UNITED STATES TAX COURT



   DONALD DECLEENE AND DORIS DECLEENE, Petitioners
    v. COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 24459-97.                     Filed November 17, 2000.



     P had operated his business on the M Street
property since 1977. In 1992, P purchased the
unimproved L Drive property as replacement property.
In September 1993, P and WLC, who wished to acquire M
Street, agreed that M Street and unimproved L Drive
were of equal value, $142,400; P quitclaimed title to L
Drive to WLC for a deferred cash consideration of
$142,400, to be paid at a second closing; WLC agreed to
build a building on L Drive to P’s specifications and
in December 1993 to reconvey L Drive to P, with the
substantially completed building on it, in exchange for
M Street. These transactions closed as agreed. While
WLC held title to L Drive, P retained beneficial
ownership thereof and was responsible for all
transaction costs and carrying charges. Construction
was financed by a note and mortgage guaranteed by P
that were nonrecourse as to WLC, and P assumed personal
                               - 2 -


     liability for them at the second closing, when WLC paid
     P the cash consideration of $142,400.


          Held: The subject transactions were a sale of M
     Street to WLC for $142,400, as determined by R, rather
     than a sale of unimproved L Street, followed by a
     reverse like-kind exchange of M Street for improved L
     Street under sec. 1031(a), I.R.C., as reported by P.
     Because P never divested himself of beneficial
     ownership of L Street, P could not acquire improved L
     Street as replacement property in exchange for his
     relinquishment of M Street to WLC. Held, further, P is
     not liable for the accuracy-related penalty under sec.
     6662(a), I.R.C.



     Brian R. Mudd, for petitioners.

     Michael J. Calabrese, for respondent.



     BEGHE, Judge:   Respondent determined for the taxable year

1993 that petitioners had a Federal income tax deficiency of

$23,796 and were liable for a section 6662(a)1 accuracy-related

penalty of $4,759.

     The sole substantive issue for decision is whether the

subject transactions qualified as a taxable sale of the Lawrence

Drive property and a like-kind section 1031(a)(1) exchange of the

McDonald Street property, as petitioners reported them, or was a

taxable sale of the McDonald Street property, as respondent


     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                                 - 3 -


determined.    We uphold respondent’s determination that the

transactions resulted in a sale of the McDonald Street property,

but we hold for petitioners on the penalty issue.

                          FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulations of fact and the accompanying exhibits are

incorporated herein by this reference.    Petitioners are husband

and wife who resided in Green Bay, Wisconsin, at the time they

filed their petition.

     Since 1969, petitioner Donald DeCleene (petitioner) has

owned and operated a trucking/truck repair business.    In 1976 and

1977, petitioner purchased improved real property located on

McDonald Street, Green Bay (the McDonald Street property).      He

used the McDonald Street property for his business operations.

     In 1993, petitioners owned and worked as employees of

DeCleene Truck Repair and Refrigeration, Inc. (Refrigeration).

Petitioner served as president.    Refrigeration installs and

repairs truck refrigeration units and performs general truck

repairs.    Through December 29, 1993, Refrigeration rented the

McDonald Street property from petitioner as its business

premises.    Petitioner computed his adjusted basis for the

McDonald Street property, including the depreciated cost of

improvements, as being $59,831 at the time he disposed of that

property on December 29, 1993.
                                - 4 -


     In 1992, petitioner was looking for land to which he could

move his business.

     On September 30, 1992, petitioner purchased 8.47 acres of

unimproved real property on Lawrence Drive in De Pere, Wisconsin

(the Lawrence Drive property), a suburb of Green Bay.   Petitioner

described the Lawrence Drive property as a “very good spot” that

he “took advantage of”.   Petitioner promptly sold 2.09 acres of

the Lawrence Drive property to an unrelated corporation.

Petitioner’s adjusted basis of the Lawrence Drive property that

he purchased and retained, with allocated fees and other closing

costs, was $137,027.

     Petitioner partially financed the purchase of the Lawrence

Drive property with a $100,000 loan from Bank One, Green Bay.

Bank One, Green Bay received petitioner’s note and a mortgage on

the Lawrence Drive property as security for its loan.

     By 1993, petitioner was ready to move his business to a new

building to be constructed on the Lawrence Drive property.

     After petitioner acquired the Lawrence Drive property, The

Western Lime and Cement Co. (WLC) expressed interest in acquiring

petitioner's McDonald Street property.

     Petitioner discussed WLC's interest in the McDonald Street

property with his accountant.   The accountant suggested that

petitioner could structure a like-kind exchange in which he would

quitclaim the Lawrence Drive property to WLC, after which WLC
                              - 5 -


would convey back to petitioner the Lawrence Drive property with

a new building built thereon to petitioner's specifications, in

exchange for the McDonald Street property.

     On September 24, 1993, WLC made an offer–-prepared by

petitioner’s attorney–-which petitioner accepted, to purchase the

Lawrence Drive property for $142,400; petitioner’s acceptance

contained an undertaking to “transfer building permit to Buyer on

or before September 27, 1993”.2   On September 24, 1993,

petitioner quitclaimed title to the Lawrence Drive property to

WLC, and WLC gave petitioner a fully nonrecourse noninterest

bearing one payment note and mortgage on the Lawrence Drive


     2
       The copy of the building permit included as Exhibit 39-J
in paragraph 67 of the Supplemental Stipulation of Facts replaces
paragraph 30 of the Stipulation of Facts, which stated as
follows: “Prior to his September 24, 1993 quit claim of title to
the Lawrence Drive property to the Western Lime & Cement Co., a
permit was obtained in Donald DeCleene’s name for construction of
a building on the Lawrence Drive property”.

