                         T.C. Memo. 1997-493



                       UNITED STATES TAX COURT



          GARY B. AND KATHLEEN MITCHELL, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 20851-95.                  Filed November 3, 1997.



     Douglas Scott Maynard and Basis J. Boutris, for

petitioners.

     Michael F. Steiner and Dale A. Zusi, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION
     GERBER, Judge:    Respondent determined income tax

deficiencies for petitioners' 1987 and 1988 taxable years in the

amounts of $24,716 and $91,878, respectively.    Respondent also

determined additions to tax for negligence in the amounts of

$1,236 for 1987 and $4,594 for 1988.   After considering
                                   - 2 -

agreements and concessions by the parties, the remaining issues

are:       (1) Whether petitioners are entitled to roll over the gain

on the sale of their residence under section 1034,1 (2) if

entitled to roll over the gain whether any of the improvements

made to the new principal residence qualify for the rollover, and

(3) whether petitioners are liable for additions to tax for

negligence for the 1987 and/or the 1988 taxable year(s).

                             FINDINGS OF FACT2

       Petitioners, at the time their petition was filed, resided

in San Jose, California.       Petitioners' 1988 residence (Freemont

property) had not been listed for sale when they were approached

by a real estate broker who presented an attractive offer that

petitioners accepted.       The sale occurred on June 21, 1988.   The

gain realized on the sale of the Freemont property was $238,380.

The sale occurred quickly and petitioners, who were required to

vacate, purchased as a transitional measure the model townhouse

in a new development while they searched for a permanent

replacement residence.       Petitioners were aware that to obtain the

rollover of any gain from the sale of the Freemont property under

section 1034 they would have to obtain and use replacement


       1
       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, unless otherwise
indicated.
       2
       The parties’ stipulation of facts and attached exhibits
are incorporated by this reference.
                                 - 3 -

property as their principal residence by June 21, 1990.     About 15

months after the sale of the Freemont property, petitioners

located and purchased for $314,000 a permanent replacement

residence (Fairway residence).    The Fairway residence was an

older residence that petitioners intended to improve and

modernize.   The interior of the Fairway residence was functional

and completely inhabitable from the date of petitioners'

purchase.    The carport, outside condition, and shrubbery were in

a state of disrepair.    At the time of purchase, petitioners did

not move into the Fairway residence.     Instead they began some

improvements, including tree removal and limited internal

renovations.    They also hired an architect and made plans for

improvements.    The planned improvements, however, were changed at

least once prior to the commencement of substantial internal

renovations of the Fairway residence.     The architectural plans

that were used for the renovations were dated June 5, 1990.

     Petitioners' adult son, Matthew, was transferred to a job

location about 125 miles from his and petitioners' home city.

Matthew sold his home located in the same city as petitioners'

residences, and while he was in transition between jobs and in

the process of establishing his new residence at the new job

location, petitioners allowed Matthew to use the Fairway

residence.   Matthew's use of the house was for several months

during the first half of 1990.    About the time of Matthew's use,

petitioners installed telephone and cable television service.
                              - 4 -

Matthew used the Fairway residence until late May 1990 when he

moved to the townhouse and used it until he purchased a new home

during July 1990.

     During the spring of 1990 petitioners were packing their

personal belongings, planning their move, and arranging for sale

of their interim residence (townhouse).   The townhouse and the

Fairway residence were only a few blocks apart.   Throughout the

period concluding on June 21, 1990, petitioners moved items into

the Fairway residence, including lamps, boxes of clothing,

furniture, and household items.   The townhouse was placed on the

market without a broker by means of a "For Sale" sign and

petitioner wife personally undertook the effort to sell it.    Due

in part to the advice of a real estate developer, petitioners

left some of their furniture in the townhouse and heated and air-

conditioned it during the period it was for sale to improve the

chances of sale.

     On June 20, 1990, petitioners, in order to complete the

process of moving into the Fairway residence, hired movers to

handle some heavy items, including a gun safe, large china

closet, large boxes of books, and other heavy items that they

were unable to move themselves.   As of June 20, 1990 petitioners

had moved all of their belongings into the Fairway residence,

leaving some of their furniture at the townhouse.   On June 20,

1990, the U.S. Postal Service effected petitioners' change of

mailing address from the townhouse to the Fairway residence.
                                - 5 -

Petitioners’ neighbor observed their use of the Fairway residence

prior to June 21, 1990, and believed that petitioners resided

there.

