                               T.C. Memo. 2012-118



                         UNITED STATES TAX COURT



     PATRICK A. REESINK AND JILL MITCHEL REESINK, Petitioners v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 2475-10.                           Filed April 23, 2012.



      Woodford Gregory Rowland, for petitioners.

      Chong S. Hong, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      GOEKE, Judge: Respondent determined a deficiency in petitioners’ 2005

joint Federal income tax of $184,349 and a section 6662(a)1 accuracy-related



      1
       Unless otherwise indicated, all section references are to the Internal Revenue
Code (Code) in effect for the year in issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
                                         -2-

penalty of $36,870. After concessions, the issues remaining for decision are:

      (1) whether petitioners’ sale of rental property followed by their purchase of

real estate qualifies as a section 1031 like-kind exchange. We hold that it does;

      (2) whether $60,000 paid to petitioners in settlement of a lawsuit is taxable

income to petitioners. We hold that it is; and

      (3) whether petitioners are liable for the section 6662(a) accuracy-related

penalty in regard to the underpayment resulting from the like-kind exchange, the

settlement proceeds, underreported rental income,2 and travel expenses.3 We hold

that they are liable for the section 6662(a) penalty on portions of the underpayment

associated with the settlement proceeds, rental income, and travel expenses.

                               FINDINGS OF FACT

      Petitioners resided in California at the time their petition was filed. They

married on September 1, 2000, and have two children--Patrick Reesink’s son from a




      2
       Petitioners concede that they underreported $16,392 of rental receipts.
However, they contest whether they should be liable for the associated sec. 6662(a)
accuracy-related penalty.
      3
      Petitioners originally contested respondent’s disallowance of $1,124 of travel
expenses. Petitioners now concede that they are unable to substantiate these travel
expenses.
                                        -3-

prior marriage (born in March 1991) and an adopted son (born in January 1996 and

adopted July 25, 2007).4

      Mr. Reesink was born and raised in San Francisco, California. In the 1970s,

he began working as a butcher and station cook for the Bohemian Club.5 Mr.

Reesink also worked for the Bohemian Grove every summer. In 2000 he bought a

trailer near the Bohemian Grove so that he would have a place to stay while

working there during the summer months. Mr. Reesink continued working for the

Bohemian Club and the Bohemian Grove until 2003 when he began to suffer from a

blood clot in his left ankle. He was declared permanently disabled by the Social

Security Administration as of April 4, 2004, and he began receiving monthly

disability benefits of approximately $1,700 in March 2006. Mr. Reesink was unable

to continue working for the Bohemian Club and the Bohemian Grove as a result of

his disability. Petitioners’ wages decreased from $45,470 in 2002, to $24,671 in




      4
        Petitioners were in adoption proceedings with respect to their adopted son
after they had physical custody in 1999. Mr. Reesink’s son from his prior marriage
lives primarily with his biological mother. Mr. Reesink has been responsible for
paying approximately $490 per month in child support since 1991.
      5
      The Bohemian Club is a private men’s club in San Francisco, California,
which owns the Bohemian Grove. The Bohemian Grove is a 2,700-acre
campground near Guerneville, California.
                                         -4-

2003, $10,105 in 2004, $3,776 in 2005, and zero in 2006. Moreover, Mrs. Reesink

did not earn any wages during 2004, 2005, and 2006.

I. The Reesink Brothers

      In 1985 brothers Patrick and Michael Reesink purchased a six-unit apartment

building (apartment building) on 38th Avenue, San Francisco, California, from their

parents. Each acquired a 50% tenancy in common ownership interest in the

building. And that concludes our record of civil behavior between the two brothers.

At trial Mr. Reesink accused Michael Reesink of attacking and strangling him on

several occasions as well as poisoning him by pouring cleaning fluid into his

drinking water. Conversely, Michael Reesink stated at trial that Mr. Reesink has

left him “holding the bag” on several occasions while Mr. Reesink went out to have

a “real, good, fancy time”. At some time after reviewing the financial statements for

the apartment building, Mr. Reesink determined that Michael Reesink had been

stealing money from him.

