T.C. Memo. 2007-369



                       UNITED STATES TAX COURT



         J. RAMSAY FARAH AND ELIZABETH FARAH, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 23412-05.           Filed December 19, 2007.


     Jurist Bruce Howard, for petitioners.

     Jay A. Roberts and Ann M. Welhaf, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     HAINES, Judge:    Respondent determined a deficiency in

petitioners’ Federal income tax of $170,925 and a penalty under

section 6662(a) of $34,185, for 2001.1



     1
      Unless otherwise indicated, section references are to the
Internal Revenue Code, as amended. Rule references are to the
Tax Court Rules of Practice and Procedure. Amounts are rounded
to the nearest dollar.
                                -2-

     After concessions,2 the issues for decision are:   (1)

Whether petitioners may exclude the gain on the sale of their

Berlin home under section 121; (2) whether petitioners may also

exclude the gain on the sale of the South Point Road lot under

section 121; and (3) whether petitioners are liable for a penalty

under section 6662(a).

                         FINDINGS OF FACT

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

The stipulation of facts, the exhibits attached thereto, and the

stipulation of settled issues are incorporated herein by this

reference.   At the time they filed their petition, petitioners

resided in Hagerstown, Maryland.

Background

     In 1976, petitioner Dr. J. Ramsay Farah (Dr. Farah) opened

his pediatric medical practice in Hagerstown, Maryland.3      Over

the years, petitioner Elizabeth Farah (Ms. Farah) also worked for

the medical practice assisting with various administrative

duties.   However, she always worked from her home.



     2
      Petitioners concede they are not entitled to a loss of
$45,733 from their Schedule E, Supplemental Income and Loss,
rental real estate activities, and they are not entitled to
Schedule C, Profit or Loss From Business, deductions of $64,915.
Petitioners also concede they failed to report State income tax
refunds of $3,354.
     3
      At various times from 1980 through 1998, Dr. Farah operated
medical offices in Waynesboro, Pennsylvania, and Boonsboro,
Maryland, in addition to his Hagerstown practice.
                                 -3-

     On November 13, 1976, Dr. Farah was appointed to the medical

staff of Washington County Hospital in Hagerstown, Maryland.     In

May 1977, petitioners purchased a large, historic house located

at 1003 The Terrace, Hagerstown, Maryland (Hagerstown house).     At

the time of trial in this case, petitioners still owned the

Hagerstown house.   Dr. Farah has always maintained an office in

the Hagerstown house.   Since 1980, he has used the Hagerstown

address as the business address for his medical practice and

myriad other business activities.

     In addition to their work in the medical practice, since

1992, petitioners have been general partners in the Boonsboro

Medical Center Partnership (Boonsboro Partnership), which owns

and leases office space to various tenants including physicians.

Dr. and Ms. Farah own a 71.74-percent and 1.74-percent interest

in the Boonsboro Partnership, respectively.

The Purchase of the Berlin House and the South Point Road Lot

     On October 18, 1989, petitioners purchased a piece of

waterfront property consisting of 3.27 acres and a house located

at 5922 South Point Road, Berlin, Maryland (Berlin house).

Petitioners intended to use it as a summer home and eventually

make it their retirement home.

     The property was originally listed for sale for $399,000.

However, the sellers accepted petitioners’ offer of significantly

less, either $315,000 as respondent contends or $365,000 as
                                 -4-

petitioners contend.    The contract for sale lists the purchase

price as $315,000.    The form HUD-1 settlement sheet issued at the

closing also lists the total purchase price as $315,000.      An

addendum to the contract provides that $50,000 is to be paid for

“personal property not specifically included in the contract for

purchase.”    Petitioners executed a promissory note in the amount

of $50,000 in favor of the sellers.    The note carried a term of 5

years and called for $5,000 of interest to be paid.

     Over the years, petitioners made significant improvements to

the Berlin house, costing a total of $274,375, to make it a

suitable retirement home.    In addition to improving the house,

petitioners required additional land for a yard and septic

drainage field as most of the property surrounding the Berlin

house was marshland.    To that end, petitioners planned to

purchase the 2.39 acre unimproved lot adjacent to the Berlin

house, known as Lot 1, Minor Subdivision of W.V. Krewatch Land,

South Point Road Berlin, Maryland (South Point Road lot).

     On April 6, 1991, on the advice of counsel, petitioners

formed the J. Ramsay Farah Family Partnership (Family

Partnership), a Maryland general partnership for the purpose of

owning and developing the South Point Road lot.    Petitioners

purchased the land through the partnership to help protect the

property from liabilities arising from Dr. Farah’s medical

practice.    Dr. Farah was told by counsel that holding the land
                                 -5-

with his children would make it difficult to attach.    Upon

formation of the Family Partnership, Dr. and Ms. Farah each held

a 35-percent interest.    Two of their four children, Frederick

Farah (then age 17) and Veronica Farah (then age 11), each owned

15-percent interests.4   The partnership agreement was signed by

Dr. and Ms. Farah.    It was not signed by either of their

children, nor did either child make a capital contribution to the

Family Partnership.    The Family Partnership did not register as a

business entity in the State of Maryland or obtain an employee

identification number.

