49 T.C. 180">*180 In these consolidated cases the respondent determined income tax deficiencies against petitioners, as follows:

Some issues have been settled by the parties and will be given effect in the Rule 50 computations. Four issues remain for decision. They are:

49 T.C. 180">*181 (1) Whether the equal distributive shares of partnership income reported by Glenn A. Woodbury and his son, Leo A. Woodbury, during the years 1958, 1959, and 1960, should be reallocated on the basis of differing capital contributions and services performed for the partnership.

(2) Whether income from the sale of certain livestock to William A. (Bill) Wilson by the partnership was constructively received in the year 1967 U.S. Tax Ct. LEXIS 11">*14 1958.

(3) Whether, in a multiparty transaction in 1960, the partnership made a nontaxable exchange of 225 cows and 425 mixed yearlings located on their Nevada ranch for a like number of cattle on their newly acquired ranch in Montana.

(4) Whether the petitioners were negligent in filing their Federal income tax returns for the years 1958, 1959, and 1960, thereby making them liable for the additions to tax under section 6653(a), I.R.C. 1954. ²

FINDINGS OF FACT

Some of the facts have been stipulated by the parties. The stipulations of facts and the exhibits attached thereto are incorporated herein by this reference.

Leo A. Woodbury (hereinafter called Leo) and Anita L. Woodbury are husband and wife whose legal residence was Geyser, Mont., at the time they filed their petitions in these proceedings. Leo was a legal resident of Stevensville, Mont., and Wells, Nev., during the year 1958 and filed his individual Federal1967 U.S. Tax Ct. LEXIS 11">*15 income tax return for that year with the district director of internal revenue at Helena, Mont. He was a legal resident of Wells, Nev., during the year 1959 and filed his individual Federal income tax return for that year with the district director of internal revenue at Reno, Nev. Leo and Anita L. Woodbury were legal residents of Wells, Nev., and Geyser, Mont., during the year 1960 and filed their joint Federal income tax return for that year with the district director of internal revenue at Helena, Mont.

Glenn A. Woodbury (hereinafter called Glenn) and Pearl Woodbury are husband and wife whose legal residences were Stevensville, Mont., and Wells, Nev., during the year 1958. They filed their joint Federal income tax return for that year with the district director of internal revenue at Helena, Mont. They were legal residents of Wells, Nev., in 1959 and filed their joint return for that year with the district director of internal revenue at Reno, Nev. They were legal residents of Wells, Nev., and Geyser, Mont., during the year 1960 and filed their joint return for that year with the district director of internal revenue 49 T.C. 180">*182 at Helena, Mont. Their legal residence was Geyser, 1967 U.S. Tax Ct. LEXIS 11">*16 Mont., at the time they filed their petition herein.

Since 1944 Glenn has been in the cattle ranching business. In November 1951, he purchased the 6,100-acre Porche Ranch at Stevensville, Mont., for $ 90,000, of which $ 9,815 was allocated to machinery and the remainder to the land and buildings. On January 1, 1957, the balance due on this purchase was $ 37,500. In 1952 Glenn purchased the 140-acre Jannsen Ranch, adjoining the Porche Ranch, for $ 28,000. The balance due on the Jannsen purchase on January 1, 1957, was $ 15,236. Glenn also owned 265 cows, 11 bulls, 1 steer, and 145 yearlings immediately prior to January 1, 1957.

Leo is the son of Glenn and Pearl Woodbury. He was born on January 2, 1938. Leo left college in the fall of 1956 and was married later that year. He has engaged in various ranching activities since he was 6 years of age, and he owned 17 cows, 6 yearlings, and 1 bull just prior to January 1, 1957.

Effective January 1, 1957, Glenn and Leo formed a "family partnership" which engaged in ranching activities during the years in issue. However, they had no written partnership agreement and no title to property 1967 U.S. Tax Ct. LEXIS 11">*17 was transferred from Glenn's name to Leo's name either prior to or during the years 1958, 1959, and 1960. Partnership assets consisted of capital contributions made by Glenn and Leo on that date.

Partnership assets and liabilities which belonged to Glenn prior to January 1, 1957, had the following values as of that date:

1967 U.S. Tax Ct. LEXIS 11">*18 49 T.C. 180">*183 Partnership assets which belonged to Leo prior to January 1, 1957, had the following values as of that date:

Neither Glenn nor Leo made any capital contributions to the partnership after January 1, 1957.

Although Leo was a minor in 1957, he had extensive ranching experience and Glenn considered him to be a full-fledged, capable rancher.

Both Glenn and Leo intended to enter into the partnership on an equal basis and to continue ranching together as partners. Pursuant thereto, each donated such time as was necessary to carry out the ranching operation; each participated in the various aspects of ranching; each drew on the partnership joint account those sums necessary for his personal expenses; and each had an equal say in partnership activities. Glenn discussed the legal ramifications of an equal partnership with an attorney at the time the partnership's 1957 tax return was prepared. Both the partnership and individual Federal income1967 U.S. Tax Ct. LEXIS 11">*19 tax returns of Glenn and Leo, as well as the partnership return for 1957, indicated an equal division of partnership profits and losses between the partners in each of the years 1957 through 1960.

Glenn kept the partnership records. No formal records were kept for the years 1957 through 1960 to show the respective capital accounts, drawing of funds, or distributive shares of the partners. The partnership return for each year was filed in the name of Glenn A. and Leo A. Woodbury and was prepared by either an attorney or a certified public accountant.