      In late 2002 Mr. Reesink sued his brother Michael Reesink in State court for

partition, breach of contract, breach of implied covenant of good faith and fair

dealing, fraud, negligent misrepresentation, and other causes of action with respect

to their joint interests in the apartment building. On September 3, 2004, the brothers

settled the case. Pursuant to the settlement agreement, the brothers agreed to sell
                                         -5-

the apartment building and divide the net proceeds equally. Moreover, the

agreement instructed Michael Reesink to pay $60,000 from his share of the net

proceeds to Mr. Reesink.6

II. The Sale of the Apartment Building

      On September 23, 2005, the brothers sold the apartment building for $1.4

million. Each brother’s pro rata share of the gross sale price was $700,000.

Pursuant to the settlement agreement Michael Reesink paid Mr. Reesink $60,000

via the apartment building sale escrow account. Petitioners elected to pursue a

section 1031 like-kind exchange7 with respect to the proceeds--they paid the

remaining debt and associated expenses of the sale, received $56,417 which they



      6
       The settlement agreement stated “[Michael] shall pay to * * * [Patrick] the
sum of $60,000 as payment in full for his claims arising from the events described in
his complaint.” While the purpose of the $60,000 payment is unclear because of the
multitude of allegations in the complaint, the complaint does not ask for damages to
compensate for physical injury or sickness. However, Michael testified at trial: “I
paid $60,000 to my brother in the sale of the proceeds of the property because he
and I had three physical, violent confrontations over different times.”
      7
        Petitioners were familiar with the concept of sec. 1031 like-kind exchanges
before the sale of the apartment building. In 2003 petitioners sold investment real
estate on Central Avenue, San Francisco, California, and used the proceeds to
purchase investment real estate on Janet Lane, Guerneville, California (Janet Lane
property). The Janet Lane property is a 1,063-square-foot single-family home built
in 1960. It has two bedrooms and one bath, with a total lot size of 6,780 square
feet. Petitioners borrowed $147,000 of the $379,000 purchase price.
                                         -6-

characterized as taxable boot under section 1031(b) on their 2005 income tax return,

and used the remaining $519,843 to purchase property on Laurel Lane in

Guerneville, California (Laurel Lane property). Petitioners did not recognize the

$429,296 gain from the sale of their interest in the apartment building as income on

their 2005 income tax return.

III. The Laurel Lane Property

      After selling the apartment building petitioners began searching for real estate

around Guerneville, California, and the Lake Tahoe area. On one trip to Lake

Tahoe, petitioners met with a realtor from Agate Bay Realty who presented them

with a few options. Petitioners eventually made an offer on one property, but the

deal fell through. Thereafter, Dave Millar, a realtor who had worked with

petitioners on their 2003 purchase of the Janet Lane property, suggested petitioners

take a look at the Laurel Lane property--a 2,226-square-foot single-family home.

      On November 4, 2005, petitioners purchased the Laurel Lane property for

$649,900 as well as an undeveloped adjacent lot for $30,000.8 They received a

residential loan of $138,200 from Home Loans USA to help finance the purchase of



      8
       The Laurel Lane property was built in 1980 and has three bedrooms, three
bathrooms, and a total lot size of 13,939 square feet. The adjacent lot size is 3,094
square feet.
                                          -7-

the Laurel Lane property, subject to a deed of trust. A box was checked on the loan

application indicating that the Laurel Lane property was purchased for investment

purposes. Petitioners paid $27,456 of settlement charges associated with the sale of

the Laurel Lane property. The seller financed $27,000 of the adjacent lot’s selling

price.

         Petitioners posted flyers throughout Guerneville advertising the Laurel Lane

property for rent but did not advertise in the newspaper.9 Mr. Reesink’s other

brother, Richard Reesink, changed light fixtures and installed security lighting at the

Laurel Lane property. He saw “for rent” signs at the Laurel Lane property every

time he was there, which he estimated to be at least 10 or 12 times.

