Petitioner contends that if either David or Billie Jean had died during the 1986-90 period, the estate would have been required to include the value of the House, because David and Billie Jean retained "the possession or enjoyment" of the House after the 1986 transaction. 1996 Tax Ct. Memo LEXIS 269">*274 Petitioner further contends that if David and Billie Jean did not effectively transfer the House to James and Hilda in 1986, James and Hilda could not have transferred the House back to David and Billie Jean in 1990, because "one cannot make a gift of something that one does not own."

Based on the foregoing analysis, petitioner concludes that Hilda was not liable for any gift tax as a result of the September 24, 1990, transfer of legal title to the House from James and Hilda to David and Billie Jean. For the reasons discussed below, we reject petitioner's attempt to recharacterize the 1986 and 1990 transactions.

In Commissioner v. Danielson, 378 F.2d 771">378 F.2d 771 (3d Cir. 1967), vacating en banc 44 T.C. 549">44 T.C. 549 (1965), the U.S. Court of Appeals for the Third Circuit imposed a limitation on a taxpayer's ability to prevail when using a "substance over form" argument. The taxpayers in Danielson entered into covenants not to compete as part of a stock sale transaction. The purchase agreement allocated part of the consideration to the covenants. The taxpayers reported on their Federal income tax returns that all the proceeds from the transaction1996 Tax Ct. Memo LEXIS 269">*275 were from the sale of capital assets. The taxpayers defended their position by contending that the allocation set forth in the agreement had no economic foundation. In rejecting the taxpayer's position, the court adopted the following rule: "a party can challenge the tax consequences of his agreement as construed by the Commissioner only by adducing proof which in an action between the parties to the agreement would be admissible to alter that construction or to show its unenforceability because of mistake, undue influence, fraud, duress, etc." 378 F.2d 771">Id. at 775 (the Danielson Rule). In reaching its conclusion, the court cited several factors, including "whipsaw" problems the Government would encounter if taxpayers could unilaterally disavow the form of their transactions for Federal tax purposes. The U.S. Court of Appeals for the Sixth Circuit, the circuit to which this case is appealable, has generally adopted the Danielson Rule. See Schatten v. United States, 746 F.2d 319">746 F.2d 319 (6th Cir. 1984).

Not all circuits have adopted the Danielson Rule in cases where taxpayers from the outset have taken tax reporting positions consistent with their view of the 1996 Tax Ct. Memo LEXIS 269">*276 substance of the transaction. But it is generally accepted that taxpayers may not execute a transaction in one form, file returns consistent with that form, and then argue for an alternative tax treatment after their returns are audited. See, e.g., Little v. Commissioner, T.C. Memo. 1993-281 (concluding that taxpayers "are entitled to attack the form of their transaction only when their tax reporting and other actions have shown an honest and consistent respect for what they argue is the substance of the transaction.")

In Estate of Durkin v. Commissioner, 99 T.C. 561">99 T.C. 561 (1992), supplementing T.C. Memo. 1992-325, we considered and rejected an attempt by a taxpayer to disavow the form of, and previous tax reporting relating to, a transaction. The taxpayer in that case engaged in two simultaneous transactions with an unrelated individual involving (1) the taxpayer's purchase of property and (2) the taxpayer's sale of stock. The parties allocated the consideration exchanged in the two transactions in a manner that minimized tax liability. The allocations, however, did not reflect economic reality. 1996 Tax Ct. Memo LEXIS 269">*277 On audit, the Commissioner determined that the taxpayer had purchased the property at a bargain price and that the bargain element should be treated as a constructive dividend. Implicitly acknowledging the validity of the Commissioner's position, the taxpayer sought to recharacterize the purchase as a stock redemption, which would have had the effect of converting ordinary income to capital gain.

The Court cited three reasons for rejecting the taxpayer's argument: (1) The taxpayer sought to disavow its own tax return treatment of the transaction; (2) the taxpayer's tax reporting and actions did not show "an honest and consistent respect for the substance of * * * [the] transaction"; and (3) the taxpayer was unilaterally attempting to have the transaction treated differently after it had been challenged by the Commissioner. Id. at 574-575 (quoting Estate of Weinert v. Commissioner, 294 F.2d 750">294 F.2d 750, 294 F.2d 750">755 (5th Cir. 1961), revg. and remanding 31 T.C. 918">31 T.C. 918 (1959)).

The circumstances in the present case are similar to those in 99 T.C. 561">Estate of Durkin v. Commissioner, supra. First, petitioner seeks to disavow1996 Tax Ct. Memo LEXIS 269">*278 its own tax return treatment of the transaction. From 1986-90, James and Hilda deducted on their joint Federal income tax returns the real property taxes relating to the House. Moreover, Hilda did not file a gift tax return for 1986. Yet petitioner now contends that James and Hilda gave David and Billie Jean $ 72,000 in exchange for no consideration. In addition, Hilda reported the 1990 transfer of the House to David and Billie Jean as a $ 130,000 gift for Federal tax purposes.

Second, Hilda's tax reporting and actions did not show an honest and consistent respect for what petitioner now contends was the substance of the transaction. The inconsistent tax reporting is described above. In addition, Hilda recorded the 1986 transaction as a transfer of the House for $ 72,000 and recorded the 1990 transaction as a transfer of the House for no consideration. Both of these actions are consistent with the making of a gift in 1990 and inconsistent with the making of a gift in 1986.

Third, petitioner did not attempt to challenge the tax treatment of the 1986 and 1990 transactions until respondent discovered that petitioner had failed to include previously reported gifts on the estate tax 1996 Tax Ct. Memo LEXIS 269">*279 return.

Because Hilda treated the 1986 transaction as a sale and the 1990 transaction as a gift for both Federal tax and State law purposes prior to respondent's audit, we hold that petitioner may not now challenge Hilda's characterization of the 1986 and 1990 transactions.

To reflect the foregoing,

Decisions will be entered for respondent.