Title to each of the ranches which the partnership owned during the years in controversy was only in the names of Glenn and Pearl 49 T.C. 180">*184 Woodbury. In a financial statement submitted to the Farmers State Bank, Victor, Mont., on December 17, 1957, Glenn stated that he and Pearl were sole owners of the assets listed therein. Similar financial statements were filed with the First National Bank in Reno, Nev., on March 2, 1959, and January 6, 1960. Those assets which were so listed included the ranches owned by Glenn that became partnership assets on January 1, 1957. However, the officers of the Farmers State Bank knew that Glenn and1967 U.S. Tax Ct. LEXIS 11">*20 Leo were partners. In addition, the purchase or sale of a ranch or major equipment by the partnership during the years in question was a joint determination contingent upon Leo's inspection and approval.

Glenn intended that Leo would have a one-half interest in all of the partnership assets, effective January 1, 1957, when the partnership was created. Glenn's attorney advised against a formal transfer of property to Leo because he was then a minor. The attorney subsequently determined, based on one-half of their equity in the Stevensville Ranch, that Glenn and Pearl owed no gift tax on the "transfer" to Leo in 1957.

Leo joined the Rodeo Cowboys of America (RCA) in 1957. He participated in approximately 10 rodeos in 1957, 15 rodeos in 1958, 20 rodeos in 1959, and 25 rodeos in 1960. During June and July 1959, Leo was able to leave the Nevada ranch for 45 to 60 days to ride in rodeos because the cattle were on the summer range and required little care.

Respondent determined that the value of Glenn's services to the partnership was $ 5,000 in both 1958 and 1959 and $ 6,000 in 1960. He determined that the value of Leo's services to the partnership was $ 3,000 in both 1958 and 19591967 U.S. Tax Ct. LEXIS 11">*21 and $ 4,000 in 1960.

On the Stevensville Ranch the partnership paid a "hired hand" a salary of $ 200 per month plus bunkhouse and board. A married employee was furnished a house, electricity, and fuel in addition to a $ 200 per month salary. The partnership employed one man there during the winter, two during the summer, and four or five during the haying season. At the Nevada ranch the partnership employed only one full-time hand.

The value of the services by Glenn and Leo to the partnership was $ 5,000 each in 1958 and 1959 and $ 6,000 each in 1960.

Under an agreement to sell, the partnership delivered 339 head of mixed yearlings to William A. (Bill) Wilson (hereinafter called Wilson) in early November 1958. Wilson was given clear title to the cattle at that time, shipped them from Wells, Nev., to Butte, Mont., and sold them at auction shortly prior to November 7, 1958.

49 T.C. 180">*185 Glenn wanted to postpone receipt of the sales proceeds until after January 1, 1959, in order to avoid two sales of cattle during 1958. Advice was sought from an official of the Farmers State Bank in Victor, Mont., and from a1967 U.S. Tax Ct. LEXIS 11">*22 certified public accountant as to how he could achieve this purpose. However, it was never discussed with Wilson, and he was unaware of any arrangements made between Glenn and the bank. Wilson was only told to deposit the funds with the bank.

The sale price for these cattle was $ 50,266.21. To pay for them, Wilson drew a draft in that amount on November 7, 1958, payable to the Farmers State Bank where Glenn had a regular bank account. This draft cleared Wilson's account at the drawee bank as of November 10, 1958. The Farmers State Bank issued a certificate of deposit in the amount of $ 50,266.21 on November 7, 1958, payable to Glenn on January 1, 1959. On January 2, 1959, the bank credited the partnership account with the amount of the certificate of deposit, and Glenn subsequently purchased a cashier's check with the proceeds. The bank paid neither Glenn nor Wilson any interest on the $ 50,266.21 certificate of deposit for the period from November 7, 1958, to January 2, 1959.

Glenn, Leo, and the partnership all reported income for the year 1958 on the cash receipts and disbursements method of accounting.

On or about May 23, 1958, 1967 U.S. Tax Ct. LEXIS 11">*23 Glenn and Pearl purchased the Ruby Valley Ranch in Wells, Nev., including cattle and equipment, for a total price of $ 280,000. They executed a deed of trust and a chattel mortgage in the amount of $ 205,000 in favor of the First National Bank of Nevada, Elko, Nev.

After residing on and operating the Ruby Valley Ranch for about a year, the petitioners became dissatisfied with its location and decided to sell it. They listed the ranch for sale with C. W. Moore in the fall of 1959, agreeing to sell it as an operating business, including land, cattle, and machinery. The only exception to this "walkoff deal" was the decision of petitioners not to list the registered cattle or horses.

Blair G. Johns made an offer on October 15, 1959, through C. W. Moore, to pay $ 255,000 for the ranch, machinery, household furniture, horses, and some hay. He also offered to buy all of the cattle at market price. Petitioners rejected the offer, as well as subsequent ones, made by Johns.

In February or early March 1960, while negotiating to sell the Ruby Valley Ranch, petitioners looked at a ranch near Geyser, Mont. (hereinafter called the Spencer Ranch) owned by Frank R. Spencer Ranch, Inc. At that1967 U.S. Tax Ct. LEXIS 11">*24 time there was no serious discussion pertaining to the purchase of personal property, either separately from or in addition to the real property. However, the cattle and machinery were not then listed for sale by Spencer. After petitioners inspected the ranch, telephone 49 T.C. 180">*186 conversations between Glenn and Frank Spencer (hereinafter called Spencer), president of Frank R. Spencer Ranch, Inc., indicated a lack of progress with regard to sale by petitioners of their Ruby Valley Ranch.

