public is a sale to the ultimate consumer of the property, that is, a sale to one of a group of persons who do not purchase the item for resale. See, e.g., Goldstein v. Commissioner, supra 89 T.C. at 545-546; Lio v. Commissioner, supra at 70. In the normal situation, a sale to the ultimate consumer is a sale to a retail customer. See Lio v. Commissioner, 85 T.C. at 66; Anselmo v. Commissioner, 80 T.C. at 882. This is not invariably the case, however, because the term "public" refers to the "customary purchasers" of an item of property and not necessarily to individual consumers. *253 Anselmo v. Commissioner, 757 F.2d at 1214. In Anselmo the Court of Appeals noted, for example, that the buying public for live cattle comprises primarily slaughterhouses, rather than individual consumers. See id. Therefore, in Anselmo, the Court of Appeals agreed with the finding of this Court that the market for low quality, unmounted gems was the market in which jewelry manufacturers and jewelry stores purchase stones to create jewelry items, rather than the retail market in which individual purchasers buy finished jewelry. Similarly, in Akers v. Commissioner, supra at 246, the court found that the market for a tract of land containing approximately 1,250 acres was the market for large tracts of over 1,000 acres and not the market for properties averaging less than a tenth that size. The court noted that the "ultimate consumer" of a 50-acre lot "does not normally have the time, inclination, expertise or capital to buy a tract of land 10 or 20 times as big as the one he wants, with a view to subdivision and sale of the excess." Id.

The above cases may be contrasted with Goldman v. Commissioner, 388 F.2d 476 (6th Cir. 1967), affg. 46 T.C. 136 (1966),*254 in which the fair market value of 151 bound volumes of medical journals that had been contributed to a hospital was at issue. The court held that the fair market value should be computed "on the price an ultimate consumer would pay", i.e., valued at retail, and further held that "what might be paid by a dealer buying to resell is not a proper consideration." Id. at 478. In Akers v. Commissioner, 799 F.2d at 247, the court reconciled that case with the others by noting that, unlike the unmounted gems in Anselmo and unlike the undivided land in Akers, the medical journals in Goldman "had already been 'subdivided,' in effect" and "were ready for immediate sale in the retail market and were not so expensive as to suggest that no retail buyer for them could have been found."

The appropriate market for estimating the value of an item of property may sometimes be the market in which the taxpayer purchased the property. For example, in Lio v. Commissioner, 85 T.C. 56 (1985), the taxpayers purchased large quantities of lithographs and donated them to a charitable organization 9 months later, claiming a charitable deduction of approximately three times*255 the amount paid, and in Goldstein v. Commissioner, 89 T.C. 535 (1987), the taxpayers purchased posters and other art and donated them to a charitable organization 4 days later, claiming a charitable deduction of approximately twice the present value of the consideration paid. The taxpayers in each case asked us to value the property by looking to the prices charged by galleries and dealers to their retail customers. In defining the appropriate market and the ultimate consumer for the property in those cases, we gave particular attention to three factors: (1) Whether the buyers purchased the item of property for resale; (2) whether the buyers received special discounts in the purchase price; and (3) whether the sellers made substantial sales of the same type of property. See id. at 545-546. We found that the taxpayers had not purchased the property for resale, they had received no special discounts, and they had purchased from dealers who were responsible for a substantial portion of the total retail sales of the property. Thus, contrary to the taxpayers' position, we found that the appropriate market for valuing the property at issue in both cases was the*256 market in which the taxpayers had purchased the property, and that the taxpayers were the ultimate consumers of the property. Accordingly, we looked to the price paid by the taxpayers as the fair market value of the property. See also Klaven v. Commissioner, T.C. Memo 1993-299; Weiss v. Commissioner, T.C. Memo 1993-228; Rhode v. Commissioner, T.C. Memo 1990-656; Weintrob v. Commissioner, T.C. Memo 1990-513, opinion modified T.C. Memo 1991-67, affd. and remanded without published opinion sub nom. Wagner v. Commissioner, 31 F.3d 1175 (3d Cir. 1994); Broad v. Commissioner, T.C. Memo 1986-340.

At the outset of our consideration of the instant cases, it is helpful to note several points about the positions of the parties. First, respondent's appraisers valued the single-family houses and one condominium unit on a different basis than they used to value the other 79 condominium units. According to respondent's brief, respondent's appraisers valued the single-family houses acquired by each partnership and one of the condominium units purchased by EA 83-III on a "retail" basis; that is: "As if*257 the properties were purchased separately by individuals." Respondent's brief describes the appraisals of 14 of the single-family houses and the condominium unit at 4107 Medical Drive as follows:

   Respondent's appraisals, which were performed 11 to 13 years

   after EA83-XII and EA84-III acquired the properties, reflect

   RETAIL VALUES of the houses at 2109, 2111, 2115, and 2117

   Avignon Drive in Carrollton, the seven houses in Odessa [viz,

   1612 Hemphill Avenue, 1921 West 17th Street, 1728 Coronado

   Avenue, 1700 Linda Avenue, 1716 Coronado Avenue, 1916 Hollywood

   Drive, and 1720 Coronado Avenue], the two houses at 5411 and

   5419 Heronwood Drive in Humble, the condominium at 4107 Medical

   Drive in San Antonio, the house at 4850 W. Ferret Drive in

Tucson AS IF THE PROPERTIES WERE PURCHASED SEPARATELY BY

   INDIVIDUALS. [Emphasis supplied.]

Similarly, respondent's brief describes the appraisals of the other

12 single-family houses as follows:

   Respondent's appraisals, which were performed 11 to 13 years

   after EA83-XII and EA84-III acquired the properties, reflect

   RETAIL VALUES*258 for the residences at 2113 Avignon in Carrollton,

   13739 Earlywood Drive and 6402 Ridgecreek Drive in San Antonio,

   and 3518 Tower Hill Lane, 12347 Northcliffe Manor Drive, 13066

   Clarewood Drive, 6351 S. Briar Bayou, 12231 Carola Forest Drive,

   and 12103, 12107, 12111, and 12115 Kingslake Forest Drive in

Houston AS IF PURCHASED SEPARATELY BY INDIVIDUALS. [Emphasis

   supplied.]

On the other hand, respondent's appraisers valued the condominium units acquired by each partnership (other than the condominium unit at 4107 Medical Drive) on a "wholesale" basis; that is, as if the purchase consisted "of multiple properties purchased in bulk sales from the same builder." Respondent's brief states as follows:

     Respondent's appraisals of the 39 units in Miami and 40-

   unit complex in San Antonio, which were performed 11 to 13 years

   after EA83-XII and EA84-III acquired the properties, reflect the

WHOLESALE VALUE OF MULTIPLE PROPERTIES PURCHASED IN BULK SALES

   FROM THE SAME BUILDER. [Emphasis supplied.]

Second, according to respondent's brief, the difference between the retail value of each single-family*259 property, as determined by respondent's appraisers, and the wholesale value of that property is the amount of the rental deficit contribution. Respondent's brief states as follows:

   because each of the [single family] properties was purchased by

   Epic in purchases involving multiple houses from the same

   builder, a discount in the amount of the rental deficit

   contribution of approximately 20% to the retail value is

   appropriate to arrive at the wholesale value of each property.

   * * *

The above statement echoes the opinion of respondent's appraisers, Messrs. Dalton and Ramos, who valued the Reflections condominium complex that was purchased by EA 84-III. In a memorandum that accompanied their appraisal, Messrs. Dalton and Ramos describe the difference between the wholesale and retail values of the properties as the amount of the rental deficit contribution. The memorandum states as follows:

   4. Another way to view the RDC [i.e., rental deficit

    contribution] is as the difference between the properties

    [sic] retail price over its wholesale price. As discussed

    above, the sum of the*260 parts is much greater than the whole.

    By selling the properties individually, the owner receives

    the greater retail price, while he would get only a wholesale

    price if he sold all of the properties to a single investor

    in one transaction. That is, multiple purchases from the same

    builder demand a wholesale price. The discount would be in

    the range of the RDC, or a 20%-25% reduction of the retail

    price of each unit if sold separately. The percentage

    reduction is supported in the 40-Unit Condominium Complex

    appraisal (TAB C). The indicated wholesale value was

    estimated at $ 2,100,000. EPIC financed the property based on

    a projected retail sale of the property of $ 3,000,000. The

    wholesale value is 30% lower than EPIC's projected retail

    value.

   5. The 40-Unit Condominium Complex (TAB C) was valued at

    wholesale as this was the market for these types of

    properties. The values obtained for the single-family houses

    in TAB's A and B of this report reflect the retail fair

 *261    market value of the properties. Multiple sales of single-

    family houses were not plentiful at the date of value and at

    the present date they are very obscure. A discount, in the

    approximate amount of the RDC, for each single-family

    property is required if these house were sold wholesale,

    i.e., grouped with a multitude of other houses, in one

    transaction to a single investor. The RDC was chosen as a

    discount from retail to wholesale based on the discussion

    presented in (4) above.

Significantly, respondent does not appear to take the position that the builder fees and rent advances are additional discounts that must be applied to the retail value of the property in computing its wholesale value. In this connection, we note the fact that the builder fees were treated as having been paid by the seller to EPIC, as opposed to the partnership, and were reported as income by EPIC, and the fact that the rent advances were treated as rents and were included in the gross income of each partnership.

