                        T.C. Memo. 1996-214



                      UNITED STATES TAX COURT



   MICHAEL HILLYER AND TERESA HILLYER, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 22118-94, 22119-94             Filed May 2, 1996.
                 22120-94, 22121-94.



     Edward F. Sutkowski, for petitioners.

     Darrell Weaver, for respondent.



                        MEMORANDUM OPINION

     KÖRNER, Judge:   Pursuant to respondent's motion, granted on

August 9, 1995, the above dockets were consolidated in this Court

for trial, briefing, and opinion.   The cases were thereafter

     1
        Cases of the following petitioners are consolidated
herewith: David D. Hillyer and Linda J. Hillyer, docket No.
22119-94; William H. Hillyer, Jr., and Kim Rae Hillyer, docket
No. 22120-94; and William H. Hillyer, Sr., and Elizabeth Hillyer,
docket No. 22121-94.
                                  2

submitted to the Court on a full stipulation of facts and

exhibits without trial, pursuant to Rule 122.     All statutory

references are to the Internal Revenue Code in effect for the

year in issue, and all Rule references are to the Tax Court Rules

of Practice and Procedure, except as otherwise noted.

     On September 2, 1994, respondent determined deficiencies in

petitioners' 1991 Federal income taxes in the following amounts:

          Petitioners                       Docket No.   Deficiency

   Michael & Teresa   Hillyer               22118-94     $13,798
   David D. & Linda   J. Hillyer            22119-94      13,576
   William H., Jr.,   & Kim Rae Hillyer     22120-94      12,724
   William H., Sr.,   & Elizabeth Hillyer   22121-94      44,077

     All the above petitioners, husbands and wives, filed joint

income tax returns for the year 1991 at Kansas City, Missouri,

and, at the time of filing the petitions herein, all such

petitioners were residents of Illinois.     All the male petitioners

(petitioners) herein were stockholders of Hillyer Excavating

Service, Inc. (the corporation), whose name was changed to

Hillyer, Inc., in 1992.

     During the 1991 calendar year, the shares of the corporation

were owned as follows:

                                 Percent
     Michael Hillyer             15.44
     David D. Hillyer            15.47
     William Hillyer, Jr.        15.47
     William Hillyer, Sr.        53.59
               Total               100

     For the year 1991, the corporation filed Form 1120-S as an S

corporation, and attributed its net income to petitioners in
                                  3

ratable shares as the shareholders of the corporation, pursuant

to section 1366.2

     Upon examination of the S return, respondent determined that

the income shown by petitioners resulting from the sale of

certain property by the corporation was not correctly reported in

the corporation's S return nor by petitioners, and the above

notices of deficiency resulted.

     The issues that the Court must decide are:

     (1) Whether the corporation's transfer of land to Penn-

Daniels, Inc., and its subsequent acquisition of land from Scott

Coggeshall and the Coggeshall Construction Co. (Coggeshall

property), and land from Marcellene J. Inness was an exchange of

like-kind property within the meaning of section 1031(a); and

     (2) whether petitioners correctly computed and reported the

gain resulting from these transactions.

     The corporation's place of business was at Macomb (McDonough

County), Illinois.   The corporation had been engaged in the

general construction business in that vicinity since 1966.     The

Coggeshall Construction Co. (the Coggeshall Co.) and its

predecessor had been engaged in the general construction

business, including road building, in this same area since 1952.

The corporation has acted as subcontractor with respect to



     2
        The parties agree that any gain to be recognized as a
consequence of the within transactions must be recognized by the
shareholders of the corporation, petitioners in these cases.
                                  4

construction contracts entered into by the Coggeshall Co. from

time to time in the past.    In late 1988 or early 1989, the

corporation determined that concrete and asphalt work would

constitute a natural extension of the corporation's existing

construction activities, and principals of the corporation and

the Coggeshall Co. in 1989 discussed the idea of the

corporation's acquiring an interest in certain property on Deere

Road, Macomb, Illinois, which was industrial property owned by

Scott Coggeshall, on which the Coggeshall Co. owned an asphalt

plant.    In addition, the Coggeshall Co. owned other equipment on

property owned by J. W. Collins, also located in Macomb,

Illinois.    The equipment in these two properties was owned by the

Coggeshall Co. in connection with its construction and related

activities (the whole (land and equipment) is referred to as the

Coggeshall property).