     On the day of its formation, the Family Partnership

completed the purchase of the South Point Road lot.    At the time

of purchase, the only structure on the lot was a tool shed.

There was no separate electricity line, well, sewer line, or

septic system.   At the closing, petitioners paid $51,880 in cash.

The balance of the purchase price was financed through a

promissory note and a purchase money mortgage to the seller made

by the Family Partnership.

     Petitioners made improvements to the South Point Road lot.

They constructed a bulkhead and concrete path that extended along

the shoreline from the Berlin Residence property into the South

Point Road lot to protect the property from the water.     They also

constructed a fence that went around both properties.    The lots

     4
      Petitioners also had two older children, Patrick Farah and
another whose name was not disclosed in the record.
                                -6-

were landscaped, and petitioners constructed a chain link dog

enclosure.

Petitioners’ Move to Berlin

     In the spring of 1997, Veronica Farah, petitioners’

daughter, was accepted as a freshman at Salisbury State

University.   It was the only school to which she applied.

Salisbury State University is located in Salisbury, Maryland,

approximately a 30-minute drive from petitioners’ Berlin house.

     At that time, Veronica required heightened parental

supervision and support, including the regular administration of

medication.   To support their daughter, petitioners planned to

move with her to the Berlin house.    In preparation for the move,

Dr. Farah put his Hagerstown medical practice up for sale in

September 1997.   He also closed his Boonsboro practice.   In June

1998, Dr. Farah completed the sale of his Hagerstown medical

practice.

     Ms. Farah moved to the Berlin House in July 1997 to be with

Veronica, who was enrolled full time at Salisbury State

University from the fall term of 1997 through the fall term of

2001.   In addition to her studies, she worked part time at

various restaurants and night clubs in Ocean City, Maryland.      Ms.

Farah drove Veronica to and from class, as well as to and from

her part-time jobs.   Both Veronica and Ms. Farah received medical
                                 -7-

treatment, including surgery, in Salisbury, Maryland, near

petitioners’ Berlin home.

     While living in Hagerstown, petitioners were involved in

several social and community activities, such as the Rotary Club,

the Northwood Swim Club, the YMCA, and the Maryland Symphony

Orchestra.    Around the time of their move to the Berlin residence

they discontinued their membership or involvement with these

activities.

     In May 1998, Dr. Farah began working part-time for Sierra

Military Health (Sierra) as an Associate Medical Director at

Sierra’s office, located in Baltimore, Maryland.   Among many

other responsibilities, Sierra credentials hospitals that provide

care to military personnel and their dependents.

     In October 1998, Dr. Farah was promoted to full medical

director working in quality assurance.   The position required

that he work 3 days a week at Sierra’s Baltimore office.

Baltimore is approximately 75 miles from Hagerstown and 138 miles

from Berlin.   Dr. Farah traveled extensively from Baltimore to

various clinics and medical facilities located along the east

coast from Maine to northern Virginia.   Dr. Farah continued his

employment with Sierra until March 28, 2005.

     His position with Sierra required that he perform a half-day

of clinical work each week, which he did with Towson Express,
                                -8-

located in Towson, Maryland, a suburb of Baltimore.   Towson is

approximately 78 miles from Hagerstown and 152 miles from Berlin.

      Until October 1998, Dr. Farah served as Medical Director at

Victor Cullen Academy, a home for juvenile detainees, located in

Sabillasville, Maryland.   On October 7, 1998, his Service

Agreement with Victor Cullen Academy was terminated because he no

longer lived within 20 miles of the facility.   Hagerstown is

approximately 17 miles from Sabillasville.   Berlin is more than

200 miles from Sabillasville.

     On April 30, 1999, Dr. Farah neglected to renew his

membership on the medical staff of Washington County Hospital, in

Hagerstown.   Although Dr. Farah traveled extensively, as often as

possible he returned to Berlin at the end of a workday.    He was

always in Berlin on weekends and other nonworking days to be with

his family.

Use of the Hagerstown House from July 1997 to September 2001

     Before the completion of the sale of his medical practice in

June 1998, Dr. Farah spent considerable time in the Hagerstown

house.   After the sale of his practice, Dr. Farah visited the

Hagerstown house more frequently than his wife did.   He would

return at least once a month to collect bulk mail sent there.