In summary, respondent's position is that valuing the subject properties as if sold*262 to separate individuals yields the retail value of the properties, whereas valuing them as if purchased in a bulk sale yields the wholesale value of the properties. Furthermore, according to respondent, the difference between the retail value and the wholesale value of a particular property is the discount that EPIC negotiated with each of the sellers, referred to as the rental deficit contribution. Both of these positions are set forth in the memorandum written by Messrs. Dalton and Ramos, the relevant portion of which is quoted above.

Third, the appraisals that were obtained pursuant to EPIC's contracts with the sellers at the time EA 83-XII and EA 84-III purchased the subject properties (referred to herein as the contemporaneous appraisals) valued all of the properties without discount as if each property were sold separately to an individual purchaser. To use respondent's terminology, all of the contemporaneous appraisals valued the properties, both single-family houses and condominiums, on a retail basis. They did not value the subject properties on a wholesale basis; that is, as if purchased in bulk by a single person.

Thus, in valuing the single-family homes and the condominium*263 unit at 4107 Medical Drive, all of the appraisers used the retail market. In valuing the other 79 condominiums, on the other hand, respondent's appraisers used the wholesale market and the contemporaneous appraisals used the retail market.

Fourth, in valuing the subject properties, none of the parties relies upon the values that were established in the contracts between EPIC and the sellers of the properties. Petitioners argue that the transactions were arm's-length transactions between unrelated parties, but they take the position that the value of each property is its contract price, rather than the discounted price that the partnership actually paid for the property. On the other hand, respondent argues that the value of each property is a discounted price, as determined in respondent's appraisals, but not the discounted price that the partnership actually paid for the property.

EPIC negotiated the purchase of the subject properties on behalf of EA 83-XII and EA 84-III from five developers, Fox & Jacobs, Raldon, Babcock, U.S. Home, and Pitman & Japhet. The contracts between EPIC and each of the sellers followed a similar pattern. Each contract set forth a purchase price for each*264 property, referred to herein as the contract price, that was based on the prices that the seller had received from sales of similar properties to individual retail purchasers. The contract provided that the seller would "pay" an amount negotiated between EPIC and the seller called the rental deficit contribution. The seller agreed to "pay" this amount to the purchaser, the limited partnership. The contract further provided that the seller would pay to EPIC a commission of 6.8 percent of the contract price and, under certain conditions, would prepay rent to the purchaser.

In negotiating these contracts with EPIC, each seller was principally interested in the amount that it would net after the above discounts and fees. A representative of one seller, Babcock, testified that his concern was the "bottom line" or "minimum number" and that he permitted EPIC to structure the discounts and fees.

There is nothing in the record of either of the subject cases to suggest that the business interests of EPIC and both limited partnerships were not adverse to the business interests of each of the five developers, nor is there anything to suggest that EPIC and the partnerships did not deal with those*265 companies at arm's length. Respondent does not suggest otherwise. In asserting that "the transactions * * * involved related parties", respondent focuses on EMI, the company affiliated with EPIC that originated the loans, and on CAG, the affiliated appraisal company that obtained contemporaneous appraisals in many cases. The activities of those companies, however, did not establish the prices of the properties. That was done through negotiation between EPIC, the willing buyer, and each of the five developers, the willing seller.

Generally, where there is evidence that parties having adverse economic interests have dealt at arm's length and have assigned a value to certain property, that evidence is viewed as the most reliable basis for a determination of fair market value of the property. See, e.g., Siegel v. Commissioner, 78 T.C. at 687; Narver v. Commissioner, 75 T.C. at 97; McShain v. Commissioner, 71 T.C. at 1004; Ambassador Apts., Inc. v. Commissioner, 50 T.C. 236, 243-244 (1968), affd. 406 F.2d 288 (2d Cir. 1969). In the instant cases, the values assigned to the properties at issue under EPIC's contracts with the*266 sellers are the discounted purchase prices paid for the properties. To use respondent's terminology, these values are the wholesale values of the properties. The following schedule shows the aggregate contract prices of the properties purchased by each partnership, less the aggregate rental deficit contributions, the aggregate builder fees, and the aggregate rent advances and compares the net amount to respondent's valuation:

                  Single

    EA 83-XII Properties      Family     Condos    Total

    ____________________      ______     ______    _____

Aggregate contract prices     $ 880,595   $ 3,020,700 $ 3,901,295

 Less: Aggregate rental deficit

    contributions         67,643     587,676    655,319

 Less: Aggregate builder fees    55,993     205,408    261,401

 Less: Aggregate rent advances    17,557      68,625    86,182

                 ________    __________   _________

Contract prices less discounts,

 fees, & advances          739,402*267    2,158,991   2,898,393

Respondent's valuation        858,600    1,800,000   2,658,600

                  Single

   EA 84-XII Properties      Family  ¹    Condos    Total

   ____________________      ______      ______    _____

Aggregate contract prices      908,700    3,048,000  3,956,700

 Less: Aggregate rental deficit

    contributions        122,873     632,414   755,287

 Less: Aggregate builder fees    61,792     207,264   269,056

 Less: Aggregate rent advances    22,425      62,640    85,065

                  _______    _________  _________

Contract prices less discounts,

fees, & advances          701,610    2,145,682  2,847,292

Respondent's valuation        789,150    2,100,000  2,889,150

*268 SINGLE-FAMILY HOUSES AND THE CONDOMINIUM AT 4107 MEDICAL DRIVE

As discussed above, all of the appraisals, including respondent's, valued the single-family houses and the condominium unit at 4107 Medical Drive on a retail basis. The reason for this in the case of the single-family houses was suggested in the memorandum of respondent's appraisers, Messrs. Dalton and Ramos, quoted above, when they stated: "Multiple sales of single-family houses were not plentiful at the date of value and at the present date they are very obscure." In effect, it appears that there was not a market for multiple sales of single-family houses in 1982 and 1983 when the properties were purchased.

Furthermore, respondent used the retail value of the single-family houses and the condominium unit at 4107 Medical Drive in computing the percentages and arguing that the aggregate nonrecourse debt exceeded the value of the properties by 39.40 percent in the case of EA 83-XII and 19.53 percent in the case of EA 84-III. Respondent does not argue that the single-family houses and the condominium unit at 4107 Medical Drive should be valued on a wholesale basis. Thus, it appears that respondent agrees with petitioners*269 that these properties should be valued on a retail basis. Accordingly, we shall review the evidence in the record to determine the retail value of the single-family houses and the condominium at 4107 Medical Drive.

The partnerships purchased a total of 26 single-family houses and the condominium unit at 4107 Medical Drive. As to 19 of these 27 properties, the difference between the principal amount of the debt and the fair market value determined by respondent's appraisers is not material. This is certainly true in the case of the 12 single-family properties purchased by EA 83-XII. According to respondent's appraisers, the aggregate value of the 12 properties is $ 858,600, or $ 22,075 more than the aggregate principal amount of the loans, $ 836,525. Similarly, according to respondent's appraisers, the difference between the value of 6 of the 14 single-family properties and the condominium unit at 4107 Medical Drive purchased by EA 84-III and the principal amount of the loan is less than 10 percent. As to these 19 properties, therefore, there is no appreciable difference in the result of the value comparison depending on whether we use respondent's valuation or the contract prices*270 of the properties.

The single-family residences as to which, according to respondent's appraisers, there is a material difference between the value of the property, and the principal amount of the debt are the following:

EA 84-III

                  Respondent's

   Property        Loan     Value     Loan / Value

   ________        ____   _____________   ____________

3518 Tower Hill Ln.    $ 60,550   $ 55,000      110.09

12347 Northcliff Manor    55,575    45,000      123.50

13066 Clarewood Dr.     54,150    48,000      112.81

6351 S. Briar Bayou Dr.   58,425    47,000      124.31

12103 Kingslake Forest    57,475    46,000      124.95

12107 Kingslake Forest    47,975    38,000      126.25

12111 Kingslake Forest    53,200    40,000      133.00

12115 Kingslake Forest    60,800    52,000      116.92

Petitioners' evidence regarding the above eight properties includes contemporaneous appraisals of the properties and testimony of the appraiser,*271 Mr. Paul Lang, regarding the general nature of his appraisals for EPIC. Mr. Lang is a licensed real estate appraiser in the State of Texas and a senior resident associate (SRA) of the Appraisal Institute. He appraised each of the subject eight properties at the time EA 84-III purchased it in 1983.

Mr. Lang's appraisals of the above single-family properties were made on FHLMC/FNMA forms, as required by EPIC's contract with the seller, U.S. Home. Those forms state as follows: "This appraisal is based upon the * * * market value definition * * * stated in FHLMC Form 439 (Rev. 10/78) and FNMA Form 1004B (Rev. 10/78)". That definition of market value is as follows:

   DEFINITION OF MARKET VALUE: The highest price in terms of money

   which a property will bring, in a competitive and open market

   under all conditions requisite to a fair sale, the buyer and

   seller, each acting prudently, knowledgeably and assuming the

   price is not affected by undue stimulus. Implicit in this

   definition is the consummation of a sale as of a specified date

   and the passing of title from seller to buyer under conditions

   whereby: (1) buyer and seller*272 are typically motivated; (2) both

   parties are well informed or well advised, and each acting in

   what he considers his own best interest; (3) a reasonable time

   is allowed for exposure in the open market; (4) payment is made

   in cash or its equivalent; (5) financing, if any, is on terms

   generally available in the community at the specified date and

   typical for the property type in its locale; (6) the price

   represents a normal consideration for the property sold

   unaffected by special financing amounts and/or terms, services,

   fees, costs, or credits incurred in the transaction. ("Real

   Estate Appraisal Terminology," published 1975.)

