UNITED STATES TAX COURT



   D. G. SMALLEY AND NELL R. SMALLEY, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 2767-98.                       Filed June 14, 2001.



     In 1994, H entered into a deferred exchange
whereby he relinquished 2-year timber cutting rights on
his land and in return received in 1995 fee simple
interests in three parcels of real estate. The
transferee’s obligation to transfer replacement
property to H was secured by cash held in a qualified
escrow account as defined in sec. 1.1031(k)-1(g)(3),
Income Tax Regs.

     Held: At the beginning of the exchange period, H
had a bona fide intent to enter into a deferred
exchange of like-kind property within the meaning of
sec. 1.1031(k)-1(j)(2)(iv), Income Tax Regs. Under
sec. 1.1031(k)-1(g)(3) and (j)(2), Income Tax Regs., H
was not in actual or constructive receipt of property
in 1994, and under the installment sale rules of sec.
453, I.R.C., Ps are not required to recognize income
from the deferred exchange in 1994.
                               - 2 -


     David D. Aughtry and Brett W. Beveridge, for petitioners.

     David R. MacKusick, for respondent.



     THORNTON, Judge:   Respondent determined a $139,180

deficiency in petitioners’ joint 1994 Federal income tax.    After

concessions, the sole issue for decision is whether petitioners

are required to recognize income in 1994 as the result of a

deferred exchange that petitioner husband (petitioner) entered

into in 1994 and that was completed in 1995.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for taxable year 1994.    Rule

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

                         FINDINGS OF FACT

     The parties have stipulated some of the facts, which we

incorporate in our findings by this reference.

     When they filed their petition, petitioners resided in

Dublin, Georgia.

     In the 1960’s, petitioner acquired some 275 acres of

timberland in Laurens County, Georgia.   By 1994, some of the

timber on this land had reached maturity.   After attending a

seminar on timber exchanges presented by a well-known timber

taxation expert and after consulting with his longtime certified

public accountant, petitioner decided to undertake an exchange of

standing timber for additional acreage containing standing
                               - 3 -

timber.   As described in more detail below, on November 29, 1994,

petitioner entered into a series of agreements with Rayonier,

Inc. (Rayonier), whereby for a term of 2 years he granted

Rayonier exclusive rights to cut and remove mature timber on some

95 acres of his Laurens County land (the 95 acres), in

consideration of $517,076.   Pursuant to the agreements, most of

the funds were held by an escrow agent and applied toward the

purchase of three parcels of land as designated by petitioner.

     More particularly, the “TIMBER CONTRACT” between petitioner

and Rayonier, executed November 29, 1994, provides that in

consideration of $517,076, petitioner grants Rayonier “the

exclusive license and right to cut all merchantable pine and

hardwood timber suitable for poles, sawtimber, or pulpwood, which

are located within the timber sale boundaries of * * * [the 95

acres] now growing and hereafter to grow during the term hereof

upon the land in Laurens County.”   The timber contract states:

          The term of this contract shall be for a period
     commencing with the date hereof and ending on November
     29, 1996 (24 months). In the event * * * [Rayonier]
     has not completed the cutting and removing of said
     bargained timber at the expiration of the above stated
     term because of abnormal circumstances such as weather
     conditions, * * * [petitioner] [agrees] to extend the
     term of this contract for a period of time necessary to
     complete the harvesting of timber but in no event shall
     the extension exceed Six (6) months.
                               - 4 -

Pursuant to the terms of the timber contract, Rayonier was to pay

the $517,076 purchase price, less $12,141 timber ad valorem

taxes, to an escrow agent, Francis M. Lewis (Lewis).1

     Also on November 29, 1994, petitioner and Rayonier executed

a “MEMORANDUM OF CONTRACT”, reciting that they had as of that

date entered into the timber contract (referred to in the

Memorandum of Contract as a “Timber Indenture Agreement”),

whereby petitioner had conveyed to Rayonier:

          All merchantable pine and hardwood timber suitable
     for poles, sawtimber, or pulpwood, which are located
     within * * * [the 95 acres].

                 *   *     *   *    *    *     *

          And, subject to the provisions of * * * [the
     timber contract], the right to cut and remove from the
     above-described lands all and singular of the said
     described trees and timber.

Petitioner recorded this memorandum of contract (but apparently

not the timber contract) in the real property deed records of

Laurens County, Georgia.