     In contrast, Ms. Farah rarely went to the Hagerstown house.

In August of 1999, she stayed in the Hagerstown house for the

baptism of her grandson and to renew her driver’s license.   To
                                 -9-

perform her management duties with the Boonsboro Partnership, Ms.

Farah rarely went to the Boonsboro building.   She handled all

bills and tenant issues by mail or by phone from Berlin.

     Although they spent little time in Hagerstown, petitioners

always used the Hagerstown address as their mailing address.

They used the Hagerstown address on their voter registrations,

their vehicle registrations, their driver’s licenses, and on all

Federal and State income tax returns.   During the relevant years,

Maryland imposed a local income tax based on the county in which

the taxpayer lived.   Although the rates changed year to year, a

taxpayer domiciled in Hagerstown paid a tax rate of approximately

2.5 percent, while a taxpayer domiciled in Berlin paid only 1

percent during the relevant period.    See Md. Code Ann., Tax-Gen.

sec. 10-106 (LexisNexis 2004).

     All bills associated with the Berlin house were sent to

Hagerstown.   Petitioners also used the Hagerstown address as

their mailing address for two shoreline construction permits

obtained for the Berlin house.

     Petitioners did not stop water or utility service to the

Hagerstown house at any time.    Both water usage and electricity

usage remained consistent from July 1997 through January 2007.5


     5
      The average quarterly water usage at the Hagerstown house
from July 15, 1997 through Oct. 12, 2001 was 128.22 units. The
average quarterly water usage at the Hagerstown house from Oct.
12, 2001 through Jan. 23, 2007 was 113.45 units. The average
                                                   (continued...)
                               -10-

     Christina Farah, who would later marry and divorce

petitioners’ son, moved into the Hagerstown house with

petitioners in 1996.   She left in July 1997 to live in Texas with

petitioners’ son, Patrick Farah.   She returned to Hagerstown in

January 1998 and stayed until October 1998.   Christina’s first

son was born November 27, 1998, in Dallas, Texas.   Petitioners

spent Christmas of 1998 in Dallas with Patrick and Christina.

Christina returned to Hagerstown in January of 1999.   After that,

she would go to Dallas periodically for visits usually lasting a

week or a weekend.   Because Christina’s husband was abusive at

times, petitioners allowed her to stay in the Hagerstown house

rent-free to provide a safe and secure environment for Christina

and her children, petitioners’ grandchildren.

     Christina often forwarded petitioners’ mail to them at their

Berlin home.   She also spent holidays with petitioners at their

Berlin home.   When Christina was not in Hagerstown, petitioners’

son Frederick Farah, who liked to use the hot tub at the

Hagerstown house with his friends, would go there to forward the

mail.




     5
      (...continued)
electricity usage at petitioners’ Hagerstown house from July 15,
1997 through Oct. 11, 2001 was 2,867.62 kilowatt hours. The
average electricity usage at petitioners’ Hagerstown house from
Nov. 9, 2001 through Feb. 14, 2007 was 3,080.23 kilowatt hours.
                                -11-

Petitioners’ Move Back to Hagerstown and the Sale of the Berlin
House and the South Point Road Lot

       In January 2001, Ms. Farah was diagnosed with an aggressive

and rare form of lung cancer requiring major surgery and medical

followup.    At that time, petitioners were unsure of her chances

of survival and their prospects for the future.    As they needed

additional funds, and felt Ms. Farah’s future medical needs would

be best served in a major medical center, petitioners decided to

sell the Berlin house and the South Point Road lot.

       In March 2001, Dr. Farah consulted with his attorney

regarding his estate plan and the sale of the two properties.    On

March 11, 2001, petitioners entered into a listing agreement to

sell the Berlin residence, together with the South Point Road

lot.    The listing agreement listed the owner of the South Point

Road lot as the Family Partnership.    Petitioners never considered

selling the properties separately.

       In the spring of 2001, Dr. Farah was a candidate for a

position on the Maryland Board of Physician Quality Assurance

(BPQA).     Dr. Farah’s candidate submission to the BPQA

represented that he resided in Hagerstown, Maryland.    In May

2001, Dr. Farah began working part time as the Medical Director

for Colonial Management Group in Hagerstown, Maryland.

Consequently, Dr. Farah began spending more time in Hagerstown.
                                -12-

       On September 24, 2001, petitioners had most of the

furnishings of the Berlin house packed and shipped to Hagerstown.