Joel McCrea (hereinafter called McCrea) made an offer for the Ruby Valley Ranch in the later part of March 1960. It was in the form of escrow instructions signed by McCrea and sent to both Moore and the Title Insurance & Trust Co. of Los Angeles, Calif. (hereinafter called Title Company). The offered price in the escrow instructions was $ 500,000 for the ranch, cattle, and machinery. McCrea deposited $ 5,000 in conjunction with the escrow instructions. Petitioner's attorney, George F. Wright (hereinafter called Wright), after a discussion with Glenn, sent McCrea's attorney a letter dated March 26, 1960, which contained, in part, a copy of the escrow instructions dated March 22, 1960, and signed1967 U.S. Tax Ct. LEXIS 11">*25 by Glenn and Pearl. The letter requested, however, that the escrow instructions be held until March 30, 1960, because Leo should have been included as a seller and changes to this effect were necessary. The letter also indicated the possibility that Frank R. Spencer Ranch, Inc., might well be the seller of the Ruby Valley Ranch because Glenn wanted to exchange the Ruby Valley Ranch for the Spencer Ranch.

On March 30, 1960, Glenn met with Spencer and his attorney. The parties initially discussed trading ranches and livestock. But the trading of ranches did not materialize because Spencer did not want to own a ranch in Nevada. The parties then reached an agreement whereby the petitioners would purchase the Spencer Ranch, machinery, equipment, and silage for $ 525,000, of which $ 5,000 was to be paid as earnest money, $ 95,000 on execution of the contract for deed, and the remaining balance of $ 425,000 at an agreed rate over a period of 15 years. The parties also agreed that the petitioners would exchange 225 cows with suckling calves and 425 mixed yearlings on the Ruby Valley Ranch for a like number of such cattle on the Spencer Ranch. Spencer's attorney reduced this agreement1967 U.S. Tax Ct. LEXIS 11">*26 to writing the following day and, after certain modifications, it was signed by the petitioners not later than April 4, 1960.

All parties assumed that the Nevada cattle acquired by Spencer under the exchange agreement would be sold to McCrea. In sending the exchange agreement to petitioners for their signature, Spencer's attorney stated in an accompanying letter that:

We understand the agreement with reference to the exchange of cattle is to be executed by the parties only in the event that the Nevada cattle can be sold to McCrea on the basis of $ 225.00 per head for the cows and $ 125.00 per head for the mixed yearlings. It would seem to me that the parties should first execute the contract for deed, then make the exchange of cattle, and following that the sale by Spencer to McCrea of the number of cattle received by the Spencer Ranch Corporation in the exchange.

49 T.C. 180">*187 Wright prepared and petitioners signed amended escrow instructions dated April 1, 1960, to reflect Leo's interest in the property to be sold and also to incorporate the cattle exchange in the escrow instructions. These amended instructions were sent to Spencer's attorney to be executed by Frank R. Spencer Ranch, 1967 U.S. Tax Ct. LEXIS 11">*27 Inc. After execution by Spencer, they were forwarded to McCrea for his signature in a letter dated April 6, 1960, along with a request that McCrea then send them to Title Company.

In a letter dated April 5, 1960, Wright notified Title Company of the pending cattle exchange and of the amended escrow instructions pertaining thereto. This letter also included a bill of sale for the Ruby Valley Ranch, which was to be delivered to McCrea upon the close of the escrow, and a bill of sale for the cattle to be exchanged for Spencer Ranch cattle, which was to be delivered to Frank R. Spencer Ranch, Inc., upon the close of the escrow. In a letter dated April 6, 1960, the bill of sale from Frank R. Spencer Ranch, Inc., for the Ruby Valley Ranch cattle to be acquired through an exchange with petitioners was deposited in escrow with Title Company to be delivered to McCrea upon receipt of $ 103,750. A copy of this bill of sale was also sent to Wright, the petitioner's attorney.

By this time McCrea, the potential buyer of the Ruby Valley Ranch, had raised objections to certain outstanding mineral leases on the property as clouds on the title. These were not acceptable under the March 22, 1960, 1967 U.S. Tax Ct. LEXIS 11">*28 escrow instructions. It thus appeared that McCrea would not sign the amended escrow agreement of April 1, 1960, and that he would refuse to complete the purchase of the ranch. In a letter dated April 18, 1960, which included an executed copy of the escrow instructions dated March 22, 1960, Wright told Title Company to advise McCrea that the escrow was completed and that he should pay the balance of the downpayment so the sale could be completed. Wright also said that the petitioners and McCrea orally agreed that part of the cattle would come from petitioners and part from Frank R. Spencer Ranch, Inc.; and that since the exchange was escrowed, it "need not go through if the buyer wishes that procedure."

McCrea made no deposit on the purchase price by April 22, 1960, the final date for closing under the March 22 escrow instructions. However, petitioners elected to pursue the escrow on the theory that it was a completed contract and that the failure to deposit the price was a default which could be waived. Therefore, by a telegram to McCrea dated April 28, petitioners demanded immediate deposit of $ 278,000, which represented the balance of the downpayment on the contract, or in1967 U.S. Tax Ct. LEXIS 11">*29 lieu thereof the deposit of an additional $ 45,000 by April 29, with instructions that if the balance of the downpayment was not deposited in escrow before May 8, 1960 (later extended to May 9), the deposit would be paid to Glenn and Pearl as liquidated damages and the escrow 49 T.C. 180">*188 cancelled. McCrea deposited the additional $ 45,000 on April 29 and authorized Title Company to treat Bill Elliott (hereinafter called Elliott) as the purchaser under the escrow instructions dated March 22, 1960. On the same date petitioner accepted Elliott as McCrea's nominee, subject to approval of Elliott's credit standing. The ultimate acceptance by petitioners of Elliott as the substitute purchaser was confirmed by their signing of substitute escrow instructions dated May 3, 1960, and the mailing of these instructions to Title Company.