     In May 1989, and again in January 1991, the corporation

sought to lease the Coggeshall property from the owners.    Both

offers were rejected.   Between November 1990 and February 1991,

there were also negotiations for the purchase of the Coggeshall

property by the corporation.    In September 1989, Scott Coggeshall

and the Coggeshall Co. entered into a management agreement with

and option to sell the Coggeshall property to the Chester Bross

Construction Co. (Bross) for a period ending October 1, 1990,

which agreement was extended by the parties until November 1,

1991.    Because of the failure by Bross to pay equipment rental,
                                 5

utilities, and taxes, the property was repossessed by Scott

Coggeshall and the Coggeshall Co. on January 7, 1992.    The Bross

agreement expired on November 1, 1991.

     On September 21, 1990, the corporation entered into a

contract to purchase 9.53 acres of real estate (Phoenix

property), which was zoned industrial and was located next to the

corporation's offices and shop in Macomb, Illinois.    The Phoenix

property was purchased and held for productive use in the

corporation's trade or business or for investment in connection

with its construction activities.    The purchase price of the

property was $105,000.   On August 9, 1991, the adjusted basis of

the Phoenix property in the hands of the corporation was $57,085.

     Penn-Daniels, Inc., is a Delaware corporation authorized to

do business in Illinois.   It operates a chain of retail stores.

Around 1990, Penn-Daniels developed an interest in acquiring

property in Macomb, Illinois, as the prospective location for a

new store.   It engaged the services of EST Acquisitions, Inc.

(EST), to act as its agent in locating and securing a store site

in Macomb.   In January 1991, the corporation and EST entered into

a real estate purchase agreement, as amended, for the sale of the

Phoenix property by the corporation to Penn-Daniels for $382,000.

Said purchase agreement, assigned by EST to Penn-Daniels,

provided that the corporation, as seller, might choose to

designate certain properties, allegedly for purposes of achieving

a tax-free exchange under section 1031, and Penn-Daniels, as
                                 6

buyer, agreed to participate in such exchange, provided that the

corporation, as seller, would reimburse the buyer for all

expenses associated therewith, that the buyer would not actually

take title to any such designated exchange property, and that the

buyer would not be exposed to any liability as the result

thereof.   The parties to the agreement understood that the

obligation of Penn-Daniels as buyer to participate in any such

designated exchange would terminate upon the closing of the sale.

     Closing of the sale of the Phoenix property was held on

August 9, 1991.   The corporation received at settlement the

closing amount of $354,065.21 and tendered the appropriate deed

to Penn-Daniels for the Phoenix property.   With reference to the

prior agreement between the corporation and Penn-Daniels, as

amended, the corporation thereupon placed the settlement funds it

had received with the Citizens National Bank of Macomb as agent

under an escrow agreement, under which the corporation reserved

the right to designate certain replacement properties.   In

significant part, the escrow agreement provided that the bank

would hold the sales proceeds for the direction of the

corporation in the acquisition of replacement properties for the

period of 180 days.   The corporation was obligated to "direct"

the acquisition of such properties within 45 days of the deposit

of the money with the bank.   No affirmative acts were required

from Penn-Daniels, as buyer of the Phoenix properties (except to

cooperate (prior to the Phoenix settlement) in the acquisition of
                                 7

desired replacement properties); in fact none were asked, and

none were performed.

     On September 20, 1991, the corporation notified the Citizens

National Bank, as escrow agent, of the designation of three

properties which the corporation intended as replacement

properties for the purposes of section 1031(a)(3).   These

properties were designated as the "McClure quarries in Tennessee

Township, Colchester, Illinois," which were not acquired by the

corporation; the Coggeshall property; and "property zoned M-2

located south and east of Route 41 in Galesburg Township, Knox

County, Illinois" (owner and size not specified).