On October 27, 2001, both the Berlin house and the South Point

Road lot were sold to one buyer for a total of $1,300,000.      At

the closing, the settlement company prepared separate form HUD-1

settlement sheets for the Berlin house and the South Point Road

lot.    Petitioners did not know there would be separate settlement

sheets for the two properties until the day of the closing.     The

separate settlement sheets allocated $800,000 of the sales

proceeds to the Berlin residence and $500,000 to the South Point

Road lot.    The allocation of the $1,300,000 between the two

properties was not negotiated by petitioners or the buyer.      The

settlement sheet for the South Point Road lot listed the Family

Partnership as the owner.    No change in ownership of the South

Point Road lot was recorded between its purchase in 1991 by the

Family Partnership and its sale in 2001.

Petitioners’ 2001 Return and the Notice of Deficiency

       On August 15, 2002, petitioners filed their joint Form 1040,

U.S. Individual Income Tax Return, for 2001.    On the Schedule C,

Profit or Loss From Business, attached to their return,

petitioners reported gross receipts of $16,798 and expenses of

$93,145, resulting in a loss of $76,347.    Some of the expenses on

the Schedule C related to Dr. Farah’s employment with Sierra.

Dr. Farah did not maintain his own records for his work
                                 -13-

activities with Sierra.    Instead, he relied on records maintained

by Sierra, which were destroyed in the fall of 2004.

     The Schedule D, Capital Gains and Losses, attached to their

2001 return reported an amount realized of $600,000 from the sale

of their Berlin house and a corresponding adjusted basis of

$600,000.   The Schedule D did not report the sale of the South

Point Road lot.   The Schedule E, Supplemental Income and Loss,

reported a loss from the Boonsboro Partnership of $45,733.

     On September 19, 2005, respondent issued petitioners a

notice of deficiency, disallowing petitioners’ Schedule C

expenses and Schedule E loss.    Respondent also adjusted

petitioners’ income to include a capital gain of $660,371 on the

sale of the Berlin house and the South Point Road lot.

                                OPINION

A.   Burden of Proof

     Generally the taxpayer bears the burden of proving the

Commissioner’s determinations are erroneous.    Rule 142(a).

However, the burden of proof with respect to a factual issue

relevant to the liability of a taxpayer for tax may shift to the

Commissioner under section 7491(a) if the taxpayer has produced

credible evidence relating to the issue, has met his

substantiation requirements, maintained records, and cooperated

with the Secretary’s reasonable requests for documents,

witnesses, and meetings.
                                 -14-

     On brief, petitioners argue that the burden of proof on the

issue of whether the Berlin house was petitioners’ principal

residence should shift to respondent.    Our resolution of the

issue is based on the preponderance of the evidence rather than

the allocation of the burden of proof; therefore, we need not

address petitioners’ section 7491(a) argument.    See Estate of

Bongard v. Commissioner, 

, 111 (2005).    Petitioners

bear the burden of proof on all other issues affecting their

liability for the deficiency in their Federal income tax.

B.   Section 121 and Principal Residence

     Section 121 provides for the exclusion from gross income of

up to $250,000 of gain from the sale or exchange of property, if

the property was owned and used by the taxpayer as the taxpayer’s

principal residence for periods aggregating 2 years or more

during the 5-year period preceding the sale or exchange.    A

husband and wife filing a joint return may exclude a maximum of

$500,000 of the gain from gross income if at least one spouse

meets the ownership requirement and both spouses meet the use

requirement of section 121(a).    Sec. 121(b).

     Petitioners argue that they may exclude the gain from the

sale of the Berlin house and the South Point Road lot from their

gross income pursuant to section 121 because they owned and used

the two properties as their principal residence from July 1997

through September 2001.   Respondent argues petitioners are not
                                   -15-

entitled to the exclusion for either property because the

Hagerstown house was petitioners’ principal residence at all

times.

        Whether a residence qualifies as the taxpayer’s principal

residence for purposes of section 121 is a question of fact that

is resolved with reference to all the facts and circumstances.

Sec. 1.121-1(b)(2), Income Tax Regs.; see also Thomas v.

Commissioner, 

, 244 (1989); Clapham v.

Commissioner, 

, 508 (1975).      “If a taxpayer alternates

between 2 properties, using each as a residence for successive

periods of time, the property that the taxpayer uses a majority

of the time during the year ordinarily will be considered the

taxpayer’s principal residence.”      Sec. 1.121-1(b)(2), Income Tax

Regs.6      In order to meet the 2-year use requirement, occupancy of

the residence is required.7      Sec. 1.121-1(c)(2)(i), Income Tax

Regs.