     Also on November 29, 1994, petitioner and Rayonier executed

a “TAX FREE EXCHANGE AGREEMENT”.   This agreement provides in

relevant part:

          WHEREAS, * * * [Rayonier] and * * * [petitioner]
     have entered into an Agreement for the purchase of
     timber wherein * * * [petitioner] has agreed to sell to


     1
       Francis M. Lewis is an attorney licensed to practice in
the State of Georgia. He performed no services for petitioner
during the 2-year period preceding Nov. 29, 1994, and is not
related to petitioner.
                         - 5 -

* * * [Rayonier] and * * * [Rayonier] has agreed to
purchase from * * * [petitioner] certain timber growing
on property of * * * [petitioner]; and

     WHEREAS, * * * [Rayonier] has agreed to cooperate
with * * * [petitioner] in the effectuation of a tax
free exchange, pursuant to Section 1031 of the Internal
Revenue Code; and

     WHEREAS, certain property will be designated by
* * * [petitioner] to be acquired for the purpose of an
exchange within one hundred eighty (180) days of the
sale of the timber by * * * [petitioner] to * * *
[Rayonier] and an escrow agent will be designated by
* * * [petitioner] to receive and hold the monies from
the sale as allowed by Section 1031 of the Internal
Revenue Code; and

     NOW, THEREFORE, for and in consideration of the
mutual benefits and detriments to the Parties, IT IS
AGREED AS FOLLOWS:

                          1.

      The Parties hereto agree that the sell [sic] of
the timber by * * * [petitioner] to * * * [Rayonier] is
expressly conditioned upon reasonable cooperation and a
tax free exchange qualifying under Section 1031 of the
Internal Revenue Code, and all Parties to this
Agreement agree to cooperate to the extent set forth
herein. The acquisition by * * * [Rayonier] of the
timber and the acquisition by * * * [petitioner] of the
property to be designated are intended to be mutually
interdependent transactions for the purpose of
qualifying under Section 1031 of the Internal Revenue
Code.

                          2.

     * * * [Rayonier] shall upon the closing of the
sale of the timber transaction between * * * [Rayonier]
and * * * [petitioner] pay the total purchase price due
for said timber to Francis M. Lewis, Escrow Agent, and
not to * * * [petitioner].
                                - 6 -

     Also on November 29, 1994, petitioner, Rayonier, and Lewis

executed an escrow agreement.   The agreement states that

petitioner “intends for his exchange under * * * [the timber

contract] to permit * * * [petitioner] to report the receipt of

the exchange property under the income tax deferral rules of

Section 1031(a) of the Internal Revenue Code”.          The escrow

agreement provides that on the closing of the timber contract,

Rayonier will deliver to Lewis the net purchase price ($517,076

less $12,141 ad valorem taxes) to be held in escrow and paid out

as provided in the escrow agreement.         The escrow agreement

(wherein petitioner is referred to as Seller and Rayonier is

referred to as Purchaser) further provides in part:

                                    3.

          Seller will designate certain real estate referred
     to in a Tax Free Exchange Agreement between Purchaser
     and Seller, which shall be acquired by Purchaser and
     transferred to Purchaser. The Escrow Agent agrees to
     apply the funds toward the purchase of the property as
     directed by the Purchaser.

               *    *    *      *        *     *    *

                                6.

          Title to the exchange property shall be acquired
     in the name of the Escrow Agent, as Agent for the
     Purchaser, and then conveyed by Escrow Agent to Seller.
     In the event the costs of acquiring and thereafter
     conveying the exchange property can be reduced by a
     direct transfer from the Seller [sic] of the exchange
     property to Seller, the Escrow Agent may arrange for a
     direct transfer to Seller upon receipt by Escrow Agent
     of a request from Seller.
                                   - 7 -

                                    7.

                  *    *       *    *      *   *   *

          In no event shall Seller have use or control of
     the funds contained in escrow on or before termination
     of said escrow. Seller shall not have the right
     to sell, assign, transfer, encumber or in any other
     manner anticipate or dispose of his interest in said
     escrow until the same is actually paid over to and
     received by Seller.

     Pursuant to the escrow agreement and the timber contract, on

November 29, 1994, Lewis received from Rayonier net proceeds of

$504,935 (the escrow funds), which he deposited into a checking

account at Farmers & Merchants Bank in Dublin, Georgia.      By three

separate letters, dated December 18, 1994, December 21, 1994, and

January 2, 1995, petitioner identified to Lewis as replacement

properties three parcels of land (the replacement properties),

ownership of each of which was transferred directly to petitioner

by warranty deed from the respective owners as follows:

                                                     Ownership
      Petitioner’s          Replacement             transferred
     letter to Lewis       property acreage        to petitioner

     Dec. 18, 1994         488.57 acres            Feb. 16, 1995
                           1
     Dec. 21, 1994         316.82 acres            Mar. 14, 1995
     Jan. 2, 1995          105.7 acres             Feb. 15, 1995
     1
       The parties have stipulated that the land contained 316.82
acres, although the letter to Lewis states that the property
contains 312 acres. To the extent there is a discrepancy, it is
immaterial to the result reached herein.