     On January 30, 1992, the corporation, Scott Coggeshall, and

the Coggeshall Co. executed a purchase agreement (Coggeshall

purchase agreement) with respect to the Coggeshall property for a

total purchase price of $577,370, including $321,000 for the real

estate owned by Scott Coggeshall and the asphalt plant located

thereon owned by the Coggeshall Co. and $256,370 for other

miscellaneous equipment, including the asphalt plant owned by the

Coggeshall Co., but located on land owned by Collins.     Payment

for this purchase was accomplished by an immediate payment of

$300,000 at closing to the sellers, as a downpayment, with the

$277,370 balance to be payable over 4 years.   This arrangement

for deferred payment was solemnized by a second escrow agreement

established by the parties with the Citizens National Bank of

Macomb.   The Coggeshall property was to be held by the
                                 8

corporation as investment property or for use by the corporation

in connection with its trade or business.   The Coggeshall

property on Deere Road is of like-kind with that of the Phoenix

property.   Respondent does not contend that the items detailed in

the stipulation with respect to the Deere Road asphalt site in

the Coggeshall property should not be considered real property,

and has conceded on brief that such items are to be considered

real estate.

     On March 30, 1992, however, the Coggeshall Co. determined

that the Coggeshall Co. could not transfer the plant equipment on

the Collins site by reason of a landlord's lien asserted by J. W.

Collins; such equipment located on the Collins' property, as

stipulated by the parties, was accordingly eliminated from the

contract, and the purchase price of the Coggeshall property was

accordingly reduced from $577,370 to $510,007.

     On January 30, 1992, apparently independently of the

Coggeshall purchase, the corporation and Marcellene J. Inness

entered into a contract for the sale to it of certain property

for $46,361.   The transaction closed the same day, on January 30,

1992, with the payment of this sum to the direction of Marcellene

J. Inness from the "escrow" account at the Citizens National Bank

of Macomb, taken from the funds entrusted to it by the

corporation, to be disbursed at its direction, and the Inness

warranty deed to the corporation was recorded.   The warranty deed
                                   9

to the property that was recorded describes the property in

question as--

          That portion of the West Half of the Southwest
     Quarter of Section 21, Township 11 North, Range 1 East
     of the Fourth Principal Meridian, Knox County,
     Illinois, which is Lot 1 of the Hillyers Excavating
     Subdivision, as per plat dated December 20, 1991, by
     Paul M. Willi, Illinois Professional Land Surveyor
     * * *.

     All of the property in section 21, Galesburg Township, is

zoned M-2, and this is also true of some portions of other

sections of land located south and east of Route 41 in Galesburg

Township.     The size of the realty conveyed is not given, but this

Court takes judicial notice that a section of land is 1 square

mile or 640 acres.

     The proceeds of the Phoenix property sale settlement of

August 9, 1991, which had been retained by the Citizens National

Bank under the existing escrow agreement, were disbursed as

follows:

   1-30-923    $300,000.00   Downpayment on Coggeshall purchase

   1-30-923      42,174.25   First Illini Bank escrow
                             (Inness property purchase)

   1-30-923       4,189.75   First Illini Bank escrow
                             (Inness property purchase)

   1-30-923          53.00   Recording fees

     3
        The dates given in the stipulation herein show an obvious
typographical error, principally as to the year of the
disbursements. They have been corrected to conform to the dates
of the property settlements. Note that the final disbursement by
the bank was just 2 days prior to the expiration of the specified
180-day holding period by the bank under the escrow agreement.
                               10

   2-7-92      7,651.21   Cash balance to corporation

     In these cases, we are met again with the tension between

section 1001(c), which broadly provides on the one hand that in

the case of a sale, the amount of gain or loss shall be

recognized, and, on the other hand, the requirement of section

1031(a), which allows for the nonrecognition of gain or loss

where like-kind properties are exchanged to be used in a

productive trade or business or for investment.   The touchstone

of section 1031, at least in this context, is the requirement

that there be an exchange of like-kind business or investment

properties, as distinguished from a cash sale of property by the

taxpayer and a reinvestment of the proceeds in other property.

As this Court said in Barker v. Commissioner, 74 T.C. 555, 561

(1980):

          The "exchange" requirement poses an analytical
     problem because it runs headlong into the familiar tax
     law maxim that the substance of a transaction controls
     over form. In a sense, the substance of a transaction
     in which the taxpayer sells property and immediately
     reinvests the proceeds in like-kind property is not
     much different from the substance of a transaction in
     which two parcels are exchanged without cash. Bell
     Lines, Inc. v. United States, 480 F.2d 710, 711 (4th
     Cir. 1973). Yet, if the exchange requirement is to
     have any significance at all, the perhaps formalistic
     difference between the two types of transactions must,
     at least on occasion, engender different results.
     Accord, Starker v. United States, 602 F.2d 1341, 1352
     (9th Cir. 1979).