     Exhibit 39-J is a photocopy that bears a variety of dates:
it was originally submitted to and preliminarily approved by the
City of DePere Building Inspector on July 29, 1993; it bears the
signature of the “Owner/Agent Michael DeCleene V.P. Date
1/12/94"; it was recorded “10/22/93" and bears the notation,
“Site Plan approved by Plan Commission on 4-27-93". The name of
petitioner as Owner, his mailing address, and telephone number
appear on the line of the permit form provided for that
information. However, the name, mailing address, and telephone
number of WLC have been written in above those of petitioner.

     On July 29, 1993, Green Bay Abstract & Title Company, Inc.
(the title company), had issued a title commitment with WLC as
the proposed insured on the owner’s policy in the insured amount
of $142,400 and Bank One, Green Bay as the proposed insured on
the loan policy in the insured amount of $522,400.
                               - 6 -


property in the amount of $142,400.    On that same day, petitioner

assigned to Bank One, Green Bay, the WLC $142,400 note and

mortgage.   The WLC $142,400 note was due by its terms “upon the

closing of an exchange transaction between” WLC and petitioner,

or 6 months from the date of the note, “whichever is earlier”.

     On September 24, 1993, WLC and petitioner also executed the

Exchange Agreement regarding the McDonald Street property and the

Lawrence Drive property.   The Exchange Agreement was drafted by

petitioner’s attorney with input from WLC’s attorney.

     Paragraph 1 of the Exchange Agreement required petitioner to

convey by warranty deed the McDonald Street property to WLC,

“free and clear of all liens and encumbrances”, in exchange for

WLC’s paying its $142,400 note to petitioner and conveying the

Lawrence Drive Property back to petitioner by quitclaim deed.

     Paragraph 2 of the Exchange Agreement provided that

petitioner would pay all costs relating to the transfers of the

McDonald Street and Lawrence Drive properties.

     In Paragraph 4 of the Exchange Agreement, petitioner made

comprehensive warranties to WLC with respect to the McDonald

Street property, but WLC expressly disavowed making any

warranties to petitioner with respect to the Lawrence Drive

property.
                              - 7 -


     The Exchange Agreement provided that WLC would construct a

building on the Lawrence Drive property to petitioner's

specifications.

     The Exchange Agreement provided that petitioner at the

closing of the exchange would pay an amount representing the

costs of the building on the Lawrence Drive property, as well as

insurance premiums, real estate taxes, interest, and all other

“soft” costs WLC might incur incident to the construction of the

building.

     Petitioner in the Exchange Agreement agreed to indemnify and

hold WLC harmless against any damages sustained or incurred in

connection with the construction and financing of the Lawrence

Drive property.

     Petitioner and WLC intended to close on the Exchange

Agreement upon completion of construction of the building on the

Lawrence Drive property "but not later than December 31, 1993".

     Bank One, Green Bay provided financing for the construction

of the building on the Lawrence Drive property.   On September 24,

1993, Bank One, Green Bay agreed to a construction loan of

$380,000, naming WLC as borrower and petitioner as guarantor.

This loan was nonrecourse as to WLC.   On the same day WLC

executed a note and mortgage to Bank One, Green Bay, which

provided that WLC had no personal liability on the note secured

by the mortgage and that the lender would look solely to the
                              - 8 -


Lawrence Drive property securing the mortgage; petitioner

guaranteed the $380,000 construction loan.

     Bank One, Green Bay considered petitioner the source of

repayment of the September 24, 1993, $380,000 construction loan.

In connection with that loan, Bank One, Green Bay never obtained

any financial statements from WLC.    The check of the

creditworthiness of WLC by the Bank One, Green Bay loan officer

consisted of calling a branch bank to discuss WLC’s business

reputation.

     The $380,000 note for the September 24, 1993 Bank One, Green

Bay construction loan required no interest or principal payments

during the time that WLC was expected to be the named borrower on

the note; the note did not require payment of interest until

March 23, 1994.

     On September 24, 1993, the following other events occurred:

Petitioner gave Bank One, Green Bay a new mortgage on the

McDonald Street property securing a total obligation of $480,000,

consisting of both his September 30, 1992, $100,000 note and the

WLC nonrecourse note of $380,000 that he had guaranteed; WLC

accepted the commitment of Bank One, Green Bay to provide a

$380,000 loan for financing construction of the building on the

Lawrence Drive property; WLC executed a corporate borrowing

resolution authorizing it to borrow from Bank One, Green Bay; WLC

executed an application to Bank One, Green Bay for a standby
                              - 9 -


letter of credit in the amount of $380,000 in favor of the title

company, which was delegated the task of making progress payments

to the contractor under the construction contract; the bank

issued its irrevocable standby credit in favor of the title

company in that amount.

     On September 24, 1993, Landmark Building Systems Ltd.

(Landmark) entered into a lump sum construction contract in the

amount of $375,688 (subject to certain adjustments) with WLC to

construct the building on the Lawrence Drive property.   The

contract named petitioner, Mike DeCleene (petitioners’ son, who

works in the family business), and/or a representative of Excel

Engineering, as owner's representative.   As owner’s

representative, petitioner and Mike DeCleene had general

authority, including the right to approve changes in design or

construction, to inspect and approve workmanship and materials,

to visit the construction site, and to determine compliance with

the contract.