     As of the 2-year deadline, petitioners had moved all of

their personal belongings into the Fairway property; however, the

major renovations had not been commenced as of the June 21, 1990

deadline.   In that connection, a building permit for kitchen and

bathroom additions to the Fairway residence was applied for June

21, 1990, and granted June 27, 1990.    Construction of the kitchen

and bathroom additions was accomplished during the period July

through the fall of 1990.    A building permit for the garage

addition to the Fairway residence was applied for June 21, 1990,

and granted June 27, 1990.    Construction of the garage was begun

during July and completed during the fall of 1990.    The county

building inspector, who inspected the construction at the Fairway

residence location, confirmed that no work was commenced on the

garage, kitchen, or bathroom additions prior to the June 27,

1990, granting of the building permits.    Various inspections

during September 1990 confirmed that the kitchen and bathroom

additions were not yet complete as of that month.    The kitchen

and bathroom additions received their final approval on December

7, 1990.    Numerous checks used as payment for the above-described

construction were dated on or prior to June 21, 1990, but not

negotiated and/or cashed or deposited by the payee until after

June 21, 1990, and mostly during July or August 1990.    Many of
                                  - 6 -

the checks to pay the construction company were dated, and cashed

or negotiated during September, October, and November 1990.

     The following amounts were paid for improvements to the

Fairway residence that were commenced and completed after June

21, 1990:

                 Payee                      Amount
            Fontaine Glass                  $4,858
            Moore Painting                   4,000
            A.B. Plumbing                      148
            Oswaldo de Santiago                150
            R.W. Construction               90,000
            Woodburners                      2,829
            ATNIP Co.                        5,793
            Budget Electric                  4,692
                 Total                     112,470

     The person who ultimately purchased the townhouse

(petitioners' interim residence) first viewed the property during

June 1990 and returned about ten times through the time of

purchase during the spring of 1991.       The purchaser recalled that

the townhouse contained furnishings but the closets and cabinets

were empty in that the townhouse did not contain clothing, food,

or other personal belongings.     The purchaser made the decision to

purchase the townhouse during December 1990 or January 1991.

     The utility usage for the period January through October

1990 reflected that the utility consumption at the townhouse

exceeded that of the Fairway residence.      During the month of

November the utility use at the Fairway residence increased and

decreased at the townhouse (both precipitously) and for December

1990 use at the Fairway residence exceeded that of the townhouse.
                                 - 7 -

The utility use at the Fairway residence, even though less in

amount than at the townhouse, tripled in the May - June 1990

period.   Likewise, telephone use records for July through

November 1990 reflect that more calls were made from the

townhouse during the predawn and evening hours than at the

Fairway residence.   Although a relatively large number of daytime

calls were made from the Fairway residence, many of those calls

concerned the construction and improvements and could have been

made by the construction company.

                     ULTIMATE FINDINGS OF FACT

     Petitioners used the Fairway residence as their principal

residence prior to June 21, 1990.    A total of $112,470 for

improvements petitioners claimed to be commenced and/or

completed, were not commenced or completed prior to June 21,

1990, and do not qualify for rollover of gain under section 1034.

Petitioners misrepresented the amount of basis or cost in the new

property and were negligent.

                                OPINION

     The primary issue here is whether petitioners met the

requirements of section 1034.    That section permits the rollover

or nonrecognition of gain on the sale of a principal residence if

a new residence "is purchased and used by the taxpayer as his

principal residence", in this case, within 2 years of the sale.

Sec. 1034(a).   Petitioners contend that they moved in and

continuously used the Fairway residence as their principal
                                 - 8 -

residence prior to the June 21, 1990, deadline.    Respondent,

relying on utility and telephone usage at the temporary townhouse

and the replacement or principal residence (Fairway), contends

that the record does not support petitioners' contentions and

proffered testimony.

     Section 1.1034-1(c)(3)(i), Income Tax Regs., contains the

following standard for use of a principal residence:

     Whether or not property is used by the taxpayer as his
     residence, and whether or not property is used by the
     taxpayer as his principal residence (in the case of a
     taxpayer using more than one property as a residence),
     depends upon all the facts and circumstances in each
     case, including the good faith of the taxpayer. * * *

Section 1.1034-1(d)(1), Income Tax Regs., explains further that

     if the taxpayer, during the period within which the
     purchase and use of the new residence must be made in
     order to have any gain on the sale of the old residence
     not recognized under this section, purchases more than
     one property which is used by him as his principal
     residence * * *, only the last of such properties shall
     be considered a new residence * * *

      Petitioners bear the burden of showing their entitlement to

the benefits of section 1034 by proving they have satisfied all

of the section's requirements.     Thomas v. Commissioner, 92 T.C.

