                       T.C. Memo. 1998-302



                     UNITED STATES TAX COURT



         NEAL T. BAKER ENTERPRISES, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 20372-95.                 Filed August 19, 1998.



     John K. Mirau, for petitioner.

     Lisa Kuo, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     WRIGHT, Judge: Respondent determined a deficiency in

petitioner's Federal income tax for the tax year ended March 31,

1990 (1989 taxable year), in the amount of $145,794.

     This case involves the question of whether petitioner may

defer recognition of gain from the disposition of certain real
                                - 2 -


property under section 1031.1   More specifically, we must decide

whether petitioner held the exchanged real property primarily for

sale so that the gain is taxable in the 1989 taxable year.

                          FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are

incorporated herein.    Petitioner's principal office was located

in San Bernardino, California, at the time it filed its petition.

Petitioner filed a U.S. Corporation Income Tax Return, Form 1120,

for the taxable year 1989, with the Director, Internal Revenue

Service Center, Fresno, California.     Petitioner used a fiscal

year ending March 31.

     Petitioner was incorporated on September 18, 1957, under the

laws of the State of California.   From petitioner's inception to

the taxable year 1991, Neal T. Baker (Mr. Baker), as president

and director of petitioner,2 controlled and directed its

operations.   Additionally, starting in 1987, Mr. Baker was

petitioner's chief financial officer.     During the period from


     1
        All section references are to the Internal Revenue Code
in effect for the year at issue, unless otherwise indicated. All
Rule references are to the Tax Court Rules of Practice and
Procedure.
     2
        At times during the period 1978 to 1991, Neal T. Baker
also served as treasurer and secretary of petitioner.
     Besides his role with petitioner, Mr. Baker was a charter
member of the Business Bank of California. As a chairman of the
bank's loan committee, Mr. Baker reviewed construction loans.
                               - 3 -


1978 to 1991, Carol Baker served as petitioner's vice president

and director.3   At times during the period from 1978 to 1991, one

other person served in the position of treasurer, secretary,

chief financial officer, or director.

     Petitioner's articles of incorporation, filed September 13,

1957, listed the following purposes:

     (a)  PRIMARY PURPOSE--To operate drive-in restaurants,
          SECONDARY PURPOSE--To construct and sell buildings and,
     (b) To manufacture, fabricate, assemble, to take, purchase
     and otherwise acquire, own, hold, use, sell, assign,
     transfer, exchange, lease, and otherwise dispose of, and to
     invest, trade, deal in and with goods, wares and merchandise
     and supplies and all other personal property of every class
     and description.
     (c) To purchase, acquire, own, hold, use, lease (either as
     lessor or lessee), grant, sell, exchange, subdivide,
     mortgage, convey in trust, manage, improve, construct,
     operate and generally deal in any and all real estate,
     improved or unimproved, stores, office buildings, dwelling
     houses, apartment houses, hotels, manufacturing plants and
     other buildings, and any and all other property of every
     kind or description, real, personal and mixed, and
     wheresoever situated, either in California, other states of
     the United States, or foreign countries.
               *    *    *    *    *    *     *

     In 1969, petitioner engaged in a corporate restructuring in

which Baker's Burger was incorporated to conduct petitioner's

fast-food business.   According to the minutes of the special

meeting of the Board of Directors on October 16, 1969:

     The Chairman [Mr. Baker] explained that Baker's Burgers,
     Inc., a California corporation, was formed to conduct the
     drive-in hamburger and Taco Stand business separate and
     apart from the contracting business, both of which were

     3
        Carol Baker was also petitioner's secretary in 1978,
1979, and 1980.
                               - 4 -


     formerly carried on by Neal T. Baker Enterprises. He
     further stated that the two businesses were for all
     practical purposes totally unrelated, and that it had become
     necessary to conduct the two businesses separately in order
     to facilitate flexibility, expansion, cost control, proper
     management and the raising of capital.

Mr. Baker testified that the restructuring was in part to prepare

Baker's Burgers, Inc., for a possible public offering.

Petitioner transferred assets (valued at $36,000) to Baker's

Burgers, Inc., in exchange for stock of Baker's Burgers, Inc.      As

a result of the restructuring, petitioner held real estate

holdings, which included buildings for fast-food locations (which

were leased to Baker's Burger, Inc.), real estate held for

investment, and real estate held for development.    After 1969,

petitioner continued to construct additional fast-food locations,

and also continued to contract with third parties for the

construction of residential properties.

     In regard to its construction operations, petitioner had a

contractor's license with the State of California, but it did not

have any contracting equipment.    All the contracting work was

done through subcontractors.   Petitioner recorded the work done

(payments) by its subcontractors under work-in-

progress/construction in-progress accounts.    Petitioner used

realtors to sell its properties.    Petitioner recognized revenue

from these sales when escrow closed.

     On February 1, 1983, petitioner filed its restated articles

of incorporation with the State of California, providing the
                                - 5 -


purpose "to engage in any lawful act or activity for which a

corporation may be organized under the General Corporation Law of

California other than the banking business, the trust company

business or the practice of a profession permitted to be

incorporated by the California Corporations Code."