     Although the standby letter of credit and the construction

contract do not expressly so state, progress payments to the

contractor were to be made only with the approval of petitioner

or Michael DeCleene as owner’s representative.   Excel Engineering

played a role in the design of the building, but lacked actual

authority to sign off as owner’s representative.
                              - 10 -


     The construction contract called for substantial completion

by December 15, 1993.   Between September 24 and December 29,

1993, Landmark worked on the construction of the building on the

Lawrence Drive property and substantially completed the building

to petitioner's specifications.

     On December 28, 1993, 1 day prior to execution and closing

of the Assumption, Release and Escrow Agreement described below,

Bank One, Green Bay executed a Satisfaction of Mortgage for the

mortgage given by WLC to petitioner that petitioner had assigned

to the bank in connection with petitioner’s quitclaim of the

Lawrence Drive property to WLC on September 24, 1993.

     On December 29, 1993, Bank One, Green Bay, WLC, and

petitioner executed the Assumption, Release and Escrow Agreement,

which provided that petitioner assumed and became personally

obligated to the bank for all obligations of WLC arising out of

the construction note and mortgage, notwithstanding their

nonrecourse language; petitioner agreed to be responsible for

completion of the construction project; and WLC agreed to pay

petitioner $142,400 for the McDonald Street property.    Petitioner

undertook to use $100,000 of the $142,400 received from WLC “to

pay a Note due the Bank in the amount of * * * $100,000" (which

had been secured by mortgages on both the Lawrence Drive property

and the McDonald Street property) and to escrow the remainder

with the bank to pay real estate taxes and any special
                              - 11 -


assessments on the McDonald Street property and to reduce the

balance of the construction loan note and mortgage to $360,000,

with any surplus of the escrowed funds to be delivered to

petitioner.   Bank One, Green Bay agreed “to release any liens

that it may have on the property located on McDonald Street”.

     On December 29, 1993, petitioner formally assumed as

borrower what had been WLC’s nonrecourse $380,000 Bank One, Green

Bay note of September 24, 1993; petitioner conveyed the McDonald

Street property to WLC by warranty deed.   WLC quitclaimed to

petitioner its interest in the Lawrence Drive property.     WLC

directly paid petitioner $142,400 by check to petitioner’s order

drawn on M&I First National Bank of West Bend, Wisconsin.

Petitioner endorsed this check “Pay only to the order of Bank

One-Green Bay”.

     Petitioner and WLC had agreed in the Exchange Agreement that

the McDonald Street property, including improvements, and the

unimproved Lawrence Drive property each had a value of $142,400.

The quitclaim deed of the Lawrence Drive property from petitioner

to WLC and the warranty deed of the McDonald Street property from

petitioner to WLC each showed that real estate transfer tax of

$427.20 had been paid, based on a value of $142,400; the

quitclaim deed from WLC to petitioner of the title to the
                              - 12 -


improved Lawrence Drive property showed that real estate transfer

tax of $1,140 had been paid, based on a value of $380,000.3

     Although petitioner had a general desire to complete his

acquisition of the improved Lawrence Drive property as soon as

possible, he didn’t particularly care whether the closing

occurred before or after December 31, 1993.    WLC wished to have

the closing occur before December 31, 1993, because it wanted the

Lawrence Drive property removed from its books for insurance

valuation purposes before the end of the year.

     On their 1993 return, petitioners treated the subject

transactions between petitioner and WLC as a sale of the

unimproved Lawrence Drive property and a like-kind exchange of

the McDonald Street property for the improved Lawrence Drive

property.   Petitioners reported no gain or loss on the

disposition of the McDonald Street property.   They reported a

$5,373 short-term capital gain ($142,400 gross "sales price" less

$137,027 basis) on their quitclaim transfer of the Lawrence Drive

property to WLC, which is described in Schedule D of their return

as a sale of “investment land”.




     3
       Although these amounts do not computationally coincide in
all respects with the transfer tax figures shown on the buyer’s
and seller’s closing statements, those statements confirm that
the transfer taxes on the subject transactions were paid by
petitioner.
                              - 13 -


     Petitioners' 1993 return includes a Form 8824, Like-Kind

Exchanges, which states that petitioners exchanged “land and

building” for “land and building”.     The return discloses no other

facts regarding the transactions between petitioner and WLC.

      Respondent used petitioner’s $59,831 adjusted basis figure

for the McDonald Street property in computing the long-term

capital gain on the sale of the McDonald Street property

determined in the deficiency notice.    However, on audit of

petitioners’ return, an adjusted basis of $61,331 had been

established.   Respondent’s deficiency notice did not back out the

gain petitioners had reported on petitioner’s quitclaim transfer

of the unimproved Lawrence Drive property to WLC, notwithstanding

that, under respondent’s theory of the case, the Lawrence Drive

property has never been disposed of by petitioner.

     On April 29, 1998, Bank One, Green Bay, WLC, and petitioner

executed an amendment to the Assumption, Release and Escrow

Agreement.   The amendment recites that the original of that

agreement contained a scrivener’s error, and recites that WLC

would pay petitioner $142,400 “in satisfaction of the Note and

Mortgage” on the Lawrence Drive property, that the Lawrence Drive

Property “is exchanged per the Exchange Agreement” for the

McDonald Street property, that petitioner will use $100,000 of

the $142,400 received from WLC to pay petitioner’s $100,000 note
                             - 14 -


to the bank, and that the balance of $42,400 will be escrowed

with the bank to pay real estate taxes and any special

assessments on the Lawrence Drive property (emphases supplied)

and to reduce the balance of the construction loan and mortgage

to $360,000.