     The replacement properties are all within 30 miles of the 95

acres.   When petitioner acquired these replacement properties,

they all contained standing timber that accounted for a

significant part of their value.
                                 - 8 -

     The purchase of these three replacement properties exhausted

all but $205.45 of the escrow funds.      By check dated May 9, 1995,

Lewis paid petitioner the $205.45 balance.

     Petitioners are cash basis taxpayers.     On their joint 1994

Federal income tax return, filed on or about April 15, 1995, they

characterized the subject transaction as a like-kind exchange of

“Timber” for “Timber and Land”, giving rise to $496,076 realized

gain, all of which they treated as deferred gain pursuant to

section 1031.

     In the notice of deficiency, dated December 4, 1997,

respondent determined that petitioners realized gain of $489,935,

instead of $496,076, from their 1994 timber sale.2     The notice of

deficiency states that “the realized gain from the sale of the

timber is to be fully recognized [in 1994] because it has not

been established that the requirements of section 1031 of the

Internal Revenue Code have been met.”

                                OPINION

A.   The Parties’ Contentions

     1.   The Like-Kind Exchange Requirement

     Petitioners argue that to continue petitioner’s timber

investment, he exchanged standing timber for standing timber that



     2
       The parties have stipulated that petitioner’s basis in the
timber conveyed to Rayonier was $3,200. On brief, respondent
contends that after subtracting this basis, the amount of
petitioners’ realized gain is $486,735.
                               - 9 -

necessarily had to have land attached.   Petitioners argue that

under applicable Georgia law, both the relinquished property and

the replacement property are characterized as real property

interests, and that under Commissioner v. Crichton, 

(5th Cir. 1941), affg. 

(1940), the subject

transaction qualifies as a tax-deferred like-kind exchange within

the meaning of section 1031.

     Respondent argues that under Georgia law, the 2-year timber

cutting contract was personal property and thus not of like kind

to the replacement real property.   In addition, relying on Oregon

Lumber Co. v. Commissioner, 

(1953), respondent argues

that regardless of how the property interests may be

characterized under State law, the property relinquished and the

properties received differ so intrinsically that they are not of

like kind within the meaning of section 1031.3

     2.   Petitioners’ Alternative Argument:   Lack of Actual or
          Constructive Receipt in 1994

     On brief, petitioners raise an alternative argument that

regardless of whether the subject transaction qualifies as a



     3
       Respondent does not dispute that petitioners have met all
other requirements for a nontaxable exchange of property held for
productive use in a trade or business or for investment within
the meaning of sec. 1031. In particular, respondent does not
dispute that petitioner’s transaction with Rayonier constituted
an “exchange” within the meaning of sec. 1031 or that petitioners
have satisfied the requirements of sec. 1031(a)(3), which in the
case of a nonsimultaneous exchange generally requires that the
replacement property be identified no more than 45 days after,
and the exchange be completed no more than 180 days after, the
transfer of the relinquished property.
                             - 10 -

like-kind exchange, respondent has erroneously determined that

they realized income from the transaction in 1994.    Relying on

section 1.1031(k)-1(g)(3) and (j), Income Tax Regs., petitioners

argue that they realized no gain in 1994 because they had no

actual or constructive receipt of property in 1994.

     Respondent contends that petitioners have improperly raised

this issue for the first time on brief.   Respondent alleges, and

petitioners do not dispute, that the 3-year limitations period

for respondent to assess tax for taxable year 1995 ran shortly

after the trial date of this case and shortly before the date

respondent received a copy of petitioners’ brief.    Respondent

contends that because of this circumstance, he is “especially

prejudiced” by petitioners’ delay in raising their alternative

arguments.

     In a memorandum filed with the Court in response to

respondent’s arguments on reply brief, petitioners argue that

they raised what they characterize as the “receipt issue”

frequently before and during trial.   In their memorandum,

petitioners catalog various references in their petition, their

trial memorandum, the parties’ stipulations of facts, and

statements at trial to arguments or facts or circumstances in

support of arguments that in 1994 petitioner never received or

had access to or control over any moneys incident to the exchange

in question.
                               - 11 -

B.   Lack of Prejudice to Respondent in Addressing Actual or
     Constructive Receipt

     A party may rely on a theory only if it provides the

opposing party fair warning so that the opposing party is not

prejudiced in its ability to prepare its case.   See Pagel, Inc.

v. Commissioner, 

, 211 (1988), affd. 