         On advice from Mr. Millar, petitioners attempted to rent the Laurel Lane

property for $3,000 per month. On two different occasions, potential renters

Tabatha Howell and Scott Wright visited the Laurel Lane property. However, both

parties ultimately notified petitioners by letter that they had decided not to rent the

Laurel Lane property because the monthly rent was out of their price range.




         9
       Petitioners used a similar advertising strategy to rent the Janet Lane property,
which was renting for $1,200 to $1,400 per month. Petitioners reported gross rental
income for the Janet Lane property of $15,400 for 2006, zero for 2005, $4,500 for
2004, and $1,830 for 2003.
                                          -8-

Petitioners never lowered their monthly asking price, nor did they ever find tenants

for the Laurel Lane property.

IV. Petitioners’ Move to the Laurel Lane Property

      At the beginning of 2006 petitioners owned the following properties: (1) their

primary residence10 on 48th Avenue, San Francisco, California (primary residence);

(2) the Janet Lane property; and (3) the Laurel Lane property with adjacent lot.

Petitioners were responsible for making mortgage payments associated with all of

the properties, as well as payments on a home equity line of credit (HELOC)

associated with their primary residence. Before the sale of their primary residence,

petitioners’ material liabilities consisted of: (1) primary residence--$78,294; (2)

Janet Lane property--$145,597; (3) HELOC--$105,761; and (4) Laurel Lane

property--$137,569. On the Laurel Lane mortgage application petitioners valued

their primary residence at $800,000 and the Janet Lane property at $379,000.

While petitioners purchased the Laurel Lane property and adjacent lot for $649,900

and $30,000, respectively, they believe the values of these properties had dropped

significantly since their purchase. Finally, petitioners faced current or upcoming

payments for their son’s adoption, their children’s tuition, child support, litigation

      10
        Mr. Reesink acquired the primary residence around 1992. It was a
Victorian style house, one block from the ocean, with a large yard and a view of the
ocean.
                                         -9-

expenses associated with the apartment building, real property expenses, and other

standard living expenses.

      After failing to rent the Laurel Lane property for several months, Mr. Reesink

became concerned that they could no longer afford all three properties. Mrs.

Reesink became very upset when Mr. Reesink proposed that they sell their primary

residence11--she loved living in San Francisco, she did not want to transfer their

adopted son to another school, and she thought about leaving Mr. Reesink if he

insisted on moving.

      On or around April 4, 2006, petitioners entered into a contract to list their

primary residence for sale. Petitioners believed they had two options at the time

they placed their primary residence for sale--either temporarily move in with Mr.

Reesink’s sister or live at the Laurel Lane property. They did not consider

purchasing another property. On May 17, 2006, petitioners entered into a contract

to sell their primary residence, and they closed the sale on June 30, 2006. The

house sold for $810,000, with petitioners receiving $587,382 in net proceeds.

Petitioners moved into the Laurel Lane property in June 2006 and continue to reside

there today.

      11
        Petitioners believed that the Laurel Lane property had dropped significantly
in value in the wake of the housing crises and that their primary residence was the
only property in which they had accumulated much equity.
                                        - 10 -

V. Other Matters

      Michael McLaughlin, an enrolled agent, has prepared Mr. Reesink’s tax

return every year since 1990 as well as petitioners’ joint income tax returns every

year since their marriage. He first learned of the sale of the apartment building and

purchase of the Laurel Lane property in 2006 upon receiving petitioners’ 2005 tax

information. Petitioners’ eventual decision to move into the Laurel Lane property

was never discussed with Mr. McLaughlin, nor was the $60,000 petitioners received

from the settlement agreement with Michael Reesink.