The amended escrow instructions dated May 3, 1960, stated that 225 cows with suckling calves and 425 mixed yearlings on the Ruby Valley Ranch were represented by a bill of sale from Frank R. Spencer Ranch, Inc., and authorized disbursement of $ 103,750 to Frank R. Spencer Ranch, Inc., upon closing. Spencer Ranch, on learning of the assignment to Elliott of McCrea's1967 U.S. Tax Ct. LEXIS 11">*30 interest, had substituted a bill of sale on the Ruby Valley Ranch cattle in favor of Elliott for the one in favor of McCrea upon the condition that the bill of sale from petitioners to the Spencer Ranch for these cattle was still on deposit with Title Company for delivery at closing.

By letter dated April 7, 1960, Frank R. Spencer Ranch, Inc., executed a more detailed contract for sale of the Spencer Ranch and forwarded it to the First National Bank of Nevada for Glenn's signature. Glenn was to deposit a $ 95,000 downpayment with the bank by April 17 to complete the contract. The time within which to deposit the downpayment was later extended to April 22, then to April 30, to May 10, and finally to May 12, 1960.

By telegram sent May 6, petitioners authorized a further delay in Elliott's payment of the $ 233,000 balance of the downpayment if $ 95,000 of that deposit was delivered to Glenn's credit at Elko, Nev., before 5 p.m. on Monday, May 9. Elliott authorized payment of $ 95,000 in escrow instructions dated May 6. Petitioners paid their $ 95,000 downpayment on the Spencer Ranch at the First National Bank of Nevada in Elko on May 9, and it was then forwarded to Spencer's attorney1967 U.S. Tax Ct. LEXIS 11">*31 along with the signed contract for the purchase of the Spencer Ranch property.

On May 9, 1960, the escrow for sale of the Ruby Valley Ranch, cattle, and equipment was finally closed. The proceeds of the sale, less certain specified adjustments including the $ 103,750 to be paid to Frank R. Spencer Ranch, Inc., were paid to petitioners. On May 10, Title Company paid $ 103,750 to Frank R. Spencer Ranch, Inc., out of the escrow funds deposited by Elliott.

A short time thereafter, Glenn and Leo, on their newly purchased ranch, selected those Spencer Ranch cattle owed to them in exchange for their Ruby Valley Ranch cattle. Although the Spencer Ranch had sufficient cattle on hand to fulfill the exchange agreement at the time it was negotiated, Spencer was short 78 cows at the time of delivery. 49 T.C. 180">*189 Glenn advised Spencer that he knew where cows, suitable to complete the exchange, were available. Glenn then went to Arlo Ellison, selected 78 cows at a price of $ 225 a head, and paid for them with a check given to him by Frank Spencer. At the same time the petitioners purchased for themselves 90 cows for $ 21,000 and 12 bulls for $ 3,600.

At the same time that petitioners sorted 1967 U.S. Tax Ct. LEXIS 11">*32 from the Spencer Ranch stock the animals to be exchanged, they also sorted other animals which they purchased from Ellison within the next few days. This purchase was comprised of 30 cows at $ 210 a head, 11 cows at $ 200 a head, 7 bulls at $ 300 a head, 93 yearlings at $ 125 a head, and 41 other cows.

Of the yearlings acquired by petitioners in the exchange with Frank R. Spencer Ranch, Inc., the partnership used a minimum of 103 heifers for breeding stock. Others were either sold to Spencer or fed by Spencer and then sold to a packing company.

On March 23, 1960, C. W. Moore, the realtor, and petitioners entered into an agreement whereby Moore agreed to accept a 7-percent commission for his services in connection with the sale or exchange of "my ranch and cattle." Petitioners paid Moore a real estate commission of $ 35,000 based on this agreement.

The petitioners kept records which consisted of calendars indicating ranch income, cattle slips, and checks to reflect partnership income for the years 1958 and 1959. A certified public accountant maintained the partnership records on the double-entry system during the year 1960. Both the partnership1967 U.S. Tax Ct. LEXIS 11">*33 and individual returns for the years 1958 and 1959 were prepared by an attorney in Stevensville, Mont., from the partnership records and Glenn's itemization of them. The 1960 partnership return was prepared by a certified public accountant.

On the original partnership return for the year 1958, Schedule D reflected several sales of cattle as section 1231 assets. During an audit examination conducted by a revenue agent, Glenn submitted a new Schedule D which indicated, in addition to the sales of section 1231 cattle, the following sales of cattle as section 1221 assets held for less than 6 months:

The revenue agent requested that Glenn substantiate the cost basis of $ 19,200 for the sale of the 96 head of cattle listed on the newly submitted Schedule D. In response Glenn submitted a sworn affidavit of Arlo Ellison that Ellison had purchased 96 head of cattle located on petitioners' Nevada ranch. However, Ellison actually received 96 head 49 T.C. 180">*190 of cattle, branded O. W., which had been raised on the Stevensville1967 U.S. Tax Ct. LEXIS 11">*34 ranch of petitioners. Nevada ranch cattle which Ellison might have purchased had a basis of $ 200 per head. The Montana cattle which Ellison might have purchased had a zero basis. Before entering into this sale of cattle to Ellison the petitioners received legal advice from their attorney concerning the transaction.