206, 242 (1989) (citing   Welch v. Helvering, 290 U.S. 111 (1933)

and Rule 142(a)).   In particular, petitioners must show here that

they used the Fairway residence as their principal residence.    In

that regard, we said in Stolk v. Commissioner, 40 T.C. 345, 353,

355 (1963), affd. 326 F.2d 760 (2d Cir. 1964):

     The elements of residence are the fact of abode and the
     intention of remaining, and the concept of residence is
                               - 9 -

     made up of a combination of acts and intention.
     Neither bodily presence alone nor intention alone will
     suffice to create a residence. * * *

     *        *        *         *        *         *        *

          The phrase "used by the taxpayer as his principal
     residence" means habitual use of the old residence as
     the principal residence. The antithesis is nonuse of
     property as the principal residence. [Citations
     omitted; fn. ref. omitted; see also Thomas v.
     Commissioner, supra.]

     Petitioners sought to rollover any gain realized on the sale

of their Freemont property by the purchase of a permanent

replacement residence (Fairway residence) within the 2-year

period.   After the unexpected receipt of an offer and the sale of

their Freemont property, petitioners purchased a townhouse as a

temporary or interim residence until a permanent replacement

property could be located.   There is no question that the

townhouse then became petitioners’ principal residence which was

used prior to the June 21, 1990, deadline under section 1034.

Just 15 months after the Freemont property sale, however,

petitioners purchased the Fairway residence and moved their

personal belongings, other than some furniture3, into the new

residence prior to the 2-year deadline under section 1034.

Petitioners also planned to make improvements to the Fairway

residence but were not able to begin the vast majority of such

improvements until after the 2-year period ended.

     3
       Some of petitioners' furniture was left in the townhouse
to enhance its salability rather than leaving that property empty
while petitioners attempted to sell it.
                              - 10 -

     Petitioners changed their mail delivery from the townhouse

to the Fairway residence, established telephone and other utility

services at the Fairway residence, and their son Matthew lived

there for a period of time prior to the 2-year deadline.

Petitioners, during May 1990, caused Matthew to move out of the

Fairway residence so that they could move in.   Matthew had to

store some of his furniture and moved to the townhouse which he

intermittently used until he purchased his own property during

July 1990.

     Petitioners intended to and did make Fairway, both legally

and physically, their principal residence prior to the June 21,

1990, deadline.   Respondent, however, has shown by competent

evidence that petitioners’ use of the townhouse was substantial

for about 6 months following the deadline.   Respondent has shown

that the townhouse utility usage was at least five times larger

than the Fairway residence utility usage during the critical

period just following June 21 through November 1990 when

construction at the Fairway residence was completed.    For

example, the July 1990 utility costs for the townhouse and

Fairway residence were $110.95 and $20.90, respectively.

     Petitioners counter that the townhouse property was being

intermittently used by Matthew, and that the air-conditioning was

being operated to better facilitate the showing and sale of the

townhouse which had been offered for sale since June.

Petitioners further explained that they were attempting to sell
                              - 11 -

the property without a broker and that petitioner wife spent her

days at the property, using the telephone and doing the family's

laundry while she was posted there for the sale of the townhouse.

Petitioners also attempt to explain a pattern of telephone calls

reflecting that the townhouse telephone was used more and at the

crucial times (early and late in the day) when a family member

would normally be home, by explaining that:   plans were being

made for Matthew's wedding; Matthew was using the phone early and

late in the day when he stayed in the townhouse; and petitioner

wife would use the phone while she was at the townhouse.

     Although petitioners' explanations would account for some of

the inconsistencies between the utility bills and petitioners’

alleged use of Fairway and/or townhouse, the evidence in this

case supports our finding that the townhouse property was being

used to an extent greater than has been explained by petitioners.