     The amendment also sets forth a revision of the provision

regarding release of liens by Bank One, Green Bay, reading as

follows:

          The Bank agrees to release any liens that it may
     have on the property located at 625 Lawrence Drive, De
     Pere, Wisconsin, that are the obligation of the Company
     [WLC] and against 917 MacDonald [sic] Street, Green
     Bay, Wisconsin that are the obligation of DeCleene.

     The terms of the foregoing transactions among WLC and

petitioner and Bank One, Green Bay assured that WLC would pay no

amounts thereunder until it received the McDonald Street

property, that WLC would have no personal liability with respect

to the Lawrence Drive property or financing while the Lawrence

Drive property was titled in its name or at any time thereafter,

and that all transaction and other costs with respect to the

McDonald Street and Lawrence Drive properties would be paid by

petitioner.

                             OPINION

     Section 1001(c) provides that the entire gain or loss on the

sale or exchange of property shall be recognized.   Section
                              - 15 -


1031(a)(1) provides for nonrecognition of gain or loss on the

exchange of certain types of like-kind property, including real

property, held for productive use in trade or business or for

investment.4   Section 1031(b) in effect provides that if the

property received in an exchange otherwise qualifying for

nonrecognition of gain under section 1031(a) includes money or

other property (“boot”), then any gain to the recipient shall be

recognized, but not in excess of the boot.

Was McDonald Street Sold or Exchanged?

     The question posed by respondent’s determination is whether

the subject transactions were a taxable sale to WLC of the

McDonald Street property, as respondent determined, or instead

were a taxable sale of the unimproved Lawrence Drive property to

WLC, followed 3 months later by petitioner’s transfer of the

McDonald Street property to WLC in a like-kind exchange for WLC’s




     4
       Clearly, the Lawrence Drive property, in both its
unimproved and improved states, and the McDonald street property
were like-kind properties within the meaning of sec. 1031(a).
Sec. 1.1031(a)-1(b), Income Tax Regs., states:

          Definition of “like kind.” As used in section
     1031(a), the words “like kind” have reference to the
     nature or character of property and not to its grade or
     quality. * * * The fact that any real estate involved
     is improved or unimproved is not material, for that
     fact relates only to the grade or quality of the
     property and not to its kind or class. * * *
                              - 16 -


reconveyance to petitioner of the Lawrence Drive property--now

substantially improved--as petitioners reported.

     The tax significance of the answer to the question stems

from the disparity in the adjusted bases of the McDonald Street

and Lawrence Drive properties in petitioner’s hands.    McDonald

Street, which petitioner purchased in 1976-77, had an adjusted

basis in his hands substantially lower than his cost of Lawrence

Drive, which he purchased in 1992.     Petitioner therefore reported

as the taxable sale not his permanent relinquishment to WLC of

the low-basis McDonald Street property, but rather the first leg

of the “repo” transaction that temporarily parked the high-basis

Lawrence Drive property with WLC.

Legal and Administrative Background

     The primary reason that has been given for deferring

recognition of gain under section 1031(a) on exchanges of like-

kind property is that the exchange does not materially alter the

taxpayer’s economic position; the property received in the

exchange is considered a continuation of the old property still

unliquidated.   See, e.g., Koch v. Commissioner, 

, 63-64

(1978).   However, section 1031(a) does not go so far in

implementing this notion as to be a reinvestment rollover

provision, like section 1033 or section 1034.    A sale of

qualified property for cash requires that gain or loss be
                              - 17 -


recognized under the general rule of section 1001(c); such a sale

does not become part of a qualifying exchange under section

1031(a) even though the cash received on the sale is immediately

invested in like property.   Compare Coastal Terminals, Inc. v.

United States, 

, 337 (4th Cir. 1963), with Rogers v.

Commissioner, 

, 136 (1965), affd. per curiam 

(9th Cir. 1967).

     Petitioners remind us, and we are well aware--as we stated

in another section 1031 exchange case in which we held against

the taxpayer--that “Notwithstanding the familiar and long-

standing rule that exemptions are to be narrowly or strictly

construed, * * * section 1031 has been given a liberal

interpretation.”   Estate of Bowers v. Commissioner, 

,

590 (1990) (citing Biggs v. Commissioner, 

, 913-914

(1978), affd. 

(5th Cir. 1980)).   The courts have

exhibited a lenient attitude toward taxpayers in like-kind

exchange cases, particularly toward deferred exchanges.   See,

e.g., Starker v. United States, 

(9th Cir. 1979).

The Commissioner has also played a facilitating role by issuing

regulations that provide safe harbors for deferred exchanges, see

sec. 1.1031(k)-1, Income Tax Regs., under the statutory

limitations imposed on such exchanges by section 1031(a)(3), as

enacted by Deficit Reduction Act of 1984, Pub. L. 98-369, sec.
                              - 18 -


77(b), 98 Stat. 596.   These regulations, with their provisions

for use of third-party “qualified intermediaries” as

accommodation titleholders, who will not be considered the

taxpayer’s agent in doing the multiparty deferred exchanges

permitted by the regulations, have encouraged the growth of a new

industry of third-party exchange facilitators.

     The subject transactions present a case of first impression

in this Court.   They reflect the effort of petitioner and his

advisers to implement a so-called reverse exchange directly with

WLC, without the participation of a third-party exchange

facilitator.   Reverse exchanges have been described as

transactions in which the taxpayer locates and identifies the

replacement property (and acquires it or causes it to be acquired

on his behalf by an exchange facilitator) before he is ready to

transfer the property to be relinquished in exchange.     The

preamble to the deferred exchange regulations, sec. 1.1031(k)-1,

Income Tax Regs., made clear the Commissioner’s view that section

1031(a)(3) and the deferred-exchange regulations do not apply to

reverse exchanges.   See T.D. 8346, 1991-1 C.B. 150, 151.