(8th Cir. 1990).   Accordingly, a party may not raise an issue for

the first time on brief where surprise and prejudice are found to

exist.   See Seligman v. Commissioner, 

, 198-199

(1985), affd. 

(5th Cir. 1986).   The general rule

against raising new issues on brief is not absolute, being

“founded upon the exercise of judicial discretion in determining

whether considerations of surprise and prejudice require that a

party be protected from having to face a belated confrontation

which precludes or limits that party’s opportunity to present

pertinent evidence.”    Ware v. Commissioner, 

, 1268

(1989), affd. 

(2d Cir. 1990).

     Respondent does not contend that he has been prejudiced in

developing or presenting evidence regarding petitioners’

alternative argument.   In respondent’s reply brief, respondent’s

response to motion by petitioners to supplement brief, and

respondent’s supplemental reply brief, the only prejudice that

respondent suggests would arise from our consideration of

petitioners’ alternative argument relates to respondent’s failure

to determine a deficiency for petitioners’ 1995 taxable year.      If
                              - 12 -

such prejudice exists, it is of respondent’s own making.    Any

such prejudice, however, is speculative, premised as it is on the

supposed tax consequences in a year not before us of a legal

determination that we decline to reach.   The only year before us

is 1994, and we confine our determinations to that year.    See

Christensen v. Commissioner, T.C. Memo. 1996-254, affd. without

published opinion 

(9th Cir. 1998).

     Moreover, petitioners’ receipt argument is based on the

application of section 1031 and respondent’s regulations

thereunder–-the same section upon which the parties have based

their positions from the outset.   See Ware v. 

.   In invoking the application of these mandatory provisions

of the section 1031 regulations, petitioners appeal to the

correct application of the law on the basis of the record

presented.   Neither party has suggested that the record contains

insufficient facts to permit us to dispose of the case on the

grounds of petitioners’ alternative argument.   We conclude that

the record is sufficient for this purpose and that we may

properly decide this case on the grounds raised in petitioners’

alternative argument.4


     4
       We are mindful that in Chase v. Commissioner, 

,
883 (1989), this Court rejected the taxpayers’ alternative
argument, raised for the first time on brief, that if sec.
1031(a) were inapplicable to the transaction in question, then
they should be allowed to elect installment sale treatment under
former sec. 453. The Court based its holding partly on the
                                                   (continued...)
                              - 13 -

C.   Coordination of Section 1031 Regulations and Section 453

     The section 1031 regulations state:   “Except as otherwise

provided, the amount of gain or loss recognized * * * in a

deferred exchange is determined by applying the rules of section

1031 and the regulations thereunder.”   Sec. 1.1031(k)-1(j)(1),

Income Tax Regs.   The section 1031 regulations contain special

rules for coordinating the determination of gain or loss under

section 1031 and under section 453, which generally requires,

subject to a host of qualifications not in issue here, that where


     4
      (...continued)
ground that the taxpayers had raised the issue for the first time
on brief. The Court cited Seligman v. Commissioner, 

(1985), affd. 

(5th Cir. 1986), and Markwardt v.
Commissioner, 

(1975). As germane here, each of these
cases stands for the general proposition that this Court will not
consider issues first raised in the parties’ briefs where
prejudice and surprise are found to exist. Accordingly, we infer
that the Court in Chase concluded that a holding for the
taxpayers on their alternative argument would prejudice the
Commissioner.

     In any event, the Court in Chase concluded that the
taxpayers were the wrong parties to claim the election under
former sec. 453. The election could be made only by the
partnership in which they were partners. By contrast, as
applicable to the years in issue here, the provisions of sec. 453
are not elective but rather are generally mandatory; the taxpayer
must elect out to avoid reporting gain or loss on the installment
method. See sec. 453(d). Moreover, the sec. 1031 regulations
applicable to the year in issue in Chase v. 

,
unlike the sec. 1031 regulations applicable here, contained no
explicit coordination with the installment sale provisions of
sec. 453. Accordingly, the taxpayers’ alternative argument in
Chase, unlike petitioners’ alternative argument here, did not
necessarily appeal to the correct application of the law
pertaining to sec. 1031 but instead was predicated on other
elective statutory provisions invoked for the first time on
brief.
                              - 14 -

a taxpayer disposes of property and is to receive one or more

payments in a later year, the taxpayer’s profit on the sale is to

be included in income as the payments are received.