Mr. Lang used both the sales comparison and the cost approach in valuing the subject properties. In the case of each of the properties, Mr. Lang concluded that the market value of the property was equal to its contract price. At trial, Mr. Lang testified that his appraisals were independent and objective, and that he had inspected each of the properties at the time of the appraisal. The appraisal forms provide support for this testimony. Mr. Lang made notations on the appraisal forms*273 describing specific work on certain of the properties that had to be completed for the valuation to be accurate. Mr. Lang testified that the copies of his appraisals which are in evidence are incomplete in that there is no map showing the comparable sales used in his analysis. The addresses and sale prices for the properties that he used as comparables appear on the forms.

Respondent's appraiser, Mr. Charles Brown, a valuation engineer employed by the Internal Revenue Service, appraised a number of single-family properties purchased by EA 84-III, including the eight properties listed above. At the time of his testimony, Mr. Brown had applied for but had not received the Appraisal Institute's designation as SRA, and he was not licensed as a real estate appraiser in Texas.

The definition of fair market value used by Mr. Brown is the following:

   The most probable price, as of a specified date, in cash, in

   terms equivalent to cash, or in other precisely revealed terms,

   for which the specified property rights should sell after

   reasonable exposure in a competitive market under all conditions

   requisite to a fair sale, with the buyer and seller*274 acting

   prudently, knowledgeably, and for self-interest, and assuming

   that neither is under undue duress.

Thus, Mr. Lang's appraisals are based upon a definition of market value formulated in terms of "the highest price", as contained on the FHLMC/FNMA forms, and Mr. Brown's appraisals are based upon a definition of market value formulated in terms of "the most probable price".

We note that the definition of market value of real property formulated in terms of "the most probable price", as contained on the FHLMC/FNMA forms, was not used in FHLMC/FNMA forms until 1986. Announcement 86-11, made by FNMA on April 24, 1986, describes the new wording of the definition, effective for appraisals completed on and after July 1, 1986, as follows:

   It also defines the market value as the "most probable price

   which a property should bring * * *" as opposed to the "highest

   price which a property will bring * * *" in the old version.

   This change recognizes that the market value of a property

   usually falls within a range and that the indicated value is AN

ESTIMATE WHICH SHOULD NOT NECESSARILY BE AT THE HIGHEST PORTION

   OF THAT*275 RANGE. [Emphasis supplied.]

Mr. Brown's report states generally that the value of single-family residences in the Houston, Texas, area decreased significantly after 1983. His report states as follows:

   These homes closely followed the prevalent Houston area real

   estate trends during the early 1980's. Values increased

   dramatically until 1983 when values declined sharply for the

   next 3 to 6 years.

Mr. Brown appraised the houses in 1995, 12 years after the sales at issue, using both the comparable sales and cost methods. Mr. Brown testified that he inspected the exterior of each house appraised, and that he reviewed the records at the Harris County Appraisal District and at Baca Landata, a company located in Houston, Texas, which assists taxpayers in dealing with the Harris County Appraisal District.

Mr. Brown's approach is illustrated by his appraisal of the property at 3518 Tower Hill Lane. That property is located on a cul-de-sac in the Northcliffe Manor subdivision approximately 12 miles northwest of downtown Houston. It consists of a 1,331-square- foot house and garage built in 1983 on a 5,775-square-foot lot.

Mr. Brown employed the comparable*276 sales approach and the cost approach to value this property. He identified four comparable sales, two sales of comparable houses in 1983 and two sales in 1987. He then used a "comparable sales adjustment grid" to adjust the sale price of each of the comparables to account for differences in the date of sale, location, lot size, size of the improvements, and year built. After determining the adjusted fair market value of each of the comparables, Mr. Brown divided the adjusted value of each property by the square footage of the improvements to arrive at the fair market value per square foot of the comparable.

For example, Mr. Brown determined that the fair market values per square foot of the two comparable sales in 1983 were $ 56.21 and $ 54.40. He found that the fair market values per square foot of the two comparable sales in 1987 were $ 40.98 and $ 38.14. Mr. Brown then chose the relatively low value of $ 40 per square foot as the market value in 1983 of the subject house, referred to in the appraisal report as Tract I. Mr. Brown's report explains his choice as follows:

   After the adjustments are made, the fair market value of Tract I

   falls in the range of $ 38*277 to $ 56 per square foot in 1983.  Since

   Tract I is one of the largest homes in the subdivision, it shall

   command a loan value per square foot, say $ 40.

We note that the size of the improvements was already taken into account in the comparable sales adjustment grid.

Mr. Brown multiplies this value by the square footage of the improvements on Tract I and estimates that the fair market value of the property, on the basis of the sales comparison approach, is $ 53,200. After further adjusting the value by his estimate of the cost to reproduce the house, Mr. Brown's final estimate of the fair market value of the property is $ 55,000.

It appears that Mr. Brown's appraisal is too low. One of the comparable sales in 1983 is a house located on the same cul-de- sac as the subject property, 3510 Tower Hill Lane. That property was 116 square feet smaller and was sold for $ 64,400 ($ 53 per square foot) to an unrelated buyer in the same month that the partnership purchased the subject property. This is $ 9,400 more than Mr. Brown's appraised value of its larger neighbor. Similarly, a second comparable that was 173 square feet smaller than the subject property sold in September*278 1983 for $ 62,500.

In valuing the 11 properties that are the subject of his report, Mr. Brown used a total of 15 comparable sales, 8 from 1983, 1 from 1982, and 6 from 1987. In applying the comparable sales approach, Mr. Brown followed the same approach in valuing the 11 properties. As to each of the properties, he reviewed three to five of the comparables. He adjusted the sales prices of the comparables for age, location, and size, as described above, and computed an adjusted fair market value per square foot of the comparable. He then selected a value per square foot that represented his opinion of the fair market value of the subject property.

Set out below is a summary, for each of the subject properties, of the fair market values per square foot of the comparables that were sold in 1982 or 1983, the fair market values per square foot of the comparables that were sold in 1987, and the fair market value per square foot that was selected by Mr. Brown as the value of the subject property:

                   Adjusted FMV Per Sq. Ft. of

 EA 84-III Properties    Tract   Comparable Sales in 1982 & 1983

 ____________________   *279 _____   ________________________________

3518 Tower Hill Ln.      I     $ 54.40   $ 56.21    -0-

12347 Northcliff Manor Dr.   II      44.73    48.64    -0-

13066 Clarewood Dr.      III     50.40    38.35    -0-

6351 S. Briar Bayou Dr.    IV      52.91    42.66    -0-

12231 Carola Forest Dr.    V      48.97    56.18   $ 57.12

12115 Kings Lake Forest Dr.  VI      49.47    56.82    57.70

12111 Kings Lake Forest Dr.  VII     44.70    51.60    52.51

12107 Kings Lake Forest Dr.  VIII     44.70    51.60    52.51

12103 Kings Lake Forest Dr.  IX      47.09    56.82    55.06

5419 Heronwood Dr.       X      45.88    48.00    -0-

5411 Heronwood Dr.       XI      45.88    48.00    -0-

             [Table continued]

                    Adjusted FMV Per Sq. Ft.

 EA 84-III Properties    Tract    of Comparable Sales in 1987

 ____________________    _____    ___________________________

3518*280 Tower Hill Ln.      I        $ 40.98    $ 38.14

12347 Northcliff Manor Dr.   II        35.89     31.77

13066 Clarewood Dr.      III        32.43     -0-

6351 S. Briar Bayou Dr.    IV        34.07     -0-

12231 Carola Forest Dr.    V         30.87     35.31

12115 Kings Lake Forest Dr.  VI        31.20     35.63

12111 Kings Lake Forest Dr.  VII        28.29     32.27

12107 Kings Lake Forest Dr.  VIII       28.29     32.27

12103 Kings Lake Forest Dr.  IX        29.78     33.95

5419 Heronwood Dr.       X         32.31     -0-

5411 Heronwood Dr.       XI        33.95     -0-

             [Table continued]

                       Subject Property

 EA 84-III Properties    Tract        FMV Per Sq. Ft.

 ____________________    _____        ________________

3518 Tower Hill Ln.      I         *281    $ 40

12347 Northcliff Manor Dr.   II             35

13066 Clarewood Dr.      III            35

6351 S. Briar Bayou Dr.    IV             30

12231 Carola Forest Dr.    V             40

12115 Kings Lake Forest Dr.  VI             35

12111 Kings Lake Forest Dr.  VII            35

12107 Kings Lake Forest Dr.  VIII            35

12103 Kings Lake Forest Dr.  IX             35

5419 Heronwood Dr.       X             35

5411 Heronwood Dr.       XI             35

It is readily apparent that, in every case, Mr. Brown selected a fair market value per square foot that is roughly equivalent to the value of the comparable sales in 1987 and is substantially below the value of the comparable sales in 1982 and 1983. In doing so, we believe that Mr. Brown gave undue weight to the comparable sales in 1987 that took place after the value of the subject properties had "declined sharply".