     The Commissioner has recently responded to industry and

practitioner requests for guidance5 by publishing a revenue


     5
       See, e.g., American Bar Association Section on Taxation,
Committee on Sales, Exchanges and Basis, Report on the
                                                   (continued...)
                              - 19 -


procedure describing the Commissioner’s conditions for qualifying

reverse exchanges for nonrecognition of gain under section

1031(a)(1).   See Rev. Proc. 2000-37, 2000-40 I.R.B. 308.   Like

the deferred exchange regulations that implement section

1031(a)(3), the revenue procedure provides for third-party

qualified intermediaries as exchange accommodation titleholders

in carrying out the “qualified exchange accommodation

arrangements” whose use will qualify reverse exchanges for

nonrecognition of gain or loss under section 1031(a)(1).    Like

the deferred exchange regulations, the revenue procedure provides

a safe harbor; it states that “the Service recognizes that

‘parking’ transactions can be accomplished outside of the safe

harbor provided this revenue procedure”, but that “no inference

is intended with respect to the federal income tax treatment of

‘parking’ transactions that do not satisfy the terms of the safe

harbor”.   Rev. Proc. 2000-37, 2000-40 I.R.B. 308.

     Because the revenue procedure is prospectively effective, it

does not apply to the case at hand.    See 

have




     5
      (...continued)
Application of Section 1031 to Reverse Exchanges, 21 J. Real Est.
Tax. 44 (1993); Handler, Pricewaterhouse Coopers Forwards
Proposed Guidance on Reverse Exchanges, 2000 TNT 16-27, Doc.
2000-2588 (Jan. 25, 2000); Safe Harbor Guidance for Reverse Like-
kind Exchanges To Come Soon, IRS Official Promises, Highlights
and Documents 1157 (Jan. 25, 2000).
                              - 20 -


recourse to general principles of tax law to answer the question

posed by repondent’s determination.

Analysis and Conclusion

     In the case at hand, petitioner did not just locate and

identify the Lawrence Drive property in anticipation of acquiring

it as replacement property in exchange for the McDonald Street

property that he intended to relinquish.   He purchased the

Lawrence Drive property without the participation of an exchange

facilitator a year or more before he was ready to relinquish the

McDonald Street property and relocate his business to the

Lawrence Drive property.   In the following year, petitioner

transferred title to the Lawrence Drive property, subject to a

reacquisition agreement--the Exchange Agreement--not to a third-

party exchange facilitator, but to WLC, the party to which he

simultaneously obligated himself to relinquish the McDonald

Street property.

     In forgoing the use of a third party and doing all the

transfers with WLC, petitioner and his advisers created an

inherently ambiguous situation.   The ambiguity is exacerbated by

the fact that petitioner and WLC agreed in the Exchange Agreement

that the McDonald Street property and the unimproved Lawrence

Drive property were of equal value, $142,400.   So when WLC paid

petitioner $142,400--at the same time that he permanently
                              - 21 -


relinquished the McDonald Street property to WLC--was the payment

received by petitioner from WLC the sale price of the McDonald

Street property at the December 29 closing, as respondent

determined?   Or was it the deferred purchase price on

petitioner’s September 24 quitclaim transfer of title to the

unimproved Lawrence Drive property (which petitioner received

back on December 29 from WLC with the substantially completed

building that had been erected on it in the intervening 3

months), as petitioner reported?

     Our approach to answering these questions is to determine

for tax purposes whether WLC became the owner of the Lawrence

Drive property during the 3-month period it held title to the

property while the building was being built on it to petitioner’s

specifications.   If petitioner remained the owner of the Lawrence

Drive property during this period, petitioner could not engage in

a qualified like-kind exchange of the McDonald Street property

for the Lawrence Drive property, and the $142,400 payment

received by petitioner would be deemed the sale price of the

McDonald Street property.   A taxpayer cannot engage in an

exchange with himself; an exchange ordinarily requires a

“reciprocal transfer of property, as distinguished from a

transfer of property for a money consideration”.   Sec. 1.1002-

1(d), Income Tax Regs.
                             - 22 -


     WLC did not acquire any of the benefits and burdens of

ownership of the Lawrence Drive property during the 3-month

period it held title to that property.   WLC acquired no equity

interest in the Lawrence Drive property.   WLC made no economic

outlay to acquire the property.   WLC was not at risk to any

extent with respect to the Lawrence Drive property because the

obligation and security interest it gave back on its purported

acquisition of the property were nonrecourse.   WLC merely

obligated itself to reconvey to petitioner prior to yearend the

Lawrence Drive property with a substantially completed building

on it that had been built to his specifications and that pursuant

to prearrangement he was obligated to take and pay for.

     The parties treated WLC’s holding of title to the Lawrence

Drive property as having no economic significance.   The

transaction was not even used as a financing device.   No interest

accrued or was paid on the nonrecourse note and mortgage, which

assured that petitioner would get back the Lawrence Drive

property after it had been improved.   WLC had no exposure to real

estate taxes that accrued with respect to the property while WLC

held the title; all such taxes were to be paid by petitioner.     No

account was to be taken under the terms of the reacquisition

agreement of any value that had been added to the property by

reason of the building constructed in the interim.   The
                                - 23 -


construction was financed by petitioner through the bank he was

accustomed to dealing with.    Petitioner through his guaranty and

reacquisition obligation was at all times at risk with respect to

the Lawrence Drive property.    WLC had no risk or exposure with

respect to the additional outlay of funds required to finance

construction of the building.    WLC had no potential for or

exposure to any economic gain or loss on its acquisition and

disposition of title to the Lawrence Drive property.