      Michael Reesink provided Mr. McLaughlin with the 2005 income and

expense statements for the apartment building. The statements were handwritten

and incomplete. Mr. McLaughlin mistakenly underreported petitioners’ 2005 gross

rental receipts by $16,392.12 Petitioners also reported a $1,124 miscellaneous

itemized deduction on Schedule A, Itemized Deductions, for 2005. That deduction

was for expenses incurred while traveling to and from the Lake Tahoe region in

search of real estate. Petitioners timely filed their 2005 joint Federal income tax




      12
         Petitioners reported $10,400 of rental gross receipts from the apartment
building on their 2005 joint Federal income tax return. Actual 2005 gross rental
receipts from the apartment building were $26,792. Moreover, petitioners’ gross
rental receipts from the apartment building were $41,538 for 2004, $38,430 for
2003, and $41,145 for 2002.
                                         - 11 -

return, and on October 22, 2009, respondent issued to petitioners a notice of

deficiency.

                                       OPINION

      Generally, the Commissioner’s determination of a deficiency is presumed

correct, and the taxpayer has the burden of proving it incorrect. Rule 142(a); Welch

v. Helvering, 290 U.S. 111, 115 (1933).13

I. The Like-Kind Exchange

      Section 1031(a) provides that no gain or loss shall be recognized on the

exchange of property held for productive use in a trade or business or for investment

if the property is exchanged solely for property of a like kind that is to be held either

for productive use in a trade or business or for investment.14 One of the primary

purposes for allowing the deferral of gain in a like-kind exchange is to avoid

imposing a tax upon a taxpayer who, while changing his form of ownership, is

continuing the nature of his investment. Wagensen v. Commissioner, 74 T.C. 653,

658 (1980). Under section 1031(d), the basis of property acquired in a section 1031



      13
        Petitioners do not contend that sec. 7491(a) should apply to shift the burden
of proof to respondent.
      14
        In an otherwise qualifying like-kind exchange, a taxpayer’s realized gain is
recognized to the extent the consideration received includes unqualified property
(boot). Sec. 1031(b); sec. 1.1031(a)-1(a)(2), Income Tax Regs.
                                         - 12 -

exchange is the same as the basis of the property exchanged, decreased by any

money that the taxpayer receives and increased by any gain that the taxpayer

recognizes.

      Section 1031 and the regulations thereunder allow for deferred exchanges of

property. Under section 1031(a)(3) and section 1.1031(k)-1(b), Income Tax Regs.,

however, the property a taxpayer receives in the exchange (replacement property)

must be: (1) identified within 45 days of the transfer of the property relinquished in

the exchange (relinquished property), and (2) received by the earlier of 180 days

after the transfer of the relinquished property or the due date (including extensions)

of the transferor’s tax return for the tax year in which the relinquished property is

transferred. Respondent concedes that these timing requirements were met.

      Respondent disputes only whether petitioners held the Laurel Lane property

with investment intent at the time of the exchange. A taxpayer’s intent to hold a

property for productive use in a trade or business or for investment is a question of

fact that must be determined at the time of the exchange. Bolker v. Commissioner,

81 T.C. 782, 804 (1983), aff’d, 760 F.2d 1039 (9th Cir. 1985); Click v.

Commissioner, 78 T.C. 225, 231 (1982). Taxpayers bear the burden of proving that

they had the requisite investment intent. Click v. Commissioner, 78 T.C. at 231;
                                         - 13 -

Regals Realty Co. v. Commissioner, 43 B.T.A. 194, 208 (1940), aff’d, 127 F.2d

931 (2d Cir. 1942). We have held that investment intent must be the taxpayer’s

primary motivation for holding the exchanged property in order for the property to

qualify as held for investment for purposes of section 1031. Moore v.