For the above reasons, in comparing the fair market*282 value of the property and the principal amount of the debt, we will treat the amount set forth in the contemporaneous appraisal of the property made by Mr. Lang as the fair market value of each of the eight properties as of September 1983.

CONDOMINIUMS

Unlike the single-family residences, it appears that there was both a retail market and a wholesale market for condominiums at the time the partnerships purchased the condominium units at issue in these cases. Respondent's principal expert witness, Dr. Richard Hewitt III, wrote an article in 1980, in which he described a "double-tiered market" for condominiums. Hewitt, "Condominium/Developed Lot Discounting Concepts…Again", 46 Real Estate Appraiser and Analyst (Jan. -- Feb. 1980). Dr. Hewitt noted that in valuing condominiums some persons advocated using the gross sellout amount, the sum of the retail sale prices of the condominiums, as the market value, while others advocated using a discounted or wholesale value. See id. According to Dr. Hewitt: "both are correct under certain circumstances". Id. Dr. Hewitt wrote the following:

   Numerous questions continue to arise relative to what exactly is

   market value for*283 condominium/ developed lots. Certain advocates

   promote the idea that gross sellout (summation of retail sales

   prices) constitutes market value, whereas others have advocated

   the use of discounted value (or wholesale value). Actually, both

   are correct under certain circumstances due to what can best be

   described as a double-tiered market phenomenon. The two-tier

   participants consist of end-product users (final condominium

   unit owners or final single family dwelling purchasers) and

   "interim" purchasers. It is the basic purchase motivation and

   investment goal differentials between these two tiers that

   result in dramatically different actual price; hence, value

   levels. The general misunderstanding of these differentials also

   serves as a major stumbling block to the proper appraisal of,

   and underwriting of loans for, such projects. In view of this,

   the estimate of market value first requires a clear recognition

   of value to whom. [Id.]

Petitioners take the position that the fair market value of the condominium units purchased by each partnership is equal to the sum of*284 the contract prices of the units, as determined by the contemporaneous appraisals. As discussed above, the contemporaneous appraisals valued each condominium unit individually, principally using the comparable sales approach. Thus, using the terminology suggested by respondent and Messrs. Dalton and Ramos, as discussed above, the contemporaneous appraisals valued the condominium units purchased by EA 83-XII and EA 84-III in the retail market. Adding together the contract prices of the individual units to derive the value of the condominium complex is the "gross sellout" approach referred to in the portion of Dr. Hewitt's article quoted above. On that basis, the fair market value of the 39 units in Paseos Castellanos that were purchased by EA 83-XII in December 1982 is $ 3,020,700, or $ 151,075 more than the aggregate principal amount of the promissory notes issued by EA 83-XII to purchase those properties. Similarly, on that basis, the fair market value of the 40 units composing the Reflections condominium complex that were purchased by EA 84-III in September 1983 is $ 3,048,000 or $ 457,800 more than the aggregate principal amount of the promissory notes issued by EA 84-III to purchase*285 those units.

Respondent contends that the condominium units purchased by each partnership should be valued on a discounted or wholesale basis. On that basis, respondent contends, the aggregate fair market value of the 39 units in Paseos Castellanos purchased by EA 83-XII is $ 1,800,000, or $ 1,069,625 less than the aggregate principal amount of the promissory notes issued by EA 83-XII. In support thereof, respondent relies on the appraisal report prepared by Mr. Harold Mogul.

Mr. Mogul's report states that the highest and best use of the 39 condominium units is "the use for which the complex was originally designed and constructed: Residential Condominium Development." The report begins by determining "the total retail sales potential" of the units. Mr. Mogul did this by looking to the prices received for 23 units in the same condominium complex that were sold to buyers other than EPIC. Treating these "retail" sales as comparables, Mr. Mogul determined the retail sales potential of the subject 39 condominium units to be $ 2,962,000.

From the total retail sales potential, Mr. Mogul deducted anticipated expenses over a 30-month absorption period in the aggregate amount of $ 797,971, *286 and he discounted the annual net income to arrive at a wholesale value of the subject condominium units of $ 1,800,000. Respondent acknowledges on brief that Mr. Mogul doubled real estate taxes and association fees in his computations and that using the correct amounts would increase the present worth of the 39 condominium units under Mr. Mogul's discounted cash-flow analysis to $ 1,856,576.

In passing, we note that a representative of Babcock Co. testified at trial that the contract prices of the subject 39 units in Paseos Castellanos were based upon the prices of actual sales of similar units to members of the public. Mr. Mogul's appraisal tends to support that testimony. The total retail sales potential of the units, as determined by Mr. Mogul, $ 2,962,000, differs from the aggregate contract prices of the units, $ 3,020,700, by $ 58,700 or less than 2 percent.

Respondent contends that on a discounted or wholesale basis the aggregate fair market value of the 40 units of the Reflections condominium complex that were purchased by EA 84-III is $ 2,100,000 or $ 490,200 less than the aggregate principal amount of the promissory notes issued by EA 84-III. In support thereof, respondent*287 relies on the appraisal report prepared by Mr. David B. Dalton, an appraiser employed by the Internal Revenue Service, and by Mr. Mark D. Ramos, an Internal Revenue Service engineer.

Messrs. Dalton and Ramos considered the highest and best use of the 40 condominium units in the long term to be "the possible sale of the units individually or as a whole". They considered the short-term highest and best use of the condominium units to be "as apartment units to exploit a possible cash-flow from the residential rental income of the forty units." In their appraisal, Messrs. Dalton and Ramos used the comparable sales approach to arrive at the "wholesale value" of the units, $ 2,100,000, based upon the sale of one apartment building with 36 units. This is an entirely different method than the discounted retail sales method used by Mr. Mogul.

In applying the sales comparison approach to the subject property, Messrs. Dalton and Ramos reviewed four buildings in the same general area that were sold in 1983. Three of the buildings were substantially larger than the Reflections both in the number of units and in square footage, and the appraisers chose not to use those sales because the size differences*288 "would require a large upward adjustment to bring them comparable to the subject." The fourth comparable, the one on which they based their appraisal, involved the sale of an apartment with 36 units that "was purchased for conversion to condominiums" and as of "December 1994, 12 of the 36 units [had] been converted."

The sale price of the apartment building, $ 1,650,000, divided by the number of apartments, 36, works out to a price per unit of approximately $ 45,800. Respondent's appraisers note that the Reflections has a more desirable setting, with a view of a lake, than the comparable and has approximately three-fourths of an acre more land. Accordingly, the appraisers increased the price per unit to $ 52,500, an increase of $ 6,700 per unit, to account for these differences. Their report, however, does not explain how this adjustment was determined. Respondent's appraisers made no adjustment for the fact that the comparable was approximately 3 years old at the time of the time of the sale, whereas the Reflections had just been built.

In passing, we note that their appraisal of the 40 units of the Reflections condominium complex is accompanied by a memorandum, discussed above, *289 in which Messrs. Dalton and Ramos point out that this "wholesale value is 30 percent lower than EPIC's projected retail value" of the condominiums, "$ 3,000,000", and they suggest that the two values are within the range of what would be expected. Messrs. Dalton and Ramos also state that EPIC over- leveraged the condominiums "by financing the properties at their retail price", and they note that "EPIC financed the Condo's at $ 3,000,000". Thus, their memorandum implies that the sum of the retail values of the condominium units is $ 3,000,000 or $ 48,000 less than the sum of the contract prices of the condominiums, $ 3,048,000.

It is evident from the above that the threshold question in these cases is whether the condominiums should be valued on a retail basis or on a wholesale basis. If we decide that the condominiums should be valued in the retail market, then it appears that the fair market value of the condominiums exceeds the amount of debt. This is true whether we base the retail values of the properties on the contract prices, as argued by petitioners, or the retail prices implied in the reports of respondent's appraisers. On the other hand, if we decide that the condominiums*290 should be valued in the wholesale market, then it appears that the fair market value of the condominiums is less than the amount of debt. This is true whether we base the wholesale values on the amounts set forth in respondent's appraisals or the prices that each partnership actually paid for the condominiums. As the court noted in Anselmo v. Commissioner, 757 F.2d at 1213: "The selection of the relevant market at a given time for appraisal purposes is tantamount to selecting the price." That is certainly true in this case.

None of the appraisers who testified in these cases considered this issue. Mr. Seph Pomerantz, who prepared the contemporaneous appraisals of the 39 units in Paseos Castellanos, testified that his firm was asked to appraise the units individually and not in bulk. He further testified that he would not have completed his appraisals in the same fashion if he had been asked for a bulk appraisal.

Similarly, Mr. Mogul's letter transmitting his appraisal report to respondent's counsel states that the report was made for the purpose of estimating the fair market value of the 39 condominium units in Paseos Castellanos as of December 30, 1982, "assuming sale*291 of thirty-nine units to a single purchaser." Thus, as he further stated during his testimony, Mr. Mogul appraised the condominium units as property to be held by a single investor, or "entrepreneur".