     The reality of the subject transactions as we see them is a

taxable sale of the McDonald Street property to WLC.

Petitioner’s purchase in 1992 of the Lawrence Drive property, on

which he intended to build a new facility for his business as the

replacement for his McDonald Street property, put him in the

position of arranging to improve the Lawrence Drive property, as

well as to sell the McDonald Street property.    Petitioner’s prior

quitclaim transfer to WLC of title to the unimproved Lawrence

Drive property, which petitioners try to persuade us was

petitioner’s taxable sale, amounted to nothing more than a

parking transaction by petitioner with WLC, which contractually

bound itself to acquire from petitioner the McDonald Street

property that petitioner was going to relinquish permanently, as

well as to reconvey to petitioner the Lawrence Drive property as
                                - 24 -


soon as the facility to be built thereon to his specifications

was substantially completed.

     The reconveyance to petitioner of the Lawrence Drive

property was not part of an exchange by petitioner of the

McDonald Street property.   That reconveyance of the Lawrence

Drive property to petitioner merely reunited in his hands the

bare legal title to the Lawrence Drive property with the

beneficial ownership therein that he had continued to hold all

along while the building that he obligated himself to pay for was

being built to his specifications.

     In support of their claim that petitioner exchanged the

McDonald Street property for the improved Lawrence Drive

property, petitioners point out that the improved Lawrence Drive

property was different from the unimproved Lawrence Drive

property that he acquired in 1992 and whose title he transferred

to WLC on September 24, 1993.    Petitioners state:   “Petitioners

sold unimproved land (and reported the transaction) and in the

exchange got back improved real estate they could continue their

business operation in.”   It’s true that unimproved property and

improved property are different from each other; they are not

“similar or related in service or use” for the purpose of the

section 1033 rollover provision.    See sec. 1.1033(a)-2(c)(9),

Income Tax Regs.   However, the transformation of the Lawrence
                               - 25 -


Drive property while title was parked with WLC does not gainsay

our conclusion.   In substance, petitioner never disposed of the

Lawrence Drive property and remained its owner during the 3-month

construction period because the transfer of title to WLC never

divested petitioner of beneficial ownership.

     Having set forth our analysis and conclusion, we now address

the authorities cited by petitioners6 as favoring their position

or as being distinguishable.

Authority in the Court of Appeals for the Seventh Circuit

     The only case in the Seventh Circuit--the circuit to which

any appeal would lie in the case at hand--that the parties have



     6
       Petitioners contend that their advisers relied on two
private letter rulings in structuring the subject transactions:
Priv. Ltr. Rul. 78-23-035 (Mar. 9, 1978), which they characterize
as “nearly identical to the facts in our case”, and Priv. Ltr.
Rul. 91-49-018 (Sept. 4, 1991), which they cite as “virtually
directly on point (even goes farther than our case) on how a
transaction can be structured”. Petitioners’ contentions are
unavailing; not only does sec. 6110(j)(3) provide that private
letter rulings cannot be cited as precedent, but, unlike the case
at hand, the other party to the transaction in both private
letter rulings had the risks of ownership during the relevant
time period. Similarly, Rev. Rul. 75-291, 1975-2 C.B. 333, and
Rev. Rul. 77-297, 1977-2 C.B. 304, cited in Priv. Ltr. Rul. 78-
23-035, don’t help petitioners; not only does this Court regard
published rulings as having no precedential value, see Estate of
Lang v. Commissioner, 

, 776 (9th Cir. 1980), affg. on
this issue 

, 406-407 (1975); Intel Corp. & Consol.
Subs. v. Commissioner, 

, 621 (1993); Stark v.
Commissioner,86 T.C. 243, 250-251 (1986), but the facts of both
rulings, like Priv. Ltr. Rul. 91-94-018 (Sept. 4, 1991), are
distinguishable from the case at hand in the same dispositive
respect.
                                - 26 -


brought to our attention is Bloomington Coca-Cola Bottling Co. v.

Commissioner, 

(7th Cir. 1951), affg. a Memorandum

Opinion of this Court dated Aug. 10, 1950.   Petitioners try to

distinguish the Bloomington Coca-Cola Bottling Co. case, but we

find it highly instructive.

     The taxpayer had originally reported the transaction in

issue as a sale at a loss in the year it occurred, 1939, but

contended--for 1943 and 1944 excess profits tax purposes--that

the transaction had been an exchange under the statutory

predecessor of section 1031(a) in which no loss had been

recognized.   The taxpayer’s change in position was attributable

to its desire not to reduce its excess profits tax base.

     The taxpayer had outgrown its old bottling plant and hired a

contractor to erect a new plant, on the taxpayer’s land, at an

agreed cost of $72,500.   Included in the consideration paid by

the taxpayer to the contractor was the old bottling plant and the

parcel of land on which it was located, at an agreed value of

$8,000, plus cash of $64,500.    The taxpayer reported on its 1939

income tax return a loss of approximately $23,000 on the sale of

the old plant.

     As this Court pointed out in its Memorandum Opinion:   “Here

the contractor was not the owner of the land upon which the new

building was constructed, never owned the new building, and never

conveyed the new building to the petitioner”.
                              - 27 -


     The Tax Court held--and the Court of Appeals affirmed--that

the transaction was in effect the purchase of a new facility, and

not an exchange of unimproved property for improved property,

inasmuch as the taxpayer already owned the land on which the new

plant was constructed.   The contractor could not be a party to an

exchange with the taxpayer because the contractor was never the

owner of the property that the taxpayer received in the so-called

exchange.   The contractor was merely acting as a service provider

in the construction of the new plant.    The only real property to

which the contractor acquired title was the land and old plant

that it received as part payment for the construction services it

provided.