Commissioner, T.C. Memo. 2007-134. The use of property solely as a personal

residence is antithetical to its being held for investment. Starker v. United States,

602 F.2d 1341, 1350-1351 (9th Cir. 1979).

      Respondent cites Goolsby v. Commissioner, T.C. Memo. 2010-64, to support

his allegation that petitioners did not hold the Laurel Lane property with investment

intent. In Goolsby, the taxpayers made the purchase of the replacement property

contingent on the sale of their former personal residence and sought advice

regarding whether they could move into the replacement property if renters could

not be found. The taxpayers’ only rental efforts consisted of placing a single

advertisement in a neighborhood newspaper. Within two weeks of purchasing the

property, the taxpayers began preparations to refinish the basement. The taxpayers

subsequently moved into the replacement property within two months of acquiring

it. On the basis of the above events, we found the taxpayers did not hold the

replacement property with investment intent at the time of the exchange.
                                          - 14 -

          In Moore, we found the taxpayers’ sale of one vacation property followed by

the purchase of another vacation property did not qualify as a section 1031 like-kind

exchange because at the time of the exchange the taxpayers’ primary motivation for

holding the properties was not for investment. The taxpayers used both vacation

properties exclusively for recreational purposes--they never attempted to rent either

property. We held that the mere expectation that the properties would increase in

value is not enough to show the properties were held primarily with investment

intent.

          Unlike the taxpayers in Goolsby, who placed a single advertisement in a

newspaper and then moved into the replacement property two months later,

petitioners placed fliers throughout Guerneville, showed the Laurel Lane property to

potential renters, and waited almost eight months before moving in. More

importantly, the taxpayers in Goolsby made the purchase of the replacement

property contingent on the sale of their personal residence. Petitioners, on the other

hand, decided to sell their personal residence almost six months after purchasing the

Laurel Lane property. Furthermore, unlike the taxpayers in Moore, petitioners made

attempts to rent the Laurel Lane property and refrained from using it for recreational

purposes before moving in.
                                         - 15 -

      Respondent argues that petitioners’ actions surrounding the purchase of the

Laurel Lane property were so unreasonable that they could not have intended to

hold the Laurel Lane property for investment purposes and that they really

purchased the Laurel Lane property to use as their residence. Respondent supports

his argument by emphasizing that petitioners had a “healthy balance sheet” and by

pointing to all of the actions they could have taken.15 In 2005 petitioners’ decision

to purchase the Laurel Lane property may not have been financially sound, but it

was not unreasonable for them to believe they could supplement their diminishing

wages with rental proceeds.

      Moreover, we do not determine petitioners’ intent on the basis of their

financial position because we find the trial testimony of Mrs. Reesink, Richard


      15
          While petitioners’ financial position has not been fully established by the
parties, respondent’s analysis of their “healthy balance sheet” is misguided.
Respondent places improper emphasis on comparing petitioners’ total assets to total
liabilities, while ignoring their potential liquidity problems. Petitioners were unable
to rent the replacement property, and Mr. Reesink’s wages had drastically
decreased because of his disability. On the other hand, petitioners had a multitude
of current liabilities, including their children’s tuition, child support, adoption
expenses, three mortgage payments, a home equity line of credit, and other real
property expenses. Most of petitioners’ assets were invested in real property, and
they chose to sell their personal residence to alleviate their liquidity problems. It is
unclear whether petitioners spent or retained any proceeds from the litigation
settlement or the taxable boot at the time they decided to sell their personal
residence; but even if they had retained the money, they were still not in the healthy
financial position that respondent envisions.
                                         - 16 -

Reesink, and Scott Wright to be credible. Mrs. Reesink testified that she never

discussed moving to Guerneville until after the exchange had been completed, and

petitioners believed they were in a financial predicament. Richard Reesink testified

that petitioners were having a hard time renting the Laurel Lane property and that he

was surprised they sold their primary residence. Finally, Scott Wright testified that

he visited the Laurel Lane property with the intention of renting it.

      Perhaps the strongest indicator of petitioners’ intent at the time of the

exchange comes from respondent’s witness--Michael Reesink. He testified that Mr.