     For purposes of section 453, payments include amounts

actually or constructively received in the taxable year.     See

sec. 15A.453-1(b)(3)(i), Temporary Income Tax Regs., 46 Fed. Reg.

48920 (Oct. 5, 1981).   In the context of a deferred exchange

where cash or a cash equivalent provides security for the

transfer of replacement property and is held in an escrow account

or trust, the question arises whether, for purposes of applying

the installment sale rules of section 453, the taxpayer has

actually or constructively received property at the commencement

of the deferred exchange.   To answer this question, the section

453 regulations cross-reference rules contained in section

1.1031(k)-1(j)(2), Income Tax Regs.    See 

1031

regulations generally provide that the determination of whether

the taxpayer has received payment for purposes of section 453

will be made without regard to the fact that the transferee’s

obligation to convey replacement property to the taxpayer is

secured by cash or cash equivalent, if the cash or cash

equivalent is held in a “qualified escrow account” or “qualified

trust” as defined in section 1.1031(k)-1(g)(3), Income Tax Regs.,

provided the taxpayer had a bona fide intent to enter into a

deferred exchange of like-kind property at the beginning of the
                               - 15 -

exchange.    See sec. 1.1031(k)-1(j)(2)(i), (iv), Income Tax Regs.5

Accordingly, in such a circumstance, if all other conditions of

section 453 are satisfied, the taxpayer must recognize any gain

or loss from such a deferred exchange pursuant to the installment

sale rules of section 453.


     5
         The sec. 1031 regulations provide that, as a general rule:

     The taxpayer is in constructive receipt of money or
     property at the time the money or property is credited
     to the taxpayer’s account, set apart for the taxpayer,
     or otherwise made available so that the taxpayer may
     draw upon it at any time or so that the taxpayer can
     draw upon it if notice of intention to draw is given.
     * * * [Sec. 1.1031(k)-1(f)(2), Income Tax Regs.]

     Strictly construed and without any further refinement, the
principles expressed in these regulations might lead to the
conclusion that petitioner had actual receipt of property in 1994
(either by virtue of the escrow agent’s acting as his agent in
receiving the escrow funds or by virtue of petitioner’s receipt
of a property interest in the escrow account) or constructive
receipt of the sale proceeds. See Williams v. United States, 

(5th Cir. 1955) (taxpayers who sold standing timber and
had sale proceeds placed in an escrow account were in
constructive receipt of the proceeds at the time of the sale).

     Under such an analysis, however, it might be difficult for
any deferred exchange involving an escrow account to qualify
under sec. 1031, because (1) the actual or constructive receipt
might indicate a sale rather than an exchange, and (2) the
property interest actually or constructively received at the
commencement of the deferred exchange would not necessarily be
like kind to the property relinquished. See 2 Bittker & Lokken,
Federal Taxation of Income, Estates and Gifts, par. 44.2.5 (3d
ed. 2000). To mitigate such problems, sec. 1.1031(k)-1(g),
Income Tax Regs., provides various safe harbors. See 

these safe harbors provides that in the case of a deferred
exchange, the taxpayer is not in actual or constructive receipt
of money or property merely because cash or a cash equivalent is
held in a “qualified escrow account or in a qualified trust.”
Sec. 1.1031(k)-1(g)(3)(i), Income Tax Regs.
                              - 16 -

     Here, petitioners contend that because they have met all

operative conditions for the application of section 1.1031(k)-

1(g)(3) and (j)(2), Income Tax Regs., and of section 453, by

operation of law they have no actual or constructive receipt of

property in 1994, and, under the rules coordinating gain

recognition under sections 453 and 1031, they are not required to

recognize income in 1994.   Respondent takes issue with only one

operative condition relative to petitioners’ argument–-that

petitioner had the requisite bona fide intent to enter into a

deferred exchange at the beginning of the subject transaction.6


     6
       In particular, respondent has not disputed that the
subject transaction was a deferred exchange within the meaning
of the regulations, which define a deferred exchange as:

     an exchange in which, pursuant to an agreement, the
     taxpayer transfers property held for productive use in
     a trade or business or for investment * * * and
     subsequently receives property to be held either for
     productive use in a trade or business or for investment
     * * * [Sec. 1.1031(k)-1(a), Income Tax Regs.]