Petitioners have shown by a preponderance of the evidence that

they used Fairway as their principal residence prior to June 21,

1990.   That evidence includes their testimony and that of their

son, Matthew, a business associate, a neighbor, a construction

workman, and the buyer of the townhouse, all of whom corroborate

petitioners' testimony about their use of the Fairway residence

as their principal residence prior to June 21, 1990. However, a

disparity remains between petitioners' explanation and certain of

the evidence in the case.
                              - 12 -

     From our perspective, the disparity between respondent's

circumstantial evidence and the petitioners' evidence is due to

petitioners' attempt to show that the improvements to the Fairway

residence were begun and/or completed prior to June 21, 1990.

Petitioners make this argument in order to rollover additional

gain in the amount of $112,4704 in improvements to Fairway.    By

contending that they continuously used the Fairway residence from

May 1990 on, petitioners counter one of respondent's arguments

that the Fairway residence was uninhabitable due to the extensive

improvements and disruption to the property.   In an attempt to

show that the Fairway residence's improvements were begun prior

to June 21, 1990, petitioners contended that they had moved into

the Fairway residence and stayed there throughout the period

under consideration.   This contention is apparently to give the

appearance that the Fairway residence did not need or undergo

extensive renovations after June 21, 1990.

     Although petitioners had purchased what they intended to be

the permanent replacement residence (Fairway) 7 months before the

June 21, 1990, deadline under section 1034, the Fairway residence

was older and in need of extensive internal renovations.

Petitioners were at all times acutely aware of the deadline and

attempted to make plans to improve the Fairway residence prior to


     4
       The $112,470 would represent nearly one-half of a $238,380
gain realized on the Freemont property for which petitioners seek
rollover under sec. 1034.
                              - 13 -

moving in.   An architect was hired and the plans were made and

revamped; however, the major renovations were not begun or made

before the June 21, 1990, deadline.    Confronted with this

situation, petitioners moved into the Fairway residence in late

May 1990 and used the property in a manner and amount that would

satisfy its use as a permanent residence under the statute and

then began the more extensive renovations which created the

inconvenience and/or forced limited use of the Fairway residence.

In that regard, the residence’s master bedroom and bathroom were

under construction.   Additionally, a garage was being constructed

adjacent to the residence.   These renovations created conditions

which, at very least, made the Fairway residence less than

habitable.   At the end of June 1990, after petitioners had used

Fairway as their principal residence, they obtained the building

permits and the extensive renovation was begun.    It was after

that time they utilized the townhouse to ameliorate the

inconvenience caused by the extensive renovations.    They argued

that their use of Fairway was continuous in order to show that

the renovations were begun before June 21, 1990, and that there

was no change in the residence's condition or their usage.5 The


     5
       In connection with that argument, petitioners dated
numerous checks (that were eventually used to pay for
renovations) June 21, 1990 (the last day in the 2-year period),
but did not negotiate them and/or the checks were not cashed by
the payees until substantially after June 21, 1990. Most of the
"June 21 checks" were cashed by the construction/payees during
July and August 1990.
                             - 14 -

record, however, only supports petitioners' argument that Fairway

was used as their principal residence prior to the critical date,

but the improvements were not begun within that same time frame.

     Petitioners' attempt to concoct a scenario to be able to

defer gain based on the renovations caused their testimony, and

that of five people they called as witnesses, to be incongruous

and out of sync with the circumstantial evidence offered by

respondent.   Based on the record before us, the only logical

explanation for the incongruity is one where petitioners

established the Fairway residence as their principal residence

and then relied on the townhouse to get them through the heavy

renovation construction that was commenced after the June 21,

1990 deadline.

     Respondent cites several cases where the taxpayer only

partially complied with the use requirement of section 1034.    For

example, in Bayley v. Commissioner, 35 T.C. 288 (1960), moving a

few pieces of furniture was insufficient to satisfy the used as

principal residence requirement.   In Henry v. Commissioner, T.C.

Memo. 1982-469, even circumstances beyond the taxpayer's control

that kept them from moving into the new residence did not

mitigate or obviate the use requirement.   Here, petitioners used

Fairway as their principal residence and took the necessary legal

and physical steps to make Fairway their permanent residence.

The precarious aspect of petitioners’ situation is their

ownership of two residences, presenting the question as to which
                              - 15 -

should be considered the principal one.   It was this aspect that

allowed respondent to make a presentation showing the potential

for petitioner's failure to meet the strict requirement of

section 1034.   Ultimately, however, petitioners passed the

threshold use test, and then proceeded to renovate necessitating

their use of the townhouse to allay the inconvenience and

difficulties encountered in their renovation.   We hold that the

Fairway residence was used as petitioner's principal residence

prior to the 2-year limit on June 21, 1990.