Reesink had told him on several occasions that petitioners planned to sell their

personal residence and move to Guerneville once their children were out of high

school. Mr. Reesink’s oldest son was born in March 1991, the apartment building

was sold September 23, 2005, and the Laurel Lane property was purchased

November 4, 2005. Therefore, at all times during the exchange process petitioners’

eldest son was only 14 years old. Moreover, he was only 15 years old when

petitioners moved into the Laurel lane property-- he was still in high school

throughout all of the events surrounding the like-kind exchange. Michael Reesink’s

testimony supports the proposition that at the time of the exchange, petitioners held

the Laurel Lane property with investment intent.
                                         - 17 -

      On the basis of the foregoing discussion, we hold that petitioners held the

Laurel Lane property with investment intent at the time of the exchange. Therefore,

petitioners’ sale of the apartment building followed by their purchase of the Laurel

Lane property qualifies as a section 1031 like-kind exchange, and they are not

required to recognize gain on the sale of the apartment building for 2005.

II. Proceeds From Litigation Settlement

      Section 61(a) includes in gross income “all income from whatever source

derived” unless excluded by a specific provision of the Code. This statute is

construed broadly, whereas exclusions from gross income are construed narrowly.

Commissioner v. Schleier, 515 U.S. 323, 328 (1995); United States v. Burke, 504

U.S. 229, 233 (1992); Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431

(1955). Section 104(a)(2) excludes from gross income “the amount of any damages

(other than punitive damages) received (whether by suit or agreement and whether

as lump sums or as periodic payments) on account of personal physical injuries or

physical sickness”.16

      16
        The Small Business Job Protection Act of 1996 (SBJPA), Pub. L. No.
104-188, sec. 1605, 110 Stat. at 1838, amended sec. 104(a)(2) to narrow the
exclusion for damages received for personal injuries or sickness to damages for
personal injury or sickness that is physical, effective for amounts received after
August 20, 1996. See United States v. Burke, 504 U.S. 229, 236 n.6 (1992)
(preamendment personal injuries or sickness did not include damages pursuant to
                                                                          (continued...)
                                         - 18 -

      To be eligible for the section 104(a)(2) exclusion, a taxpayer must

demonstrate that (1) the underlying cause of action giving rise to the recovery is

based in tort or tort-type rights, and (2) the damages were received on account of

personal physical injuries or physical sickness. Commissioner v. Schleier, 515 U.S.

at 337; Prasil v. Commissioner, T.C. Memo. 2003-100. In the context of section

104(a)(2), the terms “physical injury” and “physical sickness” do not include

emotional distress, except to the extent of damages not in excess of the amount paid

for medical care described in section 213(d)(1)(A) and (B) attributable to emotional

distress. See sec. 104(a).

      When damages are received pursuant to a settlement agreement, the nature of

the claim that was the actual basis for settlement, and not the validity of the claim,

controls whether the amount is excludable under section 104(a)(2). United States v.

Burke, 504 U.S. at 237; see also Bagley v. Commissioner, 105 T.C. 396, 406

(1995) (“[T]he critical question is, in lieu of what was the settlement amount

paid?”), aff’d, 121 F.3d 393 (8th Cir. 1997). The determination of the nature of




      16
         (...continued)
the settlement of purely economic rights but did include “nonphysical injuries to the
individual, such as those affecting emotions, reputation, or character”). SBJPA also
amended sec. 104(a)(2) to except punitive damages from the exclusion irrespective
of whether they derived from a case involving physical or nonphysical injury.
                                         - 19 -

the claim is a factual inquiry and is generally made by reference to the settlement

agreement in the light of the surrounding circumstances. Robinson v.

Commissioner, 102 T.C. 116, 126 (1994), aff’d in part, rev’d in part on another

issue, 70 F.3d 34 (5th Cir. 1995). An express allocation in the settlement agreement

of a portion of the proceeds to tort or tortlike claims is generally binding for tax

purposes if the agreement was entered into by the parties in an adversarial

relationship at arm’s length and in good faith. Bagley v. Commissioner, 105 T.C. at

406-407; Robinson v. Commissioner, 102 T.C. at 126-127. If the settlement

agreement lacks express language stating what the settlement amount was paid to

settle, we look to the intent of the payor, based on all the facts and circumstances of

the case, including the complaint that was filed and the details surrounding the

litigation. Knuckles v. Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), aff’g

T.C. Memo. 1964-33; Robinson v. Commissioner, 102 T.C. at 127.