Finally, Mr. Dalton, who appraised the 40 units of the Reflections, testified at trial that his "assignment [from respondent] was, how much should EPIC have paid for this property." In the memorandum attached to their appraisal, Messrs. Dalton and Ramos make the following statement:

   The fair market value of the properties acquired by Epic

   Associates 84-III is based on the market place in which they

   were acquired, the wholesale market. As such, the fair market

   value is the price paid by Epic Associates 84-III to the seller,

   without regard to any RDC (rental deficit contribution) or other

   supposed Builder Rebate.

They do not explain why the fair market value of the properties acquired by EA 84-III must be determined in "the market place in which they were acquired, the wholesale market" when, as they also recognize, EA 84-III purchased the properties for resale and received special discounts in the purchase price from the sellers.

*292 The report of respondent's principal expert witness, Dr. Richard Hewitt III, does not explicitly discuss the appropriate market for determining the value of the subject properties. Dr. Hewitt's report does suggest that the value of the subject properties must be based upon the bulk purchase price, the wholesale price, rather than the value of each single unit because:

   The potential market risk [to each partnership] is actually

   related to multiple units and not a single unit as would be

   unrealistically reflected by the EPIC/CAG approach of solely

   obtaining individual unit appraisals.

In his testimony, Dr. Hewitt elaborated on that concept as follows:

   What I was illustrating in the report is that if you look at the

   way Epic appraised the properties, they specifically, by the

   directive of their captive appraisal group, dictated that the

   appraisals be done on an individual basis, despite the reality

   that their purchases were done in bulk.

     And what I am saying is is [sic] that discount was

   represented because of the fact that they, in fact, had a risk

   exposure relating*293 to a bulk purchase, so they paid a fair price

   for buying 50, 60, 150 or 200.

     They may have -- and I am trying to illustrate, which is

   really the difficult concept in this whole Epic matter -- is

   there is a significant difference between the one-house-at-a-

   time appraisal versus the risk, the portfolio risk of having 50,

   having 100, having 250.

On the basis of that statement, respondent asks the Court to make the following finding of fact:

   Because market risk for EA83-XII and EA84-III related to

   multiple units acquired in bulk sales and not single units

   acquired in separate transactions and the appraisals obtained by

   Epic for the properties were only on an individual basis using

   market and cost approaches, the separate appraisals for each

   property did not realistically reflect the market risk or value

   to EA83-XII and 84-III. [Emphasis supplied.]

We agree with Dr. Hewitt that each partnership made bulk purchases of the properties and received special discounts from the sellers and that each partnership undoubtedly paid a fair price for the properties that it purchased. *294 We agree with Dr. Hewitt that each partnership purchased the properties for resale. As Dr. Hewitt stated:

   Someone buying, in the case of Epic, 40, 100, 200 homes at a

   pop, obviously, is not going to live in those homes. The intent

   from a typical market purchaser's standpoint, if you were to buy

   a hundred homes, would be to resell those.

We further agree with Dr. Hewitt that the contemporaneous appraisals valuing each property individually do not reflect the bulk purchases made by each partnership.

The question that we must decide, however, is whether, for purposes of determining the bona fides of the subject indebtedness, the fair market value of the properties must be determined in the wholesale market, the market in which the partnerships purchased the properties, or the retail market, the market in which the partnerships planned to resell the properties. The thrust of respondent's position is that the fair market value of the properties, as stated by Messrs. Dalton and Ramos: "is based on the marketplace in which they were acquired, the wholesale market." Neither respondent nor respondent's witnesses provide a reason why this must be the case.

*295 During his testimony, Dr. Hewitt touched on the appropriate market for valuing property and, contrary to respondent's position, his testimony suggests that the subject properties should be valued in the retail market. On cross-examination, Dr. Hewitt answered a number of questions from petitioners' representative about the value of a bag of peanuts as purchased by an individual, on the one hand, or the value of the same bag of peanuts as purchased by a bulk purchaser, such as an airline, on the other hand. On redirect, the following exchange took place between Dr. Hewitt and respondent's attorney:

   Q.   Mr. Hewitt, you and Mr. Griffith talked about buying

    peanuts, where he could go buy one bag of peanuts and Delta

    could go buy another bag of peanuts. Let's do this example:

    You could go to the grocery store where a bottle of Coca-cola

    sells for 50 cents a bottle, and you can buy a six-pack for

    $ 2.

     You bought a six-pack. Do you value your acquisition at $ 2

    or $ 3?

   A.   Of course not. You would value it based on what you paid

    for it, because it takes*296 into account the discount. The only

    way you could achieve the higher number would be to go into

    the soda-dispensing business and sell out individual Cokes to

    individual users of one Coke after another.

Dr. Hewitt's response suggests that the purchaser must value the property on the basis of the amount paid, unless the purchaser is a person who is in the business of reselling the property, like each of the subject partnerships, and receives a discount from the seller. In such a case, the purchaser is entitled to value the property at the resale value; i.e., $ 3 in the hypothetical example posited by respondent's counsel, or $ 1 more than the buyer paid for the property.

Dr. Hewitt's testimony on this point is consistent with the cases, discussed above, involving the determination of the appropriate market to use in estimating the value of an item of property. See, e.g., Goldstein v. Commissioner, 89 T.C. at 544-546; Lio v. Commissioner, 85 T.C. at 66; Anselmo v. Commissioner, 80 T.C. at 882-883. Under those cases, the fair market value of an item of property is its sale price in the market in which it is*297 "most commonly sold to the public" in the sense of the "customary purchasers" of the property. Anselmo v. Commissioner, 757 F.2d at 1212-1214.

It is evident that the subject condominium units were ready for immediate sale to individual purchasers and that individual purchasers were among the "customary purchasers" of condominiums. It is also evident that neither partnership was the ultimate consumer of the condominiums. The partnerships purchased the condominiums in bulk purchases and received substantial discounts from the sellers, the developers of the properties. The partnerships purchased the condominiums for the purpose of reselling them to owner occupants after leasing them for a period of time. See Goldstein v. Commissioner, supra 89 T.C. at 545-546. Therefore, on the basis of the facts of the instant cases, we find that the retail market was the appropriate market to use in estimating the fair market value of the condominiums.

Furthermore, in the instant cases, retail valuation of the condominium units appears to have been approved by the marketplace. As discussed in the findings of fact, the specific loans at issue were initially made by EMI, which originated*298 the loans and continued to service them; but the loans were insured by private mortgage insurance companies and were sold to unrelated lenders in the secondary mortgage market. Tricor and RMIC are the private mortgage insurance companies that issued mortgage insurance covering the loans at issue in the instant cases.

The information submitted as part of Dr. Hewitt's report confirms, as one would suspect, that the private mortgage insurers thoroughly investigated EPIC's business and were particularly careful to investigate the risks relating to the values of the properties that EPIC syndicated. That information also shows that the private mortgage insurers had occasion to review appraisals submitted by EPIC in connection with its application for mortgage insurance and, in some cases, the private mortgage insurers ordered spot appraisals to compare with EPIC's appraisals. It would be readily evident from reviewing the contemporaneous appraisals that EPIC had valued each of the condominiums and other residential properties purchased by its limited partnerships on an individual or retail basis and not on a discounted or wholesale basis. Therefore, the record suggests that the private*299 mortgage insurers knew or had reason to know that EPIC valued the properties that it purchased on a retail, rather than on a wholesale, basis. We do not mean to suggest that the private mortgage insurers gave advance approval to the specific loans at issue in these cases or to any other loans but only that the private mortgage insurers knew that EPIC valued the properties on a retail basis.

Respondent argues that we should disregard the actions of the private mortgage insurers and secondary lenders on the ground that there is no evidence that the mortgage insurers and secondary lenders performed due diligence. Respondent argues that they "ignored or did not understand the realities of the EPIC transactions." We disagree. While the record does not show what due diligence was conducted by or on behalf of the secondary lenders, Dr. Hewitt's testimony and the material submitted with Dr. Hewitt's report confirm that the private mortgage insurers conducted due diligence with respect to the EPIC loans, including risk assessments, spot appraisals, and other forms of due diligence and, in fact, two companies, MGIC and CMAC, ceased insuring EPIC loans after spot appraisals disclosed values*300 that were lower than the values shown on the EPIC's appraisals.

RETAIL VALUATION OF THE SUBJECT PROPERTIES

Respondent's appraisers valued the 26 single-family houses and the condominium unit at 4107 Medical Drive in the retail market. As discussed above, in the case of 19 of these properties the difference between respondent's value and the contract price of the property is not material. As to those properties, we have used respondent's values in comparing the aggregate fair market value of the properties to the aggregate principal amount of the debt. As to 8 of these 27 properties, as discussed above, we do not agree with respondent's appraisals and, for purpose of making the value comparison required in these cases, we accept the values established by the contemporaneous appraisals.

As to the 39 units of Paseos Castellanos purchased by EA 83-XII and the 40 units of the Reflections purchased by EA 84-III, respondent's appraisers used the wholesale market, rather than the retail market, to value the units. However, the aggregate retail value of the 39 units of Paseos Castellanos is implied in Mr. Mogul's appraisal report when he finds that the total retail sales potential of the*301 units is $ 2,962,000. Similarly, the aggregate retail value of the 40 units of the Reflections is implied by Messrs. Dalton and Ramos in the memorandum that accompanied their appraisal report when they referred to $ 3,000,000 as the "retail price" of the units. In comparing the aggregate fair market value of the properties to the aggregate principal amount of the debt, we shall use the retail values of the condominiums implied in the reports of respondent's appraisers.