OPINION

Petitioners assert that they intended to create a partnership in which Glenn and Leo would be equal partners; that Glenn gave Leo a one-half interest in the partnership assets and liabilities in accordance with this intent; and that the partnership was actually operated with Glenn and Leo as equal partners. While the respondent agrees that Glenn and Leo formed a family partnership, he contends that the equal distribution of partnership gains and losses by the partners is inconsistent with the applicable statute and regulations. Section 704(e) ⁴ and the regulations thereunder provide that where a disproportionate allocation of partnership income exists, the Commissioner is to allow a reasonable amount for the services rendered by each partner and divide the balance between the partners in accordance with 1967 U.S. Tax Ct. LEXIS 11">*35 their capital interests. After allowing a sum for the partners' services in each of the years in question, respondent contends that Glenn had a 97.2-percent taxable distributive share of the partnership income while Leo had a 2.8-percent taxable distributive share.

1967 U.S. Tax Ct. LEXIS 11">*36 Respondent concedes that the petitioners formed a valid partnership on January 1, 1957, and that Leo contributed 2.8 percent of the partnership capital in the form of livestock which he had owned prior to that date. Therefore, it is clear that Leo was a partner as of that date within the meaning of section 704(e)(1) without regard to Glenn's alleged gift to him of a substantial portion of the partnership assets.

49 T.C. 180">*191 Section 1.704-1(e)(1)(iv), Income Tax Regs., ⁵ sets forth guidelines as to whether capital is a material income-producing factor in a partnership. The Woodbury partnership was in the ranching and farming business, and the capital contributions to it consisted of ranch land, farm machinery, and cattle. Without belittling the valuable services contributed by Glenn and Leo to the partnership, the quality of the land, the efficiency of the machinery, and the development of the cattle were critical to its success. Thus we think the capital contributed to this partnership was "a material income-producing factor" within the intendment of section 704(e)(1). It therefore becomes necessary to determine whether Leo received a bona fide gift of certain partnership assets1967 U.S. Tax Ct. LEXIS 11">*37 and liabilities in order to ascertain, under section 704(e)(2), whether his alleged distributive share of income under the partnership agreement was "proportionately greater than the share of the donor [Glenn] attributable to the donor's capital."

1967 U.S. Tax Ct. LEXIS 11">*38 Section 1.704-1(e)(2), Income Tax Regs., ⁶ sets out guidelines for determining whether a donee of a capital interest in a partnership is the real owner of that interest. The regulation provides that the execution of legally sufficient deeds of gift under State law is a factor to be taken into account but is not determinative of ownership for purposes of section 704(e). The regulation then enumerates several other factors to be considered. We view this to mean that while proof of compliance with State gift law requirements is not determinative as to the validity of the gift for the purposes of section 704(e), such test must be met before this Court can consider other facts and circumstances.

1967 U.S. Tax Ct. LEXIS 11">*39 Section 340(b) of the Revenue Act of 1951 amended the 1939 Code by adding thereto section 191 [sec. 704(e)(2) and (3) of the 1954 Code]. The reports of the House Committee on Ways and Means (H. Rept. No. 586, 82d Cong., 1st Sess. (1951), 1951-2 C.B. 357, 380-381), and of the Senate Finance Committee (S. Rept. No. 781, 82d Cong., 1st Sess. (1951), 1951-2 C.B. 458, 485-487) state that the intention of Congress is --

to harmonize the rules governing interests in the so-called family partnership with those generally applicable to other forms of property or business. * * * Your 49 T.C. 180">*192 committee's amendment makes it clear that, however the owner of a partnership interest may have acquired such interest, the income is taxable to the owner, if he is the real owner. If the ownership is real, it does not matter what motivated the transfer to him or whether the business benefited from the entrance of the new partner.

The Committee reports further provide:

The amendment leaves the Commissioner and the courts free to inquire in any case whether the donee or purchaser actually owns the interest in the partnership which the transferor1967 U.S. Tax Ct. LEXIS 11">*40 purports to have given or sold him. Cases will arise where the gift or sale is a mere sham. Other cases will arise where the transferor retains so many of the incidents of ownership that he will continue to be recognized 49 T.C. 180">*193 as a substantial owner of the interest which he purports to have given away, as was held by the Supreme Court in an analogous trust situation involved in the case of Helvering v. Clifford (309 U.S. 351">309 U.S. 351). The same standards apply in determining the bona fides of alleged family partnerships as in determining the bona fides of other transactions between family members. Transactions between persons in a close family group, whether or not involving partnership interests, afford much opportunity for deception and should be subject to close scrutiny. All the facts and circumstances at the time of the purported gift and during the periods preceding and following it may be taken into consideration in determining the bona fides or lack of bona fides of a purported gift or sale.

In 1952 the Commissioner stated his position concerning taxability of family partnerships for years prior to 1951. ⁷ The Commissioner's mimeograph is1967 U.S. Tax Ct. LEXIS 11">*41 an elaboration of the statutory approach to family partnerships in the Revenue Act of 1951. See Stanback v. Commissioner, 271 F.2d 514 (C.A. 4, 1959). In it the Commissioner says:

(b) Documentation Not Controlling. -- The execution of legally sufficient and irrevocable deeds or other instruments of gift may, under State law, be essential to the validity of an alleged gift but is, of course, of less ultimate significance than the conduct of the parties after the gift has been made. Reality and good faith are not ascertainable by any mechanical or formalistic test.