      At the beginning of trial petitioners conceded that they should have reported

the $60,000 of settlement proceeds received from Michael Reesink on their 2005

joint Federal income tax return. However, petitioners now wish to contest the issue

after Michael Reesink testified that “I paid $60,000 to * * * [Mr. Reesink] * * *

because * * * [Mr. Reesink] and I had three physical, violent confrontations over
                                         - 20 -

different times.” The settlement agreement provided that Michael Reesink should

pay Mr. Reesink “$60,000 as payment in full for his claims arising from the events

described in his complaint.” (Emphasis added.) Mr. Reesink did not describe any

events rising to the level of physical injuries or physical sickness in his complaint,

nor did the complaint ask for damages for physical injuries or physical sickness.

Moreover, Michael Reesink’s testimony could just as easily have been referring to

emotional distress (damages for which would be taxable income) as it could have

been for physical injury. Petitioners bear the burden of proof, and there is

insufficient evidence to lead us to conclude that Mr. Reesink was compensated for

physical injuries or physical sickness. Without more, we find that the $60,000

payment from Michael Reesink to Mr. Reesink was taxable income to petitioners.

III. Section 6662(a) Accuracy-Related Penalty

      Respondent determined that petitioners are liable for a section 6662(a) and

(b)(1) accuracy-related penalty for an underpayment resulting from their negligence

in failing to substantiate travel expenses, failing to report $60,000 of settlement

proceeds as taxable income, and failing to report $16,392 of rental gross receipts.
                                          - 21 -

      Under section 7491(c), the Commissioner bears the burden of production

with regard to penalties and must come forward with sufficient evidence indicating

that it is appropriate to impose penalties. See Higbee v. Commissioner, 116 T.C.

438, 446 (2001). However, once the Commissioner has met the burden of

production, the burden of proof remains with the taxpayer, including the burden of

proving that the penalties are inappropriate because of reasonable cause or

substantial authority under section 6664. See Rule 142(a); Higbee v.

Commissioner, 116 T.C. at 446-447. We find respondent has met the burden of

production for the settlement proceeds, travel expenses, and rental receipts.

      Section 6662(c) defines negligence as including any failure to make a

reasonable attempt to comply with the provisions of the Code. Section 6662(c) also

defines “disregard” as any careless, reckless, or intentional disregard. Disregard of

rules or regulations is careless if the taxpayer does not exercise reasonable diligence

to determine the correctness of a tax return position that is contrary to rules or

regulations. Sec. 1.6662-3(b)(2), Income Tax Regs. Disregard of rules or

regulations is reckless if the taxpayer makes little or no effort to determine whether

a rule or regulation exists. Id. Disregard of rules or regulations is intentional if the

taxpayer has knowledge of the rule or regulation that he disregards. Id.
                                         - 22 -

      An underpayment is not attributable to negligence or disregard to the extent

that the taxpayer shows that the underpayment is due to the taxpayer’s having

reasonable cause and acting in good faith. Sec. 6664(c)(1); Neonatology Assocs.,

P.A. v. Commissioner, 115 T.C. 43, 98 (2000), aff’d, 299 F.3d. 221 (3d Cir. 2002).

Reasonable cause requires that the taxpayer have exercised ordinary business care

and prudence as to the disputed item. See United States v. Boyle, 469 U.S. 241

(1985); Estate of Young v. Commissioner, 110 T.C. 297, 317 (1998). Good-faith

reliance on the advice of an independent, competent professional as to the tax

treatment of an item may meet this requirement. See United States v. Boyle, 469

U.S. at 241; sec. 1.6664-4(b), Income Tax Regs. The decision as to whether a

taxpayer acted with reasonable cause and in good faith is made on a case-by-case

basis, taking into account all of the pertinent facts and circumstances. Sec.

1.6664-4(b)(1), Income Tax Regs.