        6
      Sec. 1.121-1, Income Tax Regs., generally applies to sales
and exchanges that occurred on or after Dec. 24, 2002. However,
for sales or exchanges of a principal residence before Dec. 24,
2002, but after May 7, 1997, taxpayers may elect to apply sec.
1.121-1, Income Tax Regs., by filing a return for the taxable
year of the sale or exchange that does not include the gain from
the sale. Sec. 1.121-4(j), Income Tax Regs. The sale of the
Berlin residence took place on Oct. 27, 2001. Petitioners’ 2001
return did not include the gain from the sale of the Berlin
residence. Therefore, sec. 1.121-1, Income Tax Regs., applies to
the sale. Nevertheless, our decision in this case would be the
same whether or not sec. 1.121-1, Income Tax Regs., applied.
        7
      Short temporary absences, such as for vacation, are counted
as periods of use. Sec. 1.121-1(c)(2)(i), Income Tax Regs.
                                -16-

     For example, if an individual owns homes in New York and

Florida, spending 7 months of the year in the New York home, and

5 months in the Florida home, absent facts and circumstances

indicating otherwise, the New York home is the individual’s

principal residence for all of the year.   Sec. 1.121-1(b)(4),

Example (1), Income Tax Regs.   In contrast, if an individual who

owns homes in Maine and Montana, lives in the Maine home for 2

years, then lives in the Montana home for 2 years, and then

returns to Maine, each house is her principal residence while she

lives there.   Sec. 1.121-1(b)(4), Example (2), Income Tax Regs.

     In addition to the use of the property, other relevant

factors in determining a taxpayer’s principal residence, include,

but are not limited to:

          (i) The taxpayer’s place of employment;

          (ii) The principal place of abode of the
     taxpayer’s family members;

          (iii) The address listed on the taxpayer’s federal
     and state tax returns, driver’s license, automobile
     registration, and voter registration card;

          (iv) The taxpayer’s mailing address for bills and
     correspondence;

          (v) The location of the taxpayer’s banks; and

          (vi) The location of religious organizations and
     recreational clubs with which the taxpayer is
     affiliated.

Sec. 1.121-1(b)(2), Income Tax Regs.
                               -17-

     1.   The Berlin House

     First, we turn to whether the Berlin house, without regard

to the adjacent South Point Road lot, was petitioners’ principal

residence.   Respondent does not dispute that petitioners owned

the Berlin house.   Rather, the dispute centers on petitioners’

use of the Berlin house as their principal residence.   Ms.

Farah’s use of the Berlin house is similar to section 1.121-

1(b)(4), Example (2), Income Tax Regs.   From 1977 to July 1997

she lived in Hagerstown.   After it was purchased in 1989, she

occasionally visited the Berlin house.   In July 1997, she moved

to Berlin, rarely returning to the Hagerstown house until

September 2001, when she moved back to Hagerstown because of the

impending sale of the Berlin house.

     Dr. Farah’s residency is not as simple.   After his wife

moved to Berlin, Dr. Farah continued to spend significant time in

Hagerstown until the sale of his medical practice in June 1998.

After the sale of his medical practice, he spent far less time in

Berlin than his wife because of his work schedule.

     In May 1998, he began working for Sierra, a job that

required him to be in Baltimore 3 days a week.   Baltimore is

approximately 75 miles from Hagerstown and 138 miles from Berlin.

The job also required that he travel extensively, though the

record is unclear whether that travel substituted for his 3 days

in Baltimore.
                                -18-

     In addition to his employment with Sierra, Dr. Farah also

worked at a clinic a half day a week in Towson, Maryland, a

suburb of Baltimore.    Towson is approximately 78 miles from

Hagerstown and 152 miles from Berlin.    Petitioners credibly

testified that Dr. Farah returned to Berlin on the weekends and

on all nonworkdays.    They also credibly testified that he

returned approximately once a month to the Hagerstown house after

the sale of his practice, and before he began working in

Hagerstown in May 2001.    The record is unclear, however, as to

where Dr. Farah stayed while working in Baltimore and Towson, and

how often his work required him to travel to various medical

facilities.   What is clear is that between the sale of his

medical practice in June 1998 and his return to work in

Hagerstown in May 2001, Dr. Farah spent significantly more time

in Berlin than he did in Hagerstown.

     Respondent argues that the consistent usage of utilities

between 1997 and 2007 in the Hagerstown house indicates that

petitioners spent significant time there.    However, the

consistent utility usage is explained by the occupation of the

Hagerstown house by petitioners’ daughter-in-law, Christina

Farah, and after January 1999, her newborn son.

     Respondent argues that because Dr. Farah’s employment with

Sierra called for him to work in Baltimore, which is closer to

Hagerstown than Berlin, his principal residence must be in
                               -19-

Hagerstown.   However, Dr. Farah’s employment history indicates he

stopped residing in Hagerstown in June 1998.   Around the time he

began work for Sierra, Dr. Farah sold his Hagerstown practice,

gave up his privileges at the local Hagerstown hospital, and was

terminated from employment with the Victor Cullen Academy because

he no longer lived in Hagerstown or elsewhere within a 20-mile

radius of the facility.