We believe that these statements reveal an intent, on the part of Congress, that there must be a valid gift for State law purposes before there can be an examination of the surrounding facts and circumstances to determine whether the "purported gift" transferred 49 T.C. 180">*194 real ownership. Indeed, no cases have been brought to our attention in which 1967 U.S. Tax Ct. LEXIS 11">*42 a family gift for partnership purposes was upheld where there was no gift under applicable State law. Cf. Spiesman v. Commissioner, 260 F.2d 940 (C.A. 9, 1958), affirming 28 T.C. 567">28 T.C. 567 (1957). Hence we feel compelled to determine whether there was a gift of the real property and personalty from Glenn to Leo on the date the partnership was formed.

Neither on January 1, 1957, nor at any time during the years here involved, did Glenn transfer title to any ranch land to Leo. Deeds to the various ranch land purportedly held by the partnership were always in the names of Glenn and Pearl. Yet applicable Montana law provides that: "An estate in real property * * * can be transferred only by operation of law, or by an instrument in writing subscribed by the party disposing of the same." ⁸ Here there was no transfer by operation of law, such as a constructive trust. Cf. Opp. v. Boggs, 121 Mont. 131">121 Mont. 131, 193 P.2d 379 (1948). And the petitioners have offered no evidence of a gift of one-half of the real property beyond a declaration of their intent to make such a gift and an alleged1967 U.S. Tax Ct. LEXIS 11">*43 oral agreement to that effect. This is insufficient proof to justify our finding that there was a gift of one-half of the Jannsen or Porche ranch land from Glenn to Leo on January 1, 1957, or at any subsequent time during the years in question.

Turning to the alleged gift of cattle and farm machinery from Glenn to Leo, we find that the relevant Montana statutes provide:

A gift is a transfer of personal property made voluntarily, and without consideration. [Mont. Rev. Codes Ann. sec. 67-1706.]

A verbal gift is not valid unless the means of obtaining possession and control of the thing are given, nor, if it is capable of delivery, unless there is an actual or symbolical delivery of the thing to the donee. [Mont. Rev. Codes Ann. sec. 67-1707.]

In view of these statutory provisions, we hold that under Montana law Glenn made a valid gift to Leo of one-half the partnership cattle and farm machinery on the date the partnership was created. By participating in the partnership management, 1967 U.S. Tax Ct. LEXIS 11">*44 Leo obtained both possession and control of the personal property, such possession being the result of actual delivery. Cf. Marans v. Newland, 141 Mont. 32">141 Mont. 32, 374 P.2d 721 (1962); and In Re Brown's Estate, 122 Mont. 451">122 Mont. 451, 206 P.2d 816 (1949).

There still remains, however, the question of whether Leo meets the ownership requirements of section 704(e) and the regulations. ⁹ Applying the criteria contained in the regulations, it is clear that 49 T.C. 180">*195 Leo received a valid gift of one-half the partnership personalty and related liabilities. Glenn purported to make a gift of one-half the partnership cattle and machinery. Leo and Glenn exercised equal control over these assets in terms of distribution of income, liquidation of partnership assets, and management powers. They participated equally in the management of the partnership. Leo received actual distribution, for his sole benefit and use, of at least his distributive share of the partnership income. Likewise, with relatively few inconsistencies, Leo was held out to the public as an equal partner. Nor is section 1.704-1(e)(2)(viii), 1967 U.S. Tax Ct. LEXIS 11">*45 Income Tax Regs., ¹⁰ pertaining to the partnership interest of minor children relevant since the evidence shows that Leo was competent to manage his own property and participated in partnership activites in accordance with his interest in the property.

1967 U.S. Tax Ct. LEXIS 11">*46 Respondent determined that Glenn's services to the partnership were worth $ 5,000 in the years 1958 and 1959 and $ 6,000 for 1960, whereas Leo's services were worth $ 3,000 for the years 1958 and 1959 and $ 4,000 for 1960. As indicated by our findings of fact, we think the services of each partner should be valued at $ 5,000 for the years 1958 and 1959 and at $ 6,000 for the year 1960 for purposes of the section 704(e)(2) computation of income. This reflects our belief that Leo made a contribution equal to Glenn's in terms of services rendered to the partnership.

Accordingly, we hold that the distributive shares of partnership income for the years in issue should be reallocated to Glenn and Leo on the basis of their services and capital interests, as follows: First, to services in the amount of $ 5,000 by each partner in both 1958 and 1959, and to services of $ 6,000 by each partner in 1960. Second, as to the remaining partnership income, their capital interests are: The real property and related liabilities as of January 1, 1957, are attributable solely to Glenn; and all other partnership assets and liabilities (cattle and farm machinery) as of January 1, 1957, are attributable1967 U.S. Tax Ct. LEXIS 11">*47 to Glenn and Leo in equal shares. The exact amounts of reallocated income can be determined in the Rule 50 computations.

The regulations relating to the constructive receipt of income provide as follows:

Sec. 1.451-2. Constructive receipt of income.

(a) General Rule. Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions. * * *

Petitioners contend that while the cattle sold by them were delivered to Bill Wilson in 1958, Wilson purchased a certificate of deposit payable to them in 1959, the money was not available until 1959, and the sale was conditioned on the handling of the transaction in such manner. Hence they maintain that the funds from the sale1967 U.S. Tax Ct. LEXIS 11">*48 of the cattle were not constructively received during the year 1958. Taking the contrary view, respondent contends that the sales proceeds were subject to Glenn's unfettered control as of November 1958 and, therefore, they were constructively received at that time.