     Nor has respondent disputed that the escrow account used in
the subject transaction was a “qualified escrow account” within
the meaning of sec. 1.1031(k)-1(g)(3)(ii), Income Tax Regs.,
which defines a “qualified escrow account” as:

          an escrow account wherein–-

               (A) The escrow holder is not the taxpayer or
          a disqualified person (as defined in paragraph (k) of
          this section), and

               (B) The escrow agreement expressly limits the
          taxpayer’s rights to receive, pledge, borrow, or
          otherwise obtain the benefits of the cash or cash
                                                   (continued...)
                             - 17 -

     Accordingly, we turn to consideration of that issue.

D.   Bona Fide Intent Test

     Section 1.1031(k)-1(j)(2)(iv), Income Tax Regs., provides:

          Bona fide intent requirement. The provisions of
     paragraphs (j)(2)(i) and (ii) of this section [which
     coordinate gain recognition rules under sections 453
     and 1031 with respect to a deferred exchange involving
     a qualified escrow account, qualified trust, or
     qualified intermediary] do not apply unless the
     taxpayer has a bona fide intent to enter into a
     deferred exchange at the beginning of the exchange
     period. A taxpayer will be treated as having a bona
     fide intent only if it is reasonable to believe, based
     on all the facts and circumstances as of the beginning
     of the exchange period, that like-kind replacement
     property will be acquired before the end of the
     exchange period.

     In arguing that petitioner lacked the requisite bona fide

intent, respondent takes issue only with whether it was

reasonable for petitioner to believe that the property he

relinquished and the properties he received in the subject

transaction were of like kind within the meaning of section 1031.

Respondent does not contend that petitioner otherwise failed to

satisfy the requirements of section 1.1031(k)-1(j)(2)(iv), Income



     6
      (...continued)
          equivalent held in the escrow account as provided in
          paragraph (g)(6) of this section.

     Furthermore, respondent has not contended that the subject
transaction fails to meet any of the conditions for application
of sec. 453, other than as relate to the satisfaction of the bona
fide intent requirement of sec. 1.1031(k)-1(j)(2)(iv), Income Tax
Regs.
                             - 18 -

Tax Regs. (the bona fide intent test).7   Accordingly, we focus

our inquiry on that aspect of the bona fide intent test.

     On reply brief, respondent argues as follows:

     Here, petitioner’s intent was always to acquire
     precisely the type of replacement property he
     ultimately acquired. There is no evidence anywhere in
     the record to suggest that petitioner intended to
     acquire as replacement property anything but a fee
     simple interest in timberland. Since the replacement
     properties and the relinquished property are not like
     kind, petitioner’s intent from the outset was to
     acquire replacement property that was not of like kind
     with the relinquished property and Treas. Reg. sec.
     1.1031(k)-1(j)(2)(iv) does not apply. The regulation
     does not address the situation such as here where the
     taxpayer actually acquires the replacement property he
     intended to acquire and which does not qualify as like
     kind with the relinquished property.

Respondent’s argument is at odds with the bona fide intent test

as described in his own regulations, which requires only that it

be “reasonable to believe” that like-kind replacement property

will be acquired within the requisite exchange period.    Sec.

1.1031(k)-1(j)(2)(iv), Income Tax Regs.

     As explained in greater detail below, we conclude that at

the commencement of the exchange period for the subject

transaction, petitioner had a bona fide intent that he would

satisfy the like-kind deferred exchange requirements.    This

conclusion is bolstered by the fact that respondent has



     7
       For instance, respondent does not contend that petitioner
did not reasonably believe that he would acquire replacement
property within the requisite 180-day period.
                               - 19 -

determined no negligence penalty or other penalty with regard to

the subject transaction, from which we infer that respondent does

not dispute that petitioners had reasonable cause and acted in

good faith in treating the subject transaction as a tax-deferred

like-kind exchange within the meaning of section 1031.    See sec.

6664(c)(1) (no accuracy-related penalty is to be imposed to the

extent there was reasonable cause and the taxpayer acted in good

faith).

E.   Application of the Bona Fide Intent Test

     In Oregon Lumber Co. v. Commissioner, 

(1953),

the taxpayer conveyed to the United States certain land adjoining

national forests in Oregon and containing a specified amount of

standing timber.    In exchange, the United States granted the

taxpayer the right to cut and remove national forest timber of

equal value on acreage to be definitely designated by the

national forest officer before cutting.    This Court concluded

that under Oregon State law, because an agreement to cut and

remove standing timber from the land immediately or within a

reasonable time was an agreement for the sale of goods only, the

property rights acquired under the agreement were personalty.

See 

   Accordingly, this Court held that the taxpayer’s

exchange was of realty for personalty and was thus not an

exchange of properties of like kind.    See 

-

     Noting that some Oregon case law arguably supported a

contrary view that a sale of standing timber is deemed to be a

conveyance of an estate upon condition subsequent, this Court

stated:

          Arguendo, if, from the record, we were able to
          find and hold that the standing timber was realty
          in the hands of the petitioner, we must
          nevertheless reach the same conclusion as above
          for the reasons stated below.