The following schedules show the aggregate retail value of the properties purchased by each partnership as compared to the aggregate debt:

EA 83-XII Properties       Loan     Value    Loan / Value

____________________       ____     _____    ____________

1612 Hemphill Ave.      $ 54,525    $ 57,400     94.99

1921 W. 17th St.        51,300     54,000     95.00

1728 Coronado Ave.       51,300     54,000     95.00

1700 Linda Ave.         54,050     56,900     94.99

1716 Coronado Ave.       54,050     56,900     94.99

1916 Hollywood Dr.    *302    53,200     56,000     95.00

1720 Coronado Ave.       56,425     59,400     94.99

2109 Avignon Dr.        84,525     84,000     100.63

2111 Avignon Dr.        85,025     85,000     100.03

2113 Avignon Dr.        95,475     91,000     104.92

2115 Avignon Dr.        95,475    100,500     95.00

2117 Avignon Dr.        101,175    106,500     95.00

Paseos Castellanos      2,869,625   2,962,000     96.88

              _________   _________     ______

  Total           3,706,150   3,823,600     96.93

  EA 84-XII Properties      Loan     Value    Loan / Value

  ____________________      ____     _____    ____________

5419 Heronwood Dr.       $ 51,300    $ 58,000     88.45

5411 Heronwood Dr.        61,750     65,000     95.00

3518 Tower Hill Lane       60,550     63,750     94.98

12347 Northcliff Manor Dr.    55,575   *303   58,500     95.00

13066 Clarewood Dr.       54,150     57,000     95.00

6351 S. Briar Bayou Dr.     58,425     61,500     95.00

12103 Kings Lake Forest Dr.   57,475     60,500     95.00

12107 Kings Lake Forest Dr.   47,975     50,500     95.00

12111 Kings Lake Forest Dr.   53,200     56,000     95.00

12115 Kings Lake Forest Dr.   60,800     64,000     95.00

12231 Carola Forest Dr.     56,050     54,000     103.80

4850 West Ferret Dr.       67,450     71,200     94.73

4107 Medical Dr.         56,950     56,400     100.98

13739 Earlywood Dr.       60,800     57,600     105.56

6402 Ridgecreek Dr.       60,800     55,950     108.67

The Reflections        2,590,200   3,000,000     86.34

              _________   __________    _______

 Total            3,453,450   3,889,900     88.78

As shown above, on a retail basis, the aggregate fair market value of the subject properties exceeds*304 the aggregate amount of the debt. Accordingly, on the basis of the record of these cases, we find that the debt incurred by each partnership in purchasing the subject properties is bona fide indebtedness.

POINTS AMORTIZATION

Both partnerships paid loan origination fees to EMI equal to 4 percent of the principal amounts of the first mortgage loans. This amounted to $ 148,246 in the case of EA 83-XII and $ 138,138 in the case of EA 84-III. These fees were nonrefundable and were similar in amount to origination fees charged by other lenders. As discussed above, they were paid in connection with bona fide indebtedness. Accordingly, we agree with petitioners that these fees are deductible ratably over the life of the first mortgage loans. See Von Muff v. Commissioner, T.C. Memo 1983-514.

PROFIT MOTIVE

Respondent determined in the subject notices of FPAA that the activity conducted by each partnership, EA 83-XII and EA 84-III, during each of the years in issue, was an "activity not engaged in for profit" within the meaning of section 183. Thus, in effect, respondent determined that the activity of each partnership was an "activity other than one with respect to which deductions*305 are allowable for the taxable year under section 162 or under paragraph (1) or (2) of section 212." Sec. 183(c).

Petitioners do not contend that the partnerships are entitled to deductions under section 212. Accordingly, we must redetermine whether EA 83-XII and EA 84-III are entitled to deductions under section 162 during the taxable years in issue. See Brannen v. Commissioner, 722 F.2d at 704.

Section 162(a) provides for the deduction of all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. See sec. 162(a). It is settled that in order to constitute the carrying on of a trade or business under section 162(a), the activity must be entered into in good faith with the dominant hope and interest of realizing a profit. See, e.g., Brannen v. Commissioner, supra 722 F.2d at 704; Siegel v. Commissioner, 78 T.C. at 698. As we have noted in many cases, the taxpayer must show that he or she had an "actual and honest objective of making a profit." E.g., Marine v. Commissioner, 92 T.C. 958, 988 (1989); Hulter v. Commissioner, 91 T.C. 371, 392-393 (1988); Dreicer v. Commissioner, 78 T.C. 642, 645 (1982),*306 affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983). For this purpose, the term "profit" means economic profit independent of tax consequences. E.g., Ronnen v. Commissioner, 90 T.C. 74, 88 (1988); Herrick v. Commissioner, 85 T.C. 237, 255 (1985).

Generally, in the case of an activity to which section 183 applies, the deductions attributable to the activity are grouped into two categories: Those that would be allowable "without regard to whether or not such activity is engaged in for profit" and those that would be allowable "only if such activity were engaged in for profit." Sec. 183(b). Paragraph (1) of section 183(b) allows a taxpayer to take the deductions in the first category without limit, but paragraph (2) of section 183(b) limits the aggregate amount of the deductions in the second category, i.e., deductions which are allowable only if the activity is engaged in for profit, "to the extent that the gross income derived from such activity for the taxable year exceeds the deductions allowable by reason of paragraph (1)." Sec. 183(b)(2).

The depreciation deductions claimed by each partnership under section 167 are allowed only if the expenses*307 were incurred in connection with an activity that constitutes a trade or business of the taxpayer. See sec. 167(a)(1). Thus, if section 183 applies to the activities of EA 83-XII and EA 84-III, the depreciation deductions would be subject to limitation under section 183(b)(2).

On the other hand, the interest deductions claimed by each partnership under section 163(a) are not subject to the trade or business requirement. However, the notices of FPAA determined that the activity of neither partnership was engaged in for profit, with the result that "all interest expenses relative to this activity are not allowable as deductions against ordinary income, but are separately stated items subject to the investment interest limitations." The notices of deficiency thus take the position that, if section 183 applies to the activities of each partnership, then the interest expense incurred with respect to the partnership's activities will be treated as interest on investment indebtedness and will be subject to the rules prescribed by section 163(d) limiting the allowable deduction before the limitation under section 183 is computed. See sec. 1.183-1(b)(1)(i), Income Tax Regs.

*308 In the case of a limited partnership, the profit motive determination under section 183 is made at the partnership level. See, e.g., Brannen v. Commissioner, 722 F.2d 695 (11th Cir. 1984); Fox v. Commissioner, 80 T.C. 972 (1983); Feldman v. Commissioner, T.C. Memo 1993-17, affd. 20 F.3d 1128 (11th Cir. 1994). Therefore, in the instant cases, we look to the actions of the general partner, EPIC, to determine whether both of the partnerships are subject to section 183.

The determination whether an activity is engaged in for profit is to be made by reference to objective standards, taking into account all of the facts and circumstances of each case. See sec. 1.183-2(a), Income Tax Regs. No one factor is determinative in making this determination. See sec. 1.183-2(b), Income Tax Regs. Greater weight is to be given to objective facts than to the taxpayer's statement of his or her interest. See sec. 1.183-2(a), Income Tax Regs.

As a preliminary matter, we note that none of the parties to these cases contends that either partnership conducted more than one activity. *309 See generally sec. 1.183-1(d)(3), Income Tax Regs. For example, no party contends that the holding of the residential properties for appreciation and the renting of those properties by either partnership were separate activities for purposes of section 183.

The regulations list the following nine factors that should be taken into account in determining whether an activity was engaged in for profit: (1) The manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectations that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) any elements of personal pleasure or recreation. See sec. 1.183-2(b), Income Tax Regs.

The properties purchased by EA 83-XII and EA 84-III were highly leveraged and produced operating losses. The*310 offering memorandum issued by each partnership disclosed the fact that the partnership would incur such operating losses and that the properties had to appreciate in value in order for an investor to realize a profit. The offering memorandum issued for EA 83-XII projected a break-even appreciation rate of 7.99 percent, and the offering memorandum for EA 84-III projected a break-even appreciation rate of 9.15 percent. The appreciation rates required for a profit were high, but there is nothing in the record of these cases to show that, as of the initiation of either partnership, such appreciation rates could not be achieved. For example, respondent's appraiser, Mr. Charles D. Brown, testified that in Houston, Texas, property values increased during 1981, 1982, and 1983, even though interest rates were increasing. He testified that if interest rates had dropped, then the real estate market in Houston "would have gone even more ballistic."

Moreover, in an internal memorandum, prepared in late 1983 or early 1984, a member of EPIC's management noted that "since 1964, mortgage rates have averaged 2.75% above the inflation rate" and "appreciation rates have also averaged 2.09% above the*311 inflation rate." On the basis of these relationships, the memorandum concludes that EPIC's "partnerships could be expected to generate positive economic benefits". The memorandum also notes that there have been periods, notably 1980, 1981, and 1982, when home price appreciation performed below average, relative to inflation and interest rates.