We agree with the respondent. Wilson took clear title to the cattle in early November 1958 and sold them at auction prior to November 7 of that year. He then made out a check payable to the Farmers State Bank where Glenn had a regular account. In his deposition Wilson said that he placed no restrictions on the check and knew of no arrangement whereby the partnership was not to receive such funds from the bank until 1959. The check cleared Wilson's account with the drawee bank on November 10, 1958.

On these facts it is plain that Glenn had unfettered control of the money as of November 1958. Although the bank issued to Glenn a certificate of deposit which was not payable until January 1, 1959, this method of handling the transaction was without Wilson's knowledge. His understanding of the agreement was simply that he deposit the funds with the Farmers State Bank. As we see it, the arrangement whereby Glenn could 1967 U.S. Tax Ct. LEXIS 11">*49 not reach the funds until 1959 was made at his own behest with the bank serving as his agent. At the critical point in time, namely when Wilson paid the check to the bank, Glenn, through the bank, had complete control over the flow of the funds. See United States v. Pfister, 205 F.2d 538 (C.A. 8, 1953).

Petitioner relies heavily on J. D. Amend, 13 T.C. 178">13 T.C. 178 (1949), and Rev. Rul. 58-162, 1958-1 C.B. 234, for the proposition that where limitations upon the receipt of income are an integral part of the agreement between the parties and the seller does not have an unqualified right to receive payment, the funds are not yet constructively received. Unlike those situations, there was no agreement here, either written 49 T.C. 180">*197 or oral, between Glenn and Wilson placing restrictions on Glenn's receipt of the funds in November 1958. Consequently, we regard those cases as inapposite. We hold that the funds from the sale of the cattle to Wilson were constructively received by the partnership during the year 1958. As such, they must be reported as income for that year and not in 1959.

With respect to this issue, the petitioners argue that the transaction in which they traded their cattle for Spencer Ranch cattle qualifies as an exchange of "like kind" property under the provisions of section 1031. They maintain that the contemporaneous negotiations for the sale of the Ruby Valley Ranch did not transform the nature of the cattle transfer to one of sale instead of exchange, and that the cattle involved in the exchange qualified as section 1031 "property held for productive use in trade or business." Respondent, on the other hand, argues that the multiparty, multistep transaction was a sale and subsequent repurchase of cattle which resulted in taxable gain with respect to the 225 cows and ordinary income with respect to the 425 mixed yearlings. First we must decide whether the cattle petitioners received from the Spencer Ranch were section 1031 property. Section 1031(a) provides that:

No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale * * *) is exchanged solely for property of a like kind to be1967 U.S. Tax Ct. LEXIS 11">*51 held either for productive use in trade or business or for investment.

In order for the exception to section 1031 to apply the only requirement is that the property received in exchange be "held primarily for sale." See Ethel Black, 35 T.C. 90">35 T.C. 90 (1960).

In this particular transaction there is no doubt that the 225 cows with suckling calves which petitioners received from the Spencer Ranch were held for breeding purposes rather than for sale. With respect to the 425 mixed yearlings, the evidence discloses that Frank Spencer purchased yearlings from petitioners in years subsequent to the purported exchange and also sold other yearlings in petitioners' name to a packing company after feeding them for petitioners. Therefore, we have made a finding of fact that only 103 of the mix yearlings which petitioners received from the Spencer Ranch were held for breeding purposes, the remainder being held primarily for sale. As a result, only the 225 cows and 103 of the mixed yearlings qualified as section 1031 property.

The purpose of section 1031(a) is to defer recognition of gain or loss when a taxpayer makes a direct exchange of property with another party. 1967 U.S. Tax Ct. LEXIS 11">*52 The sale of property and simultaneous purchase of similar property does not constitute such an exchange. See Coastal Terminals, 49 T.C. 180">*198 v. United States, 320 F.2d 333 (C.A. 4, 1963); and John M. Rogers, 44 T.C. 126">44 T.C. 126 (1965), affirmed per curiam 377 F.2d 534 (1967). Hence we must next decide whether this transaction was an exchange of petitioners' cattle for the Spencer Ranch cattle or whether petitioners sold their cattle to McCrea and made a subsequent repurchase of cattle from the Spencer Ranch.

McCrea tendered an offer for the Ruby Valley Ranch, including cattle, in March 1960. The escrow instructions dated March 22 which he signed were to that effect. While Glenn signed these escrow instructions, an accompanying letter to the title company requested that they not be delivered until the possibility of an exchange of ranches could be explored. Moreover, McCrea raised objections to outstanding mineral leases on the property. And Leo's name had to be included on the escrow instructions as a seller. From these facts we conclude that the original escrow instructions were merely1967 U.S. Tax Ct. LEXIS 11">*53 an executory agreement, not a binding contract, under which petitioners would sell their cattle to McCrea. Indeed, based on the reservations which the petitioners and McCrea had to the March 22 escrow instructions, we doubt whether any agreement between them was ever reached. Cf. Alderson v. Commissioner, 317 F.2d 790 (1963), reversing on other grounds 38 T.C. 215">38 T.C. 215 (1962). Since petitioners began negotiations with Frank R. Spencer Ranch, Inc., for the exchange of ranches and cattle as early as March 30 and had discussed the advantages of such an exchange with their attorney as early as March 26, and since their agreement with Moore dated March 23 stated that his services would include either the sale or exchange of the ranch and cattle, we think the petitioners contemplated and intended the exchange of cattle from the very beginning of their discussions with McCrea. Cf. Coastal Terminals, Inc. v. United States, supra; and Alderson v. Commissioner, supra.