     Respondent relies heavily on the fact that petitioners used

the Hagerstown address on their tax returns, driver’s licenses,

vehicle registrations, and voter registrations.   Petitioners

explain that they did not change their mailing address because

they wanted to maintain a consistent appearance considering Dr.

Farah’s myriad professional and business activities, including

positions with various State medical boards.   Since 1980, Dr.

Farah has used the Hagerstown address for all of his business

activities.   Petitioners further argue that the addresses were

not changed on their tax returns, voter registrations, driver’s

licenses or vehicle registrations because they still resided in

Maryland, they still owned the Hagerstown house, they did not

believe that changing the address made any difference,8 and they

wanted all mail sent to a single address.



     8
      In fact, petitioners’ residency affected the amount of
Maryland local income tax petitioners paid. The local income tax
rate imposed on residents of Hagerstown is greater than that
imposed on residents of Berlin. See Md. Code Ann., Tax-Gen. sec.
10-106 (LexisNexis 2004).
                                 -20-

     Respondent argues that petitioners’ lack of affiliation with

social organizations in the Berlin area indicates that the

Hagerstown house was their principal residence.    Petitioners were

involved in the Rotary Club, the Northwood Swim Club, the YMCA,

and the Maryland Symphony Orchestra while living in Hagerstown.

The record indicates petitioners discontinued affiliation with

the Hagerstown organizations in 1997.    Petitioners did not become

involved with similar organizations in Berlin.    Petitioners

explain that they did not join a swim club in Berlin because they

lived on the water.   Furthermore, they did not join similar

organizations because Dr. Farah spent a great deal of time

traveling, and Ms. Farah spent much of her time caring for her

daughter.

     For the foregoing reasons, we hold on the preponderance of

the evidence that the Berlin house was Ms. Farah’s principal

residence from July 31, 1997 through September 24, 2001, and that

the Berlin house was Dr. Farah’s principal residence from June

30, 1998 through April 30, 2001.    Therefore, petitioners have

each met the 2-year use requirement of section 121 and are

entitled to exclude up to $500,000 of the gain from the sale of

the Berlin house.9


     9
      The parties dispute   whether the purchase price of the
Berlin house was $315,000   as respondent contends, or $365,000 as
petitioner contends. The    parties stipulated that in addition to
the purchase price of the   property, petitioners are entitled to
                                                      (continued...)
                              -21-

     2.   The South Point Road Lot

     Having decided that the gain on the sale of Berlin house was

excludable under section 121, we now must determine whether the

gain on the adjacent South Point Road lot is also excludable.

Generally, gain from the sale or exchange of vacant land is not

excludable under section 121 unless--

          (A) The vacant land is adjacent to land containing
     the dwelling unit of the taxpayer’s principal
     residence;

          (B) The taxpayer owned and used the vacant land as
     part of the taxpayer’s principal residence;

          (C) The taxpayer sells or exchanges the dwelling
     unit in a sale or exchange that meets the requirements
     of section 121 within 2 years before or 2 years after
     the date of the sale or exchange of the vacant land;
     and

          (D) The requirements of section 121 have otherwise
     been met with respect to the vacant land.

Sec. 1.121-1(b)(3)(i), Income Tax Regs.

     Respondent contends that the South Point Road lot was owned

by the Family Partnership, and therefore, petitioners are not

entitled to exclude the gain under section 121.   Petitioners



     9
      (...continued)
an increase in basis of $282,054 with respect to the cost of
improvements, taxes, and settlement charges. Accordingly, the
adjusted basis of the Berlin house at the time of sale was either
$597,054 or $647,054. The parties stipulated that petitioners
received net sales proceeds of $752,582. Therefore, petitioners
realized a capital gain of either $103,528 or $153,528 on the
sale of the Berlin house. As both of these amounts are less than
the $500,000 exclusion, we need not decide the basis of the
Berlin house.
                                -22-

advance two theories to support their argument that they owned

the property.    First, petitioners argue that the partnership was

never fully implemented and therefore should be disregarded.10

Petitioners argue alternatively that the partnership distributed

the South Point Road lot to petitioners in 1992.    As we determine

that petitioners failed to meet their burden of proving that they

owned the property, we need not address whether petitioners have

met the other requirements of section 121.    See also sec. 1.121-

1(b)(3)(i), Income Tax Regs.

     All relevant documentary evidence shows that when the South

Point Road lot was sold in 2001, the seller was the Family

Partnership.    Petitioners essentially ask us to apply the

substance over form doctrine.    They argue that we should

disregard the form of the transaction (sale by the partnership)

and look instead to the purported substance of the transaction

(sale by petitioners).