                  *    *     *     *      *   *   *

          * * * petitioner exchanged a fee simple title for
          a limited right to cut and remove standing timber.
          It is our conclusion that the right to cut and
          remove standing timber is so intrinsically
          different from a fee in land that an exchange of
          one for the other is not an exchange of like
          property within * * * [the meaning of the
          predecessor statute to section 1031]. [Id. at
          197.]

     Petitioners argue that Oregon Lumber Co. v. 

, is distinguishable because under Georgia State law, both

sets of property involved in petitioner’s exchange constituted

realty.   Furthermore, petitioners argue, the above-quoted

statements from Oregon Lumber are dicta and thus not controlling.

     We agree with petitioners that under Georgia State law, the

prevailing view appears to be that a conveyance of standing

timber, to be severed by the buyer, generally constitutes a

transfer of real property.   See Smith v. Alexander & Bland, 

(Ga. 1929); McLendon Bros. v. Finch, 

, 691-692

(Ga. 1909); McRae v. Stillwell, 

(Ga. 1900); Chavers
                             - 21 -

v. Kent Diversified Prods., Inc., 

, 262-263 (Ga.

Ct. App. 1989).8



     8
       Some Georgia case law arguably supports respondent’s
contention that the property petitioner relinquished constituted
personalty. In Johnson v. Truitt, 

, 136 (Ga. 1905),
the contractual right of a purchaser to cut standing timber
within 12 months was referred to as “merely a license to cut and
remove the timber for the purposes stated, during the time fixed
in the contract.” See also Graham v. West, 

(Ga.
1906) (sale of standing timber where the growing trees are to
remain in the soil for a fixed time or indefinitely concerns an
interest in the land, but if the trees are to be immediately
severed and carried away, the sale is of personal property). In
North Ga. Co. v. Bebee, 

, 874 (Ga. 1907), the Georgia
Supreme Court cited Johnson v. 

, with approval for
the proposition that “the owner of the land may convey a right to
cut and remove timber within a specified time, in which case the
absolute title to the timber described does not pass to the
purchaser, but only a license to use it for the purpose stated,
during the period specified in the contract.” To the same
effect, see also Seabolt v. Christian, 

, 543 (Ga.
Ct. App. 1950); Pope v. Barnett, 

, 518 (Ga. Ct. App.
1932).

     In Camp v. Horton, 

, 353 (Ga. 1909), the Georgia
Supreme Court reviewed other Georgia precedents to contrary
effect and concluded that the above-quoted language from Johnson
v. 

, was “not essential to the decision of the case
or the correctness of the judgment”. See also Chavers v. Kent
Diversified Prods., Inc., 

, 263 (Ga. Ct. App. 1989)
(dicta in Johnson v. 

, is not controlling).

     In short, on the issue of whether an agreement for the sale
of growing trees is a contract for the sale of an interest in
land, Georgia State law is less than a seamless web of
jurisprudence. In this regard, Georgia State law is not unique.
With regard to this legal issue, among the various States “There
is considerable difference of opinion, often in the same
jurisdiction, * * * undoubtedly due to diverse theories of the
courts with respect to the exact nature of standing trees.”
Davis, Annotation, Sale or Contract for Sale of Standing Timber
as Within Provisions of Statute of Frauds Respecting Sale or
Contract of Sale of Real Property, 

, 518 (1949).
                             - 22 -

     In arguing that the properties are of like kind, petitioners

rely in part on Commissioner v. Crichton, 

(5th Cir.

1941), which held that an undivided fractional interest in

mineral rights on unimproved country land was of like kind to

undivided interests in improved city lots.   Petitioners cite

Crichton for the proposition that section 1031 is to be liberally

construed to effect legislative intent and that the only

distinction that would justify disqualification must be “the

broad one between classes and characters of properties, for

instance, between real and personal property.”   

see

also sec. 1.1031(a)-1, Income Tax Regs.9   Petitioners argue that


     9
       In pertinent part, sec. 1.1031(a)-1, Income Tax Regs.,
provides as follows:

                (b) Definition of “like kind.” As used
          in section 1031(a), the words “like kind”
          have reference to the nature or character of
          the property and not to its grade or quality.
          One kind or class of property may not, under
          that section, be exchanged for property of a
          different kind or class. 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.
          Unproductive real estate held by one other
          than a dealer for future use or future
          realization of the increment in value is held
          for investment and not primarily for sale.
          * * *

               (c) Examples of exchanges of property of
          a “like kind.” No gain or loss is recognized
          if * * *
                                                   (continued...)
                               - 23 -

under Crichton, “the conveyance of an entire interest in a

delineated natural resource treated as real property under state

law constitutes like kind property * * * when exchanged for other

real property interests.”   In support of their position,

petitioners also cite Rev. Rul. 68-331, 1968-1 C.B. 352

(leasehold interest in a producing oil lease is like kind to an

improved ranch), and Rev. Rul. 55-749, 1955-2 C.B. 295 (perpetual

water rights are like kind to land).