          The line between an exchange on the one hand and a
     nonqualifying sale and reinvestment on the other
     becomes even less distinct when the person who owns the
     property sought by the taxpayer is not the same person
     who wants to acquire the taxpayer's property. This
                                  11

     means that multiple parties must be involved in the
     transaction. * * *

     As a result, courts have acknowledged that transactions that

take the form of a cash sale and reinvestment cannot, in

substance, constitute an exchange for purposes of section 1031,

even though the end result is the same as a reciprocal exchange

of properties.     Bell Lines, Inc. v. United States, 480 F.2d 710,

714 (4th Cir. 1973); Carlton v. United States, 385 F.2d 238, 241

(5th Cir. 1967).    Thus, our inquiry is narrowly focused on

whether the corporation's disposition of the Phoenix property in

this case was a sale, as argued by respondent, or an exchange for

the Coggeshall and Inness properties, as argued by petitioners.

     Petitioners contend that the series of transactions here

culminating in the acquisition of the Coggeshall property and the

Inness property with funds resulting from the Phoenix property

transfer, were steps in an integrated transaction, the substance

of which was an exchange of properties within section 1031(a).

     In some multiparty transactions, the taxpayer desires to

exchange, rather than to sell, his property, but the potential

buyer owns no property that the taxpayer wishes to receive in

exchange.   Thus, some cases involve three or more parties and

multiple conveyances of property in an effort to structure an

exchange instead of a sale and reinvestment.    In some of them,

these multiparty transactions have been held to constitute an

exchange within the meaning of section 1031.    In so holding, the

courts have allowed taxpayers great latitude in structuring their
                                12

transactions and have allowed nonsimultaneous exchanges, see

Starker v. United States, 602 F.2d 1341 (9th Cir. 1979); deposit

of proceeds into a bank account controlled by an independent

third party before an exchange property is located, J.H. Baird

Publishing Co. v. Commissioner, 39 T.C. 608 (1962); transactions

in which the intermediary did not acquire legal title to the

exchange property, Biggs v. Commissioner, 69 T.C. 905, affd. 632

F.2d 1171 (5th Cir. 1980); and change from a sale transaction to

an exchange transaction even though the property to be received

on the exchange was not identified as of the date the original

agreement was made, Alderson v. Commissioner, 317 F.2d 790 (9th

Cir. 1963), revg. 38 T.C. 215 (1962).

     These multiparty cases have explained that section 1031

"only requires that as the end result of an agreement, property

be received as consideration for property transferred by the

taxpayer without his receipt of, or control over, cash".   Coupe

v. Commissioner, 52 T.C. 394, 409 (1969).

     On the other hand, receipt of or control over cash proceeds

by a taxpayer will prevent characterization of a multiparty

transaction as an exchange.   In the Deficit Reduction Act of

1984, Pub. L. 98-369, sec. 77(a), 98 Stat. 596, an attempt was

made to clarify some of the uncertainties that exist in this area

by the enactment of a new section 1031(a)(3), which provides:

     For purposes of this subsection, any property received
     by the taxpayer shall be treated as property which is
     not like-kind property if--
                                  13

               (A) such property is not identified as
          property to be received in the exchange on or
          before the day which is 45 days after the date on
          which the taxpayer transfers the property
          relinquished in the exchange, or

               (B) such property is received after the
          earlier of--

                    (i) the day which is 180 days after the date
               on which the taxpayer transfers the property
               relinquished in the exchange, or

                    (ii) the due date (determined with regard to
               extension) for the transferor's return of the tax
               imposed by this chapter for the taxable year in
               which the transfer of the relinquished property
               occurs.

     Further attempting to clarify the new statutory provisions

under section 1031, section 1.1031(k)-1, Income Tax Regs.,

effective on or after June 10, 1991, provides in section

1.1031(k)-1(c)(3), Income Tax Regs.:

          Replacement property is identified only if it is
     unambiguously described in the written document or
     agreement. Real property generally is unambiguously
     described if it is described by a legal description,
     street address, or distinguishable name * * *

     Section 1.1031(k)-1(c)(4), Income Tax Regs., further

provides that the number of replacement properties that will

qualify under section 1031(a) to be designated by the taxpayer

may not exceed three in number.