     10
      Petitioners do not argue that the Family Partnership
should be “disregarded” as the term is used in sec. 301.7701-
3(a), Proced. & Admin. Regs., which provides that a noncorporate
entity with a single owner can elect to be disregarded as an
entity separate from its owner. Rather, petitioners argue that
the Family Partnership was an alternative means for petitioners
to hold the property in joint tenancy, and therefore, we should
look past the partnership to its purported substance.
     If a residence is owned by a single-owner entity that is
disregarded for Federal tax purposes under sec. 301.7701-3(a),
Proced. & Admin. Regs., the owner is treated as owning the
residence for purposes of the sec. 121 ownership requirement.
Sec. 1.121-1(c)(3)(ii), Income Tax Regs. As the Family
Partnership has multiple owners, it may not be disregarded under
sec. 301.7701-3(a), Proced. & Admin. Regs.
                                 -23-

     We have observed that “‘the taxpayer may have less freedom

than the Commissioner to ignore the transactional form that he

has adopted.’”    Ill. Power Co. v. Commissioner, 

,

1430 (1986) (quoting Bolger v. Commissioner, 

, 767 n.4

(1973)).   In applying the substance over form doctrine, we are

concerned with the intentions of the parties at the time of the

transaction.     Groetzinger v. Commissioner, 

, 542

(1986).

     To prevail, the taxpayer must provide objective evidence

that the substance of the transaction is in accord with the

position argued by the taxpayer rather than the form set forth by

the relevant documents.

   Furthermore, for substance,

as opposed to form, to control the tax consequences of a

transaction, the taxpayer must establish the claimed substance of

the transaction under a heightened burden of proof.       Norwest

Corp. v Commissioner, 

, 140, 145 (1998); Ill. Power

Co. v. Commissioner, supra at 1434.       The strong proof standard

requires the taxpayer to present more than a preponderance of the

evidence in support of his characterization of the transaction.

Ill. Power Co. v. Commissioner, supra at 1434 n.15.

     Petitioners argue that although the South Point Road lot was

purchased by the Family Partnership, the partnership was never

fully implemented, and therefore, it should be disregarded.

However, petitioners stipulated that the Family Partnership was
                               -24-

formed.   They stipulated that the partners were petitioners and

two of their children, and that the partnership purchased the

South Point Road lot.

     Petitioners argue that because their children did not sign

the partnership agreement, contribute to the partnership, and

that the partnership did not register with the state or receive

an employee identification number, the partnership was not fully

implemented.   In determining whether a partnership exists under

Maryland law, the controlling factor is the intent of the

partners to create a partnership.     Cohen v. Orlove, 

,

812 (Md. 1948).   Petitioners admit they intended to form a

partnership to insulate the property from attachment by judgment

creditors.   Their minor children were central to that goal

because petitioners believed partial ownership by the children

would make the property less susceptible to attachment by

judgment creditors.

     Although petitioners’ children did not make contributions to

the partnership, partnerships that are created by gift may be

recognized for Federal tax purposes.    See sec. 704(e); sec.

1.704-1(e), Income Tax Regs.   That the partnership never

registered with the State of Maryland, nor obtained an employee

identification number is not dispositive.

     At all relevant times, petitioners represented that the

property was held by the Family Partnership.    It was not until
                               -25-

receipt of the notice of deficiency that they began to hold

themselves out as the owners of the property.     Therefore, we hold

that petitioners have failed to meet their burden of proving that

the Family Partnership was not fully implemented and should be

disregarded.

     Petitioners argue alternatively that the Family Partnership

distributed the property to them in 1992.     In support of their

position, petitioners introduced into evidence a document

purporting to assign the property to petitioners as tenants by

the entirety.   The document is not a deed.    The purported

transfer was not recorded, and thus record title to the South

Point Road lot remained with the Family Partnership until its

sale in 2001.   The property was never titled in petitioners’

names.   Therefore, property tax bills always listed the owner of

the property as the Family Partnership.    Similarly, the listing

agreement and the form HUD-1 settlement sheet listed the owner as

the Family Partnership, not petitioners.

     Petitioners argue that the property was transferred to

themselves to facilitate a refinancing of the South Point Road

lot and the Berlin house because the lender required the property

be held by petitioners individually.   However, the record

indicates that after petitioners used the proceeds of the

refinancing to pay off the respective purchase loans, there was

no longer a mortgage on the South Point Road lot; the only
                                 -26-

mortgage was on the Berlin house.       Furthermore, it is unlikely a

lender would require a change in ownership, but not require that

the change be reflected by recordation of a deed of transfer.

       Maryland law recognizes that ownership of property may be,

either formally or informally, separated from title to property.

Vlamis v. De Weese, 

(Md. 1958).       However, we cannot

treat lightly the formal manner in which property is held, lest

we subject legal titles to unnecessary uncertainties and

complicate the administration of law.       Estate of Rosenblatt v.