     On the other hand, not every exchange of real property

interests meets the section 1031 like-kind requirement.     See Koch

v. Commissioner, 

, 65 (1978) (holding that real estate

subject to a long-term lease is like kind to real estate not so

encumbered).10   For instance, carved-out oil payments, although

characterized as real property under State law, are not like kind

to a fee interest in real estate.   See Fleming v. Commissioner,



     9
      (...continued)
                    (2) a taxpayer who is not a dealer
          in real estate exchanges city real estate for
          a ranch or farm, or exchanges a leasehold of
          a fee with 30 years or more to run for real
          estate, or exchanges improved real estate for
          unimproved real estate * * *
     10
       In Koch v. Commissioner, 

, 65 (1978), this
Court stated that sec. 1031 requires a comparison of all factors
bearing upon the “nature and character” of the exchanged
properties as opposed to their “grade or quality.” These factors
include “the respective interests in the physical properties, the
nature of the title conveyed, the rights of the parties, [and]
the duration of the interests”. 

-

, 823-824 (1955), revd. 

(5th Cir. 1957),

revd. sub nom. Commissioner v. P.G. Lake, Inc., 

(1958); see also Clemente, Inc. v. Commissioner, T.C. Memo. 1985-

367 (8-acre parcel of land was not like kind to gravel extraction

rights in another parcel of land).       In addition, for purposes of

section 1031, a short-term leasehold of real property is not

equivalent to a fee interest.    See Capri, Inc. v. Commissioner,

, 181-182 (1975); May Dept. Stores Co. v.

Commissioner, 

, 556 (1951); Standard Envelope

Manufacturing Co. v. Commissioner, 

, 48 (1950).11

     Because of the posture of this case, it is unnecessary, and

we do not undertake, to resolve the legal issue whether the like-

kind requirement was satisfied.    It suffices to find, as we do,

that petitioner had a bona fide intent that the subject

transaction would meet the like-kind exchange requirement, taking

into account that it constituted an exchange of realty for

realty.

     Other relevant factors indicating that petitioner had, at

the beginning of the exchange period, a bona fide intent that

like-kind property would be acquired before the end of the 180-


     11
       Notably, this characterization of short-term leasehold
interests derives not from any particular State law but from
negative implication of longstanding Treasury regulations which
provide that an exchange of a 30-year lease for a fee interest
qualifies as a like-kind exchange under sec. 1031. See sec.
1.1031(a)-1(c), Income Tax Regs.
                                 - 25 -

day exchange period include:     (1) The agreement that petitioner

and Rayonier entered into on November 29, 1994, expressly made

the transaction conditioned on “reasonable cooperation and a tax

free exchange qualifying under Section 1031”; (2) petitioner used

a qualified escrow account and a proper escrow agent as required

by section 1.1031(k)-1(g)(3), Income Tax Regs.; (3) petitioner

identified and received the replacement properties within the 45-

day and 180-day periods as required by section 1031(a)(3); (4)

petitioner testified credibly that he intended to have a like-

kind exchange; and (5) in planning the transaction, petitioner

relied on advice from a well-known timber taxation expert and

from his long-time accountant.     Moreover, as previously

mentioned, respondent has determined no negligence or accuracy-

related penalty in regard to the subject transaction.

F.   Conclusion

      In light of all the facts and circumstances, we conclude and

hold that petitioners have satisfied the bona fide intent test

and that under section 1.1031(k)-1(j), Income Tax Regs.,

petitioners had no actual or constructive receipt of property in

1994 for purposes of applying the installment sale provisions of

section 453.      We conclude and hold that petitioners recognized no

gain from the subject transaction in 1994 and that respondent’s

determination was in error.
                             - 26 -

     In light of this holding, it is unnecessary to decide the

issue of whether the subject transaction qualifies as a like-kind

exchange within the meaning of section 1031.

     To reflect the foregoing and the parties’ concessions,


                                        Decision will be entered

                                   under Rule 155.