     Once again, the new regulations, in section 1.1031(k)-1(f),

Income Tax Regs., reemphasize:

     A transfer of relinquished property in a deferred
     exchange is not within the provisions of section
     1031(a) if, as part of the consideration, the taxpayer
     receives money or other property. * * *
                                14

          * * * The taxpayer is in actual receipt of money
     or property at the time the taxpayer actually receives
     the money or property or receives the economic benefit
     of the money or property. * * *

     Finally, in section 1.1031(k)-1(g)(3), Income Tax Regs., the

new regulations provide that in the case of an exchange in a

deferred plan, the exchange will be recognized under section

1031(a) without regard to the receipt of cash if the cash is held

in a qualified escrow account, which is defined as one where (a)

the escrow holder is not the taxpayer or a disqualified person,

and (b) the escrow agreement expressly limits the taxpayer's

rights to receive the cash held in the escrow account.

     With these new statutory and regulatory requirements in

mind, and recalling that the transfer of the Phoenix property by

the corporation took place in August 1991, and the Coggeshall and

Inness properties were acquired by it on January 30, 1992, we

address the situation in these cases.

     The facts show that the designation by the corporation of

the intended replacement properties took place on September 20,

1991, which was within the 45 days required under the language of

section 1031(a)(3)(A).   Both the Coggeshall and Inness properties

were received by the corporation on January 30, 1992, within 180

days after the date of the disposition of the Phoenix properties

to Penn-Daniels on August 9, 1991, as required by section

1031(a)(3)(B).   Only three replacement properties were

designated.
                                15

     Nevertheless, an examination of the facts in this record

leads us to conclude that the disposition of the Phoenix property

in August 1991 and the acquisition of the Coggeshall and Inness

properties in 1992 do not qualify for nontaxable treatment under

section 1031(a), because although the alleged escrow agreement

with the Citizens National Bank was not with the corporation or a

disqualified person, as described in section 1.1031(k)-

1(g)(3)(ii)(A), Income Tax Regs., nevertheless the escrow

agreement did not expressly limit the corporation's right to

receive or use the cash held in the escrow account, as specified

by section 1.1031(k)-1(g)(3)(ii)(B), Income Tax Regs.     The facts

show here that the so-called escrow agreement entered into

between the corporation, the Citizens National Bank, and Penn-

Daniels was nothing more than a facade.   At the settlement of the

Phoenix property disposition to Penn-Daniels on August 9, 1991,

the stipulated facts recite that the settlement funds were

actually received by the corporation, and thereafter were

transferred to the bank under the so-called escrow agreement.

Further, there were no restrictions upon the right of the

corporation, as transferor of the Phoenix property, to use the

proceeds in any way which the corporation saw fit.   The money was

simply held by the bank for future disposition at the direction

of the corporation.   The only requirement was that the

corporation designate the desired replacement properties in 45

days, and the bank was not required to hold the funds for the
                                 16

account of the corporation beyond 180 days.    There was no

obligation or requirement of any kind upon Penn-Daniels, as the

transferee of the Phoenix properties; with the conclusion of the

settlement of the transaction, as stipulated by the parties,

Penn-Daniels was not required to do anything, was not called upon

to do anything, and in fact did nothing.    It just took the

Phoenix properties and went its way.    There were no effective

restrictions nor escrow provisions of any kind with respect to

the use of the funds by the corporation as transferor of the

Phoenix properties nor by Penn-Daniels as the transferee.

       We must therefore conclude that the overall transaction--

involving involving the transfer of the Phoenix property by the

corporation to Penn-Daniels in August 1991, and thereafter the

acquisition of the Coggeshall and Inness properties from parties

other than Penn-Daniels--did not qualify as a tax-free exchange

under the provisions of section 1031(a).    The acquisition of the

latter two properties by the corporation did not take place until

1992; we conclude that the transfer of the Phoenix properties by

the corporation to Penn-Daniels in August 1991 for cash was

taxable under section 1001(c) for 1991 in the normal course, with

gain or loss to be computed as provided in section 1001(a) and

(b).

                                      Decisions will be entered

                                under Rule 155.