       For a taxpayer to rely reasonably upon advice so as possibly to negate a

section 6662 accuracy-related penalty determined by the Commissioner, the

taxpayer must prove by a preponderance of the evidence that the taxpayer meets

each requirement of the following three-prong test: (1) the adviser was a competent

professional who had sufficient expertise to justify reliance; (2) the taxpayer

provided necessary and accurate information to the adviser; and (3) the taxpayer
                                        - 23 -

actually relied in good faith on the adviser’s judgment. Neonatology Assocs., P.A.

v. Commissioner, 115 T.C. at 99.

      A. Substantiation of Travel Expenses

      Petitioners concede that they are unable to substantiate $1,124 of travel

expenses incurred in searching for replacement property for the section 1031 like-

kind exchange. While petitioners testified that: (1) the expenditures were actually

incurred, and (2) they provided a summary worksheet of the expenses to their tax

preparer, no summary worksheet was produced. Petitioners have failed to show

reasonable cause for failure to substantiate their travel expenses. Therefore, we

hold that petitioners are liable for the section 6662(a) accuracy-related penalty on

the portion of the underpayment associated with the travel expenses deducted on

their joint 2005 Federal income tax return.

      B. Settlement Proceeds

      Petitioners argue that they provided Mr. McLaughlin with the closing

statement from the sale of the apartment building, and the closing statement listed

“Settlement from Michael Reesink to Patrick Reesink--$60,000” separately from the

sale proceeds. While Mr. McLaughlin was aware that petitioners received $56,417

of taxable boot in the like-kind exchange, Mr. McLaughlin testified that he was not

told about the $60,000 of settlement proceeds. Petitioners argue that Mr.
                                        - 24 -

McLaughlin confused the two numbers and therefore failed to report the settlement

proceeds.

      Even if petitioners informed Mr. McLaughlin about the settlement proceeds,

we still find petitioners liable for the section 6662(a) accuracy-related penalty. Both

the settlement proceeds and the boot received in the like-kind exchange were

taxable. Even a cursory review of petitioners’ 2005 tax return would have revealed

that the $60,000 of settlement proceeds was not reported. There is no evidence that

petitioners ever inquired with a professional or anyone else about the taxability of

the settlement payment. Therefore, we hold petitioners have failed to show

reasonable cause and are liable for the section 6662(a) accuracy-related penalty on

the portion of the underpayment associated with the settlement proceeds.

      C. Underreported Rental Gross Receipts

      Petitioners also concede that they failed to report $16,392 of rental gross

receipts. Michael Reesink was in charge of keeping the accounting records for the

apartment building. He provided Mr. McLaughlin with handwritten income and

expense statements for the apartment building for the 2005 tax year. While these

statements were sloppily constructed, petitioners should have noticed that rental

gross receipts had substantially declined in 2005 from what was reported on their
                                          - 25 -

2002, 2003, and 2004 joint Federal income tax returns. While the sale of the

apartment building during 2005 may have accounted for some of this discrepancy,

petitioners were well aware that Michael Reesink’s bookkeeping could not be

trusted. Petitioners failed to make even basic inquiries into the substantial decrease

in rental gross receipts. Therefore, petitioners have failed to show reasonable cause

and are liable for the section 6662(a) accuracy-related penalty on the portion of the

underpayment associated with their failure to report $16,392 of rental gross receipts.

IV. Conclusion

         We conclude that petitioners’ sale of the apartment building followed by the

purchase of the Laurel Lane property qualifies as a section 1031 like-kind exchange.

Moreover, we conclude that the $60,000 of settlement proceeds should have been

reported as taxable income on petitioners’ 2005 joint Federal income tax return.

Finally, we conclude that petitioners are liable for the section 6662(a) accuracy-

related penalty associated with the portions of the underpayment relating to the

settlement proceeds, the rental income, and the travel expenses. In reaching our

holding herein, we have considered all arguments made by the parties, and, to the

extent not mentioned above, we conclude they are moot, irrelevant, or without

merit.
                            - 26 -

To reflect the foregoing,


                                           Decision will be entered

                                     under Rule 155.