     The subject transactions are similar to those in Bloomington

Coca-Cola Bottling Co. v. 

, in significant

respects.   The taxpayer sold its old bottling plant (petitioner

sold the McDonald Street property) to the only other party it was

dealing with, the contractor (WLC).    The taxpayer hired a

contractor to build a new facility on land that it owned.     In the

case at hand, petitioner’s conveyance of title to the unimproved

Lawrence Drive property and the conveyance of that property back

with a substantially completed building on it are to be

disregarded; WLC never acquired any of the benefits and burdens

of ownership of the Lawrence Drive property.    WLC acquired no

equity or beneficial interest in the Lawrence Drive property, no
                              - 28 -


risk of loss or opportunity for gain, no exposure to real estate

taxes or other carrying charges, no liability even for interest

on its nonrecourse secured obligation during the interim period.

All we are left with, as in Bloomington Coca-Cola Bottling Co.,

is that a building was built for petitioner according to his

specifications on land that he owned and petitioner was obligated

to pay for that building.   The taxpayer in Bloomington Coca-Cola

Bottling Co. and petitioner also sold their old property to the

party with whom they dealt in connection with the building of the

new facility.7

Authorities Relied on by Petitioners

     We now turn to the cases petitioners rely on to support

their contention that petitioner exchanged the McDonald Street

property for the substantially improved Lawrence Drive property:

J.H. Baird Publg. Co. v. Commissioner, 

(1962); Coupe


     7
       We have found no other like-kind exchange cases in the
Seventh Circuit that bear on the issue in the case at hand.
However, another Seventh Circuit case worth noting is Patton v.
Jonas, 

(7th Cir. 1957), which applies the same
analysis as the line of Sixth Circuit cases culminating in First
Am. Natl. Bank of Nashville v. United States, 

(6th
Cir. 1972), which hold that “repo” transactions in tax-exempt
bonds are to be treated as secured loans so that the purchaser in
form is treated as a lender not entitled to exclude the tax-
exempt bond interest from its income; this is because the
original seller remains the owner of the bonds for tax purposes.
See also Green v. Commissioner, 

, 825 (7th Cir.
1966), affg. T.C. Memo. 1965-272; Commercial Capital Corp. v.
Commissioner, T.C. Memo. 1968-186. Compare Rev. Rul. 74-27,
1974-1 C.B. 24 (repurchase obligation) with Rev. Rul. 82-144,
1982-2 C.B. 34 (separately purchased and paid-for put).
                              - 29 -


v. Commissioner, 

, 409-410 (1969); 124 Front Street,

Inc. v. Commissioner, 

(1975); Biggs v. Commissioner, 

(l978), affd. 

(5th Cir. 1980); Fredericks

v. Commissioner, T.C. Memo. 1994-27.

     We preface our review of these cases by acknowledging that

they all reflect, to some degree, the liberal interpretation in

favor of taxpayers that this Court and other courts have applied

in cases under section 1031(a)(1).     We also observe that none of

these cases concerned a reverse exchange and that all of them are

highly fact specific and therefore distinguishable from the case

at hand.   Petitioners have read these cases selectively,

emphasizing in each of them what the taxpayer got away with.    In

so doing, petitioners have lost sight of the cumulative adverse

effect on their position of all the facts in the case at hand,

which have led to our conclusion that WLC never acquired

beneficial ownership of the Lawrence Drive property.    It would

therefore be a sterile exercise to engage in a detailed

recitation of the facts of these cases and a point-by-point

refutation of their applicability to the case at hand.    A couple

of highlights from J.H. Baird Publg. Co. v. 

,

will suffice.

     Petitioners try to make something of the fact that the Court

in J.H. Baird Publg. Co. v. Commissioner, 

,

distinguished Bloomington Coca-Coca Bottling Co. v. Commissioner,
                              - 30 -

(7th Cir. 1951), on the ground that “It was clear

that the contractor did not own the other property which, it was

claimed, was transferred to the taxpayer in the exchange.”     As

already indicated, we have found dispositive in the case at hand

that WLC never acquired beneficial ownership of the Lawrence

Drive property.8   WLC merely served as an accommodation party,

providing the parking place for legal title to the Lawrence Drive

property, while petitioner remained the beneficial owner before

and after and throughout the 3-month focal period of the subject

transactions.

     When petitioner conveyed to WLC title to the Lawrence Drive

property, WLC became contractually bound to reconvey it, and

petitioner was bound to take it back, prior to yearend (not much

more than 3 months).   Indeed, under Wisconsin law, both parties

were entitled to specific performance of the other party’s

obligation.   See Anderson v. Onsager, 

(Wis. 1990);

Heins v. Thompson & Flieth L. Co., 

(Wis. 1917).

It’s difficult to imagine commitments more binding than the

reciprocal obligations of petitioner and WLC in the case at hand.