Respondent takes the position that neither EPIC nor any of its limited partnerships, including EA 83-XII and EA 84-III, ever intended to realize a profit. Respondent's position is that EPIC formed EA 83-XII and EA 84-III and other limited partnerships in order to "satisfy its ravenous appetite for funds necessary to support its real estate empire." According to respondent, the centerpiece of EPIC's "scheme" involved overmortgaging the properties purchased by each partnership "by obtaining inflated, defective appraisals to support nominal purchase prices that permitted EPIC to generate substantial builder fees, rental deficit contributions, and rental advances". Respondent also contends that EPIC's projected break-even appreciation rates of 7.99 percent and 9.15 percent "were approximately twice as high as the actual appreciation rates from 1980*312 to 1985" and that EPIC failed to disclose its inability to sell the properties of older partnerships, the adverse market conditions in the housing industry, the re-syndications of properties from "matured" partnerships into new properties, the use of defective appraisals to arrive at inflated values, the purchase of properties for partnerships from EPIC subsidiaries, the nature and use of the "sweep" account, and the payment and appraisal fee for property not purchased by EA 83-XII. We disagree.

Under respondent's view of the facts, EPIC was interested only in obtaining lump-sum payments from new property acquisitions and the fees attributable to those new properties. Respondent ignores the fact that EPIC's business of syndicating real estate partnerships depended upon the perceived success of the limited partnerships that it syndicated. As a result, EPIC advanced a high percentage of the lump-sum payments and fees that it realized from the acquisition of new properties to satisfy the obligations of older partnerships, and thus to make sure that none of the partnerships defaulted on its obligations. In choosing to make those advances and prevent any default, the management of EPIC*313 continued to believe that it could carry the properties until interest rates decreased and the real estate market turned around. Respondent also ignores the fact that EPIC was entitled to 25 percent of the net profits from the sale of properties, so-called back-end appreciation. Mr. Clayton McQuistion, an important member of EPIC's management, referred to this as "a gigantic profit opportunity".

Based upon the record of these cases, we find that EPIC, acting as the general partner of both EA 83-XII and EA 84-III, engaged in the activities of both partnerships with an actual and honest objective of making a profit.

EPIC's ADVANCES TO EA 83-XII AND EA 84-III

As mentioned above, respondent determined in the subject notices of FPAA that the deductions for interest claimed by each partnership with respect to the unsecured advances made by EPIC were not allowed on the ground that any such interest expenses were not paid or accrued on bona fide indebtedness. Respondent cites Hambuechen v. Commissioner, 43 T.C. 90 (1964), and invites the Court to test whether the advances in this case are valid indebtedness in accordance with the holding of that case. Hambuechen involved an*314 advance of money to a partnership by a limited partner. In that case, we noted that the question whether a transaction created a debtor- creditor relationship for tax purposes is a question of fact. See id. at 98. We applied the same factual analysis used to resolve debt- equity issues in the context of a corporation and its stockholders, and we held that the subject advance constituted a capital contribution, rather than a loan. See Kingbay v. Commissioner, 46 T.C. 147, 154-155 (1966).

Petitioners argue that the advances in this case constitute bona fide indebtedness rather than equity. In support of that argument, petitioners review each of the 13 factors that were taken into account by the court in Estate of Mixon v. United States, 464 F.2d 394, 402 (5th Cir. 1972), in determining whether the advances in that case constituted debt or equity. Those factors are the following:

   (1) the names given to the certificates evidencing the

   indebtedness; (2) the presence or absence of a fixed maturity

   date; (3) the source of payments; (4) the right to enforce

   payment of principal and interest; (5) participation in

*315    management flowing as a result; (6) the status of the

   contribution in relation to regular corporate creditors; (7) the

   intent of the parties; (8) "thin" or adequate capitalization;

   (9) identity of interest between creditor and stockholder; (10)

   source of interest payments; (11) the ability of the corporation

   to obtain loans from outside lending institutions; (12) the

   extent to which the advance was used to acquire capital assets;

   and (13) the failure of the debtor to repay on the due date or

   to seek a postponement.

See also Stinnett's Pontiac Serv., Inc. v. Commissioner, 730 F.2d 634 (11th Cir. 1984), affg. T.C. Memo 1982-314, applying the same 13 factors.

Some of the above factors support respondent's position that the advances are equity. For example, there was no fixed maturity date for repayment of the advances, and the only realistic source of repayment was from gains from the sale of partnership properties. Furthermore, it is unlikely that either partnership could have obtained credit on the same basis from outside sources.

Other factors support petitioners' position that the advances*316 are debt. For example, the partnership agreement governing each partnership treats the unsecured advances as indebtedness, establishes an interest rate, and gives EPIC the right to collect payment of the advances from the partnership. Furthermore, the advances were disproportionate to EPIC's interest in the partnership.

Certain other factors do not clearly indicate that the advances were either debt or equity. For example, EPIC did not receive increased management control over either partnership by reason of the advances, but, as general partner, EPIC already exercised full management control of both partnerships. Similarly, it appears that the advances were used for all partnership needs.

We believe that the weight of the evidence tips in favor of finding that the subject unsecured advances are equity when we consider the intent of the parties. In our view, EPIC's management placed these funds at the risk of the business and had no reasonable expectation of repayment without regard to the success of all of the partnerships. As discussed above, EPIC's management anticipated that EA 83-XII and EA 84-III would have surplus cash during their early lives but that each partnership eventually*317 would incur operating deficits and would need to receive advances from EPIC in order to avoid defaults.

Other than the sale of a partnership's properties, a partnership had only four sources of cash to fund these operating deficits: Capital contributions by the limited partners, partnership income consisting primarily of rental income, builder rebates, and general partner advances. EPIC's management realized that its ability to remain in business would be hurt if any of its limited partnerships defaulted on an obligation. EPIC's management recognized that EPIC had to advance funds to its partnerships. EPIC's management also recognized that the advances would not realistically be repaid until and unless the properties were sold at a profit. An internal memorandum prepared sometime after September 1983 states as follows:

   To the extent anticipated operating deficits are greater than

   depreciation (5.3% of purchase price), one half of this deficit

   must be funded by sources other than limited partner

   contributions. To the extent we initially over-estimate

   partnership income in the offerings, all of the increased

   operating deficit will*318 come from the general partner.

On the basis of the testimony at trial and the above, we find that EPIC's advances to both partnerships were in the nature of equity rather than indebtedness. Accordingly, any "interest" attributable to such advances claimed as a deduction by either partnership for any of the years in issue is not allowable under section 163(a).

SIXTEEN PROMISSORY NOTES EACH IN THE PRINCIPAL AMOUNT OF $ 5,000

As mentioned above, EA 84-III issued 16 promissory notes payable to CSL each in the principal amount of $ 5,000 and dated February 1, 1985. Each promissory note was secured by a deed of trust also dated February 1, 1985, in favor of CSL. Eleven of the deeds of trust purport to have been filed on September 6, 1985, with the County Clerk of Harris County, Texas. Five of the deeds of trust do not appear to have been filed.

In the bankruptcy filing that was made on behalf of EA 84- III, CSL is listed as a secured creditor with respect to 16 promissory notes in the aggregate amount of $ 80,000. The filing also states that accrued interest in the amount of $ 4,000 is payable to CSL as a secured creditor.

At trial, respondent introduced appraisals of the subject 16*319 properties as of February 1, 1985, and respondent argues on brief that the appraisals demonstrate that the value of the underlying properties declined or did not appreciate enough to support the new debt. Set out below is a list of the 16 properties that shows the sum of the original purchase money indebtedness, plus $ 5,000, the value of each such property on February 1, 1985, as determined by respondent's appraisers, and the difference between those amounts:

  EA 84-111 Properties     Loan + $ 5,000  Value 2/1/85  Difference

  ____________________     _____________  ____________  __________

5419 Heronwood Dr.        $ 56,300     $ 55,000    -$ 1,300

5411 Heronwood Dr.         66,750      62,000     -4,750

3518 Tower Hill Lane        65,550      50,000    -15,550

12347 Northcliff Manor Dr.     60,575      42,000    -18,575

13066 Clarewood Dr.         59,150      46,000    -13,150

6351 S. Briar Bayou Dr.       63,425      45,000    -18,425

12103 Kings Lake Forest Dr.     62,475      44,000    -18,475

12107*320 Kings Lake Forest Dr.     52,975      36,000    -16,975

12111 Kings Lake Forest Dr.     58,200      38,000    -20,200

12115 Kings Lake Forest Dr.     65,800      48,000    -17,800

12231 Carola Forest Dr.       61,050      50,000    -11,050

4850 West Ferret Dr.        72,450      74,287     1,837

4107 Medical Dr.          61,950      58,846     -3,104

13739 Earlywood Dr.         65,800      60,098     -5,702

6402 Ridgecreek Dr.         65,800      58,324     -7,476

The Reflections, unit 101      69,755      54,790    -14,965

                _________     _______    ________

 Total             1,008,005     822,345    -185,660

In the case of the property at 4850 West Ferret Drive, it appears, according to respondent's evidence, that the value of the property as of February 1, 1985, $ 74,287, exceeds the amount of the indebtedness, $ 72,450. Accordingly, it appears that respondent's evidence shows that the*321 second trust note secured by that property was valid indebtedness. Furthermore, in the case of the properties at 5419 Heronwood Drive, 5411 Heronwood Drive, 4107 Medical Drive, and 13739 Earlywood Drive, the difference reflected in respondent's appraisals is not material.