     We also note that petitioners, although well aware of the 2-

year limitation and even though they purchased what was to be

their permanent replacement residence 7 months prior to the 2-

year deadline, allowed matters to slip to the point where they

risked losing the benefit of any rollover whatsoever.   The timing

in this case placed petitioners in a precarious position where

they attempted to make it appear that renovations were commenced

and/or completed, when they were not.   By waiting until the very

end of the 2-year period, petitioners risked losing any section

1034 benefit.

     Respondent, in the event that we decide that petitioners met

the threshold test of section 1034 regarding the Fairway

residence, alternatively argues that petitioners are not entitled

to treat $112,470 of the improvements made to the Fairway

residence as part of the cost of that residence for purposes of

section 1034.   Section 1.1034-1(b)(7), Income Tax Regs., defines
                               - 16 -

the "Cost of purchasing the new residence" as the "total of all

amounts which are attributable to the acquisition, construction,

reconstruction, and improvements constituting capital

expenditures".    Unless the reconstruction or improvement to the

new residence is commenced within the replacement period, none of

the cost may be considered part of the "Cost of purchasing the

new residence".    See, e.g., sec. 1.1034-1(b)(7), (c)(4)(iii),

Income Tax Regs.

     The record is replete with evidence that the improvements

claimed to have been made by petitioners were not begun prior to

June 21, 1990.    The dates that checks were negotiated and/or

cashed, the dates of building permits and inspections, and the

testimony of the county building inspector all firmly establish

that the garage, kitchen, and bathroom additions/renovations were

not commenced until after June 21, 1990, and, therefore, that

petitioners’ expenditures for those projects do not enter into

the cost of the new residence eligible for rollover treatment.

We hold that $112,470 of the improvements to the Fairway

residence were commenced after June 21, 1990, and do not qualify

for section 1034 treatment.    See Kern v. Granquist, 291 F.2d 29

(9th Cir. 1961).

     Finally, we consider whether petitioners are liable for

additions to tax attributable to their negligence for 1987 and

1988.   Respondent determined additions to tax for negligence

under section 6653(a)(1)(A) and (B) for 1987 and section
                                - 17 -

6653(a)(1) for 1988.    For 1987, if any part of the underpayment

is due to negligence, the addition to tax is 5 percent of the

underpayment, plus 50 percent of the interest due on the part of

the underpayment that is due to negligence.    In this instance,

respondent determined that the entire underpayment was due to

negligence.   For 1988, if any part of the underpayment is due to

negligence, the addition to tax is 5 percent of the underpayment.

     Negligence is defined as the lack of due care or failure to

do what a reasonable and ordinarily prudent person would do under

the circumstances.     Neely v. Commissioner, 85 T.C. 934, 947

(1985).    Petitioners bear the burden of proving that additions to

tax do not apply.    Rule 142(a); Luman v. Commissioner, 79 T.C.

846, 860-861 (1982).

     Petitioners claimed on their return that substantial amounts

of renovations ($112,470) were part of the cost of the new

residence and thus eligible for section 1034 treatment, knowing

that those renovations had not been begun prior to the 2-year

limit.    Compounding their claim, they dated checks to make it

appear that the total amount claimed on their tax return

qualified, knowing that such dates were not correct.

Accordingly, for the 1988 taxable year in which petitioners would

have been required to report any gain which was not rolled over,

they are negligent.    In addition, petitioners did not offer any

evidence to show that any portion of any underpayment for 1987
                                  - 18 -

was not due to negligence.6      Petitioners simply argue that they

are entitled to section 1034 treatment and, accordingly, are not

negligent.       That argument only addresses the negligence issue for

1988.       Regarding respondent's 1987 negligence determination,

petitioners have failed to carry their burden inasmuch as they

did not present any evidence relevant to that determination.

     We hold petitioners liable for additions to tax for

negligence for 1987 and 1988, as determined by respondent, to the

extent of any underpayment decided for those years.

     To reflect the foregoing and concessions of the parties,

                                        Decision will be entered

                                   under Rule 155.




        6
       The 1987 income tax deficiency was based on seven income
adjustments and a self-employment tax adjustment. Of the seven
adjustments, respondent appears to have conceded one and the
parties settled the others.