The conveyance and reconveyance of title to the Lawrence Drive



     8
       We also observe that J.H. Baird Publg. Co. v.
Commissioner, 

, 618 (1962), on which petitioners rely,
applied the concept of beneficial ownership in the taxpayer’s
favor. Petitioners have failed to persuade us that the concept
of beneficial ownership is an illegitimate importation into the
tax law of qualified like-kind exchanges.
                              - 31 -


property must be disregarded as having no tax significance

because, at the end of the day, petitioner ended up where he

started, with title to and beneficial ownership of the Lawrence

Drive property.9

Computational Questions

     Petitioners point out that respondent’s deficiency notice,

which made an upward adjustment of $82,569 in long-term gain

realized and recognized by petitioners on the disposition of the

McDonald Street property, which we have found to be the actual

sale, failed to back out the short-term gain of $5,373 that

petitioners reported on the transfer of title to the unimproved

Lawrence Drive property.   Petitioners’ point is well taken.   It

should be addressed in the Rule 155 computation.

     Similarly, other matters not completely resolved, such as

the calculation of additional costs paid by petitioner in

connection with the sale of the McDonald Street property, as well

as his adjusted basis in that property, should be addressed in

the Rule 155 computation of the gain on the sale.

Penalty Question

     The subject transactions were structured by petitioner’s

accountant and attorneys after petitioner presented them with the



     9
       In so doing, the subject transactions satisfy the
requirements for application of what the Court of Appeals for the
Seventh Circuit has characterized as the most restrictive and
rigorous version of the step-transaction doctrine: the binding
commitment test. McDonald’s Restaurants, Inc. v. Commissioner,

, 525 (7th Cir. 1982), revg. 

(l981).
                              - 32 -


accomplished fact of his purchase of the Lawrence Drive property.

Petitioners’ 1993 income tax return, prepared by petitioner’s

accountant, reported a taxable short-term gain of $5,373 on the

sale of “investment land” and reported a like-kind exchange of

“land and building” for “land and building” on Form 8824.     The

disclosures were bare bones but adequate to trigger the audit

that led to the deficiency notice and the case at hand.

     Respondent determined that petitioners were liable for an

accuracy-related penalty under section 6662(a) and (b)(1) or (2).

Section 6662(a) imposes a 20-percent accuracy-related penalty on

the portion of an underpayment that is due to one or more causes

enumerated in section 6662(b).   Respondent relies on subsections

(b)(1) (negligence or intentional disregard of rules or

regulations) or (b)(2) (substantial understatement of income

tax).

     Petitioners argue they are not liable for the penalty.

Petitioners point out that a certified public accountant outlined

the subject transactions as they were carried out and prepared

their return and that the deal was structured and the papers

drawn by petitioners’ attorneys.   Petitioners contend that they

reasonably relied on professional advice in the preparation of

their return and that they are entitled to relief under the

exceptions that apply to a substantial understatement.

     Negligence includes a failure to attempt reasonably to

comply with the Code.   See sec. 6662(c).   Disregard includes a
                              - 33 -


careless, reckless, or intentional disregard.   See 

the failure to exercise due care or the failure to

act as a reasonable and prudent person.   See Neely v.

Commissioner, 

, 947 (1985).

     No penalty is imposed for negligence or intentional

disregard of rules or regulations or a substantial understatement

of income if the taxpayer shows that the underpayment is due to

reasonable cause and the taxpayer’s good faith.    See sec.

6664(c); secs. 1.6662-3(a), l.6664-4(a), Income tax Regs.

     Reasonable cause requires that the taxpayer have exercised

ordinary business care and prudence as to the disputed item.      See

United States v. Boyle, 

(1985); see also Estate of

Young v. Commissioner, 

, 317 (1998).    The good faith,

reasonable reliance on the advice of an independent, competent

professional as to the tax treatment of an item may meet this

requirement.   See United States v. Boyle, supra; sec. 1.6664-

4(b), Income Tax Regs.; see also Richardson v. Commissioner, 

(7th Cir. 1997), affg. T.C. Memo. 1995-554; Ewing v.

Commissioner, 

, 423 (1988), affd. without published

opinion 

(9th Cir. 1991).

     Whether a taxpayer relies on advice and whether such

reliance is reasonable depend on the facts and circumstances of

the case and the law that applies to those facts and

circumstances.   See sec. 1.6664-4(c)(i), Income Tax Regs.    A

professional may render advice that may be relied upon reasonably
                              - 34 -


when he or she arrives at that advice independently, taking into

account, among other things, the taxpayer’s purposes for entering

into the underlying transaction.   See sec. 1.6664-4(c)(i), Income

Tax Regs.; see also Leonhart v. Commissioner, 

(4th

Cir. 1969), affg. T.C. Memo. 1968-98.   Reliance is unreasonable

when the taxpayer knew, or should have known, that the adviser

lacked the requisite expertise to opine on the tax treatment of

the disputed item.   See sec. 1.6664-4(c), Income Tax Regs.

     In sum, for a taxpayer to rely reasonably upon advice so as

possibly to negate a section 6662(a) accuracy-related penalty

determined by the Commissioner, the taxpayer must prove that the

taxpayer meets each requirement of the following three-prong

test:   (1) The adviser was a competent professional who had

sufficient expertise to justify reliance, (2) the taxpayer

provided necessary and accurate information to the adviser, and

(3) the taxpayer actually relied in good faith on the adviser’s

judgment.   See Ellwest Stereo Theatres, Inc. v. Commissioner,

T.C. Memo. 1995-610; see also Rule 142(a).

     We conclude on the record before us that petitioners

actually relied in good faith on disinterested professional

advisers who structured the transactions and prepared their

return.   Petitioners were justified in their reliance,

notwithstanding that we have upheld respondent’s determination
                             - 35 -


that the subject transactions did not qualify as a like-kind

exchange of the Lawrence Drive property.    Accordingly, we hold

for petitioners on the penalty issue.

     To give effect to the foregoing,



                                           Decision will be entered

                                   under Rule 155.