Petitioners executed amended escrow instructions dated April 1, 1960, to incorporate the exchange1967 U.S. Tax Ct. LEXIS 11">*54 of cattle with Frank R. Spencer Ranch, Inc., in the original escrow instructions. They also notified Title Company of such change and deposited a bill of sale for their cattle to be transferred to Frank R. Spencer Ranch, Inc., upon the closing of the escrow. Frank R. Spencer Ranch, Inc., also signed the amended escrow instructions and deposited for delivery to McCrea, upon the receipt of $ 103,750, a bill of sale for the cattle which were to be acquired from the petitioners. Consequently, it seems that an exchange was contemplated by the other parties as well as petitioners.

Petitioners never entered into a binding contract with McCrea for the sale of their cattle. They wanted to exchange cattle with the Spencer Ranch from the start of negotiations. The fact that the Spencer Ranch found a potential buyer for the Ruby Valley cattle prior to the actual exchange and that petitioners were active in finding the potential buyer do not alter the nature of the cattle exchange. McCrea 49 T.C. 180">*199 did not make a deposit on the purchase price by April 22, the final date for closing under the March 22 escrow instructions, and Elliott was not actually accepted as buyer of the Ruby Valley Ranch1967 U.S. Tax Ct. LEXIS 11">*55 until May 4. Although the Spencer Ranch was reasonably certain that it had a purchaser for the Ruby Valley cattle, there was some risk that it had no buyer and would have to sell the cattle elsewhere. Moreover, the fact that a party obtains property on the understanding that the property can be disposed of elsewhere does not necessarily mean that he is merely acting as an agent for another or that his subsequent sale or exchange of the property has no substance by itself. See Coastal Terminals, Inc. v. United States, supra; Alderson v. Commissioner, supra; and Mercantile Trust Co. of Baltimore, et al., Executors, 32 B.T.A. 82">32 B.T.A. 82 (1935). Here the petitioners intended to exchange cattle with the Spencer Ranch and the form is entirely consistent with their intent. Cf. Gregory v. Helvering, 293 U.S. 465">293 U.S. 465 (1935).

Respondent maintains that the difference between a sale and an exchange is that in a sale the property is transferred in consideration of a concrete price expressed in terms of money, while in an exchange the property is transferred in return for 1967 U.S. Tax Ct. LEXIS 11">*56 other property without the intervention of money. He then notes that negotiations between petitioners and Spencer Ranch were at a set unit price of $ 225 per cow and $ 125 per yearling, and that Spencer purchased additional cows at $ 225 a head from Arlo Ellison to complete the transfer as agreed to by the parties. However, we find that price was the common denominator for describing the quality of the cattle to be exchanged rather than a means of ascertaining the sales price of petitioners' cattle. Cf. J. H. Baird Publishing Co., 39 T.C. 608">39 T.C. 608, 39 T.C. 608">618 (1962).

Accordingly, we hold that the petitioners and Frank R. Spencer, Inc., made an exchange of cattle which, to the extent the cattle were not held primarily for sale, qualified for nonrecognition of gain under section 1031(a).

Issue 4. -- Additions to Tax Under Section 6653(a)

Section 6653(a) provides that an addition to tax shall be imposed if any part of the underpayment of taxes is due to negligence or intentional disregard of rules and regulations. We do not need to discuss the argument of petitioners that the burden of proof on this issue falls on the respondent because we are persuaded, 1967 U.S. Tax Ct. LEXIS 11">*57 on these facts, that the underpayments in income tax were not due to any negligence or an intentional disregard of the rules and regulations on the part of the petitioners.

Section 1.6001-1(b), Income Tax Regs., provides that farmers [ranchers] need not keep the complete records required of other taxpayers. But they are required to keep "such records as will enable the district director to determine the correct amount of income subject to 49 T.C. 180">*200 the tax." The calendars, "farm file," checks, and receipts kept by petitioners were adequate records of their income. Petitioners' attorney testified that the records which they kept for the years 1958 and 1959 were better than those maintained by other farmers and ranchers in that area. He also testified that errors in reporting the 96 cattle and the 23 cattle were attributable entirely to him. In 1960, the records were kept on the double-entry system by a certified public accountant.

Petitioners consulted either an attorney or an accountant for the preparation of their income tax returns for the 3 years involved. Their reliance on attorneys or accountants indicates their good faith and evidences due care of their obligations under1967 U.S. Tax Ct. LEXIS 11">*58 the income tax laws. In addition, the petitioners consulted attorneys or accountants or both for guidance and tax advice about every transaction before us. While it is true that some errors were made in the individual and partnership returns for the years 1958, 1959, and 1960, we believe that no part of the deficiency was due to petitioners' negligence or their intentional disregard of the rules and regulations. See L. L. Moorman, 26 T.C. 666">26 T.C. 666 (1956); Rhett W. Woody, 19 T.C. 350">19 T.C. 350 (1952); Miller v. United States, 211 F. Supp. 758">211 F. Supp. 758 (D. Wyo. 1962); and Spouting Rock Beach Corp. v. United States, 176 F. Supp. 938">176 F. Supp. 938 (D. R.I. 1959). We hold that the respondent erred in determining the additions to tax under section 6653(a).

To reflect the conclusions reached herein,

Decisions will be entered under Rule 50.