Commissioner, T.C. Memo. 1977-12.

       Petitioners had approximately 10 years in which to record

the change in ownership of the South Point Road lot, but they did

not.    Petitioners contend they had been the owners of the lot

since 1992.    However, when selling the property they listed the

Family Partnership as its owner.    It was not until petitioners

realized ownership of the property through the Family Partnership

produced adverse tax consequences that they held themselves out

as the owners of the property.    Petitioners were free to organize

their affairs as they chose; nevertheless, having done so, they

must accept the tax consequences of their choices, whether

contemplated or not.    See Commissioner v. Natl. Alfalfa

Dehydrating & Milling Co., 

, 149 (1974).

       For the foregoing reasons, we hold that petitioners have

failed to meet their burden of proving they were the owners of
                                -27-

the South Point Road lot.   As they did not own the South Point

Road lot, petitioners are not entitled to exclude the gain on its

sale under section 121.11   Allied Marine Sys., Inc. v.

Commissioner, T.C. Memo. 1997-101, affd. without published

opinion sub nom. Gibbons v. Commissioner, 

(4th Cir.

1998).

C.   Penalty Under Section 6662(a)

     Section 6662(a) imposes a 20-percent penalty on the portion

of an underpayment attributable to negligence or disregard of the

rules or regulations.   Although the Commissioner bears the

initial burden of production and must come forward with

sufficient evidence showing it is appropriate to impose an

accuracy-related penalty, the taxpayer bears the burden of proof

as to any exception to the penalty.    See sec. 7491(c); Rule

142(a); Higbee v. Commissioner, 

, 446-447 (2001).     In

order to meet the burden of proof, a taxpayer must present

evidence sufficient to persuade the Court that the Commissioner’s



     11
      The parties have stipulated that the sale of the South
Point Road lot resulted in a gain of $278,962. In accordance
with the partnership agreement, petitioners had a combined 70
percent profits interest in the Family Partnership. Therefore,
there is a taxable gain to petitioners of their distributive
share of the gain in the amount of $195,273.

     As the Family Partnership qualifies under the “small
partnership” exception to the partnership audit and litigation
procedures, secs. 6221-6233, respondent was not required to issue
a notice of final partnership administrative adjustment to the
Family Partnership. Sec. 6231(a)(1)(B).
                                 -28-

determination is incorrect.     Higbee v. Commissioner, supra at

447.

        Petitioners failed to keep adequate records related to their

business expenses, claimed highly inflated deductions,

misreported the gain from the sale of the Berlin house, and

failed to report the substantial gain from the sale of the South

Point Road lot.     Therefore, respondent has met his burden of

production.

        An accuracy-related penalty is not imposed on any portion

of the understatement as to which the taxpayer acted with

reasonable cause and in good faith.     Sec. 6664(c)(1).   Reliance

on the advice of a tax professional may constitute reasonable

cause and good faith, if under all the facts and circumstances

the reliance is reasonable and in good faith.     Neonatology

Associates, P.A. v. Commissioner, 

, 98 (2000), affd.

(3d Cir. 2002); sec. 1.6664-4(c)(1), Income Tax

Regs.     To qualify for this exception, a taxpayer must prove by a

preponderance of the evidence:     (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.     Neonatology Associates,

P.A. v. Commissioner, supra at 98-99.
                                -29-

     Petitioners argue that they sought professional tax advice

for the preparation and filing of their 2001 return.   Petitioners

presented no evidence of the competence or expertise of their

return preparers.   Therefore, petitioners have failed to meet the

first prong of the Neonatology test.    See G. Kierstead Family

Holdings Trust v. Commissioner, T.C. Memo. 2007-158.

     Petitioners further argue that they provided their return

preparers with all their raw financial data.   Petitioners’ 2001

return listed the amount realized on the sale of their residence

as $600,000 and the adjusted basis as $600,000.   Neither of these

numbers is accurate.    The gross proceeds were $800,000, the net

proceeds were $752,582, and the adjusted basis was either

$597,054 or $647,054.   Furthermore, the return did not report any

amount with respect to the $500,000 of gross proceeds received

from the sale of the South Point Road lot.   Considering these

major errors and omissions, either petitioners failed to provide

their preparers with the necessary information, or the preparers

lacked the expertise to properly file a Federal income tax

return.

     Because petitioners failed to prove they reasonably relied

on a competent tax professional, and because they failed to

assert any other basis for relief, we hold that petitioners

are liable for an accuracy-related penalty under section 6662(a).

     In reaching our holdings, we have considered all arguments
                                 -30-

made, and, to the extent not mentioned, we conclude that they are

moot, irrelevant, or without merit.

     To reflect the foregoing,

                                        Decision will be entered

                                 under Rule 155.