Petitioners presented no evidence to substantiate the fair market value of any of the subject properties as of February 1, 1985. Petitioners argue that the 16 promissory notes are, in fact, "unsecured debt" and are bona fide indebtedness without regard to the value of the property. Initially, petitioners argued that "the promissory notes were not recorded until after the bankruptcy filing", and thus the notes had "no substance in the eyes of the bankruptcy court." On the basis of that premise, petitioners argued: "respondent should not be allowed to rely upon defective documents to assert that those notes represented secured debt". Petitioners further argued that the notes should be treated as unsecured debt "indistinguishable from the unsecured advances which they replaced."

In their reply brief, petitioners withdrew the factual assertion that the 16 promissory notes replaced unsecured advances made by EPIC. They*322 continue to take the position that the validity of the notes should be determined without regard to the value of the 16 properties in 1985 for either of two reasons. First, petitioners argue that the notes were related to "an $ 80,000 line of credit from Community" that is described in respondent's brief as "a nonrecourse line of credit with Community [CSL] totalling $ 80,000 secured by notes of limited partners", and thus petitioners contend that the 16 promissory notes were "adequately secured" without regard to the value of the real estate. Second, they argue that "the real estate was never legal security for the promissory notes; therefore, the value of the real estate in 1985 is irrelevant." We disagree.

Each of the 16 promissory notes states that it "is the Note described in and secured by a Deed of Trust dated February 1, 1985, on property located in HARRIS COUNTY, State of TEXAS", and each note sets forth the address of the property. Each related deed of trust provides a legal description and an address of the property securing the note. Those documents are complete in and of themselves and make no reference to "an $ 80,000 line of credit from Community". In form, each of*323 the 16 promissory notes purports to be secured by one of the 16 properties. Furthermore, petitioners do not take issue with the premise of respondent's argument that each of the 16 promissory notes that was issued by EPIC, the general partner of each partnership, to CSL, an affiliated savings and loan associate, is a nonrecourse obligation. Accordingly, we agree with respondent that none of the promissory notes can be treated as bona fide indebtedness unless petitioners prove that the amount of the debt does not unreasonably exceed the value of the property securing it. See, e.g., Brannen v. Commissioner, 722 F.2d 695 (11th Cir. 1984); Estate of Franklin v. Commissioner, 544 F.2d 1045 (9th Cir. 1976).

As mentioned above, petitioners introduced no evidence of the value of any of the properties as of February 1, 1985. There is no evidence to show that the fair market values of the properties on February 1, 1985, exceed the aggregate indebtedness secured by the property at that time, except in the case of the property at 4850 West Ferret Drive, as to which respondent's evidence shows that the fair market value exceeds the amount of the debt, and except in the*324 case of the properties at 5419 Heronwood Drive, 5411 Heronwood Drive, 4107 Medical Drive, and 13739 Earlywood Drive, as to which the discrepancies between the fair market value of the property and the amount of the debt are negligible. Accordingly, we hereby sustain respondent's adjustment disallowing any interest deduction claimed by EA 84-III on its 1985 return attributable to the remaining 11 promissory notes payable to CSL issued by EA 84-III on February 1, 1985.

To reflect the foregoing,

Decisions will be entered under Rule 155.

APPENDIX A

            EPIC Associates 83-XII

            Schedule D -- Pro Forma

      Cash-Flow and Taxable Income (Loss) Analysis

            Through June 30, 1987

Application of Funds          1983     1984      1985

____________________          ____     ____      ____

ANNUAL CASH-FLOW

Rental Income  ¹/

Interest income         $ 229,517.00 $ 325,246.14 $ 333,247.08

Interest income           17,877.95  *325  17,533.96    6,660.78

Less: First mortgage

   payments  ²         386,822.00   546,101.64   546,101.64

Additional interest

 payments  ³             -0-      -0-      -0-

Taxes                34,859.01   51,516.95    55856.44

Insurance              15,229.20   22,467.54   24,402.55

Audit fees              3,454.27    4,876.62    4,876.62

Maintenance and repairs  ⁴     12,095.85   19,059.93   21,811.80

Property administration fee     21,675.00   30,600.00   30,600.00

Net cash-flow from operations   -226,740.38  -331,842.58  -343,741.19

TAXABLE INCOME (LOSS) ANALYSIS

Net cash-flow from operations   -226,740.38  -331,842.58  -343,741.19

Plus: Mortgage amortization      -0-      -0-      -0-

Other income recognized  ⁵      -0-      -0-      -0-

Less: Depreciation         122,625.76   173.118.72   173,118.72

Amortization of mortgage

 loan fee             11,808.84   16,671.30   16,671.30

Accrued*326 mortgage interest       -0-       -0-      -0-

Net taxable income        -361,174.98  -521,632.60  -533,531.21

             [Table continued]

Application of Funds         1986      1987      Total

____________________         ____      ____      _____

ANNUAL CASH-FLOW

Rental Income  1/

Interest income         $ 356,488.68 $ 186,475.74 $ 1,430,974.63

Interest income           -0-      -0-      42,072.68

Less: First mortgage

   payments  2        546,101.64   273,050.82  2,298,177.74

Additional interest

 payments  3           5,111.18    7,487.36    12,598.54

Taxes               59,926.95   30,981.10   233,140.45

Insurance             26,337.55   13,652.53   102,089.36

Audit fees             4,876.62    2,438.31    20,522.44

Maintenance and repairs  4    23,348.69   12,058.57    88,374.84

Property administration fee    30,600.00*327   15,300.00   128,775.00

Net cash-flow from operations  -339,813.95  -168,492.94 -1,410,631.04

TAXABLE INCOME (LOSS) ANALYSIS

Net cash-flow from operations  -339,813.95  -168,492.94 -1,410,631.04

Plus: Mortgage amortization     -0-      -0-      -0-

Other income recognized  5     -0-      -0-      -0-

Less: Depreciation        173,118.72   86,559.36   728,541.28

Amortization of mortgage

 loan fee             16,671.30    8,335.65    70,158.38

Accrued mortgage interest       -0-      -0-      -0-

Net taxable income        -529,603.97  -263,387.95 -2,209,330.71

*328                * * * * *

APPENDIX B

EPIC ASSOCIATES 84-III

            Schedule D -- Pro Forma

      Cash-Flow and Taxable Income (Loss) Analysis

       October 1, 1983 Through December 31, 1987

Application of Funds          1983     1984      1985

____________________          ____     ____      ____

Annual cash-flow

Gross rental income from

 individuals            $ 83,640   $ 294,341   $ 315,619

Less: Rental commissions        5,305     27,885     25,250

  Vacancy               -0-     69,169     37,874

Net rental income from

 individuals  ¹           78,335    197,287    252,495

                  _______    _______    ________

Interest income on partnership

 funds

  Lent to EPIC            5,937     6,888     -0-

Less: First*329 mortgage payments  ²   128,155    504,374    502,217

Interest expenses on funds lent by

  EPIC to the partnership  ³     -0-      2,325     24,056

Taxes                 20,003     73,836     79,274

Insurance                3,620     10,705     9,299

Home owner association dues        333     2,069     4,359

Audit fees               1,250     4,986     4,946

Maintenance and repairs  ⁴      10,225     49,170     21,597

Miscellaneous              5,444      -0-      -0-

Property administration fee       8,250     33,000     33,000

Net cash-flow from operations    -103,384    -476,291    -426,253

Taxable income (loss) analysis

Net cash-flow from operations    -103,384    -476,291    -426,253

Less: Depreciation           42,686    170,741    170,742

Amortization of mortgage loan fee    3,453     13,814     13,814

Net taxable income     *330      -149,524    -660,846    -610,809

             [Table continued]

Application of Funds          1986      1987     Total

____________________          ____      ____     _____

Annual cash-flow

Gross rental income from

 individuals            $ 338,435   $ 362,901  $ 1,394,936

Less: Rental commissions        27,075     29,032    114,547

  Vacancy              40,612     43,548    191,203

Net rental income from

 individuals  1           270,748    290,321   1,089,186

Interest income on partnership

 funds

  Lent to EPIC            -0-      -0-      12,824

Less: First mortgage payments  2   502,217    502,217   2,139,182

Interest expenses on funds lent by

  EPIC to the partnership  3    53,197     80,733    160,312

Taxes                 85,004     91,149    349,266

Insurance                9,972    *331 10,693     44,289

Home owner association dues       4,674     5,012     16,446

Audit fees               4,946     4,946     21,074

Maintenance and repairs  4      23,158     24,832    139,359

Miscellaneous              -0-      -0-      5,444

Property administration fee      33,000     33,000    140,250

Net cash-flow from operations    -445,421    -462,262   -1,913,611

Taxable income (loss) analysis

Net cash-flow from operations    -445,421    462,262   -1,913,611

Less: Depreciation          170,742    170,742    725,653

Amortization of mortgage loan fee   13,814     13,814     58,709

Net taxable income          -629,976    -646,818   -2,697,972

*332