Beaumont Property--Tract No. 10018

     On March 10, 1978, petitioner purchased from the Simoffs

vacant land in Beaumont, California (Beaumont Property), for

$155,000.   Beaumont Property is bounded on the west by

Pennsylvania Avenue, the east by Cherry Avenue, the south by 10th

Street, and the north by another lot north of 11th Street.    When

petitioner purchased the Beaumont Property, the property was

zoned R-1 for single-family residential use.   Petitioner never

made an application to have the Beaumont Property rezoned to R-4

multi-family residential use.

     From 1978 through 1989, petitioner hired three engineering

firms to process tentative maps on the Beaumont Property:

(1) H. D. Marcell; (2) Wes Engineering; and (3) Garner, Troy &

Associates, Inc.

     Petitioner's purchase of the Beaumont Property was

contingent upon the Tentative Subdivision Map being approved by

the City of Beaumont Planning Commission (Planning Commission).

At that time, there was a subdivision map prepared by H. D.

Marcell for the Simoffs.   This tentative map proposed to
                                 - 6 -


subdivide the property into 48 lots for the construction of

single-family residential houses.    On June 22, 1978, the

tentative subdivision map was approved by the Planning

Commission.   The map was assigned Tract No. 10018.

     On April 23, 1979, petitioner's Board of Directors

authorized the preparation and filing of an application to the

Real Estate Commissioner of the State of California for a Public

Report in connection with the subdivision and sale of real

property on the 48 lots of the Beaumont Property.

     Later, petitioner hired Wes Engineering to prepare a revised

tentative map for Tract No. 10018.       The map proposed 56 single-

family residential lots, and was resubmitted to the city of

Beaumont on February 28, 1980.    In July 1980, the new tentative

map was approved by the Planning Commission.      On July 9, 1980,

Wes Engineering prepared and executed a rough grading plan for

Tract No. 10018, which was approved by the city of Beaumont on

March 16, 1981.

     In regard to the entire Beaumont Property in 1981, the city

of Beaumont required a bond of $365,000 to be posted to guarantee

construction of street improvements and sewer improvements.

     In early 1981, the city of Beaumont contracted with CG

Engineering to design and prepare improvement plans for

Pennsylvania Avenue.   During 1981 and 1982, the city of Beaumont
                                 - 7 -


built street improvements on Pennsylvania Avenue.   This

construction was funded by the city of Beaumont.

     14 Lots Fronting Pennsylvania Avenue--Tract No. 10018-1

     In 1981, petitioner subcontracted with Matich Corporation to

construct curbs, gutters, sidewalks, water service, waterline and

gate valves, and fire hydrants relating to the 14 lots along

Pennsylvania Avenue.   Petitioner paid $23,874.35 for this work.

     In 1982, petitioner applied for a 1-year extension, which

was approved by the city of Beaumont, of its tentative map Tract

No. 10018.   In mid-1983, petitioner submitted a request to record

a final map for Tract No. 10018-1 to the city of Beaumont.    Tract

No. 10018-1 pertained to the portion (14 lots) of Beaumont

Property fronting Pennsylvania Avenue.   On September 20, 1983,

the Planning Commission conditionally approved petitioner's

phasing for Tract No. 10018-1.    On December 12, 1983, petitioner

and the city of Beaumont entered into an agreement for

subdivision improvements on Tract No. 10018-1.   The final map for

Tract No. 10018-1 was recorded on December 20, 1983, creating 14

lots along Pennsylvania Avenue.

     In 1984, petitioner contracted with Michael C. Mize to

install 8-inch sewer laterals for the 14 lots along Pennsylvania

Avenue, at a total cost of $22,500.00.

     On or about October 1986, petitioner contracted for the

construction of 14 single family residences in Tract No. 10018-1.
                                    - 8 -


Petitioner entered into contracts with subcontractors, who built

the residences.     The 14 houses were constructed in two phases,

the first phase of 6 houses (construction commenced on October

17, 1986) and the second phase of 8 homes (construction commenced

on June 25, 1987).     Petitioner sold the 14 homes from July 21,

1987, through March 31, 1989, as follows:

     Date of Sale             Address               Selling Price

     07/21/87          1202   E. 10th Street         $79,950
     09/30/87          1050   Pennsylvania Avenue     87,950
     12/22/87          1070   Pennsylvania Avenue     77,950
     01/08/88          1090   Pennsylvania Avenue     87,950
     09/16/88          1010   Pennsylvania Avenue     89,500
     09/23/88          1110   Pennsylvania Avenue     77,950
     11/17/88          1202   E. 11th Street          79,950
     11/22/88          1201   E. 11th Street          77,550
     01/27/89          1130   Pennsylvania Avenue     80,950
     02/10/89          1120   Pennsylvania Avenue     89,950
     02/28/89          1030   Pennsylvania Avenue     77,000
     03/06/89          1100   Pennsylvania Avenue     87,950
     03/13/89          1140   Pennsylvania Avenue     89,950
     03/31/89          1150   Pennsylvania Avenue     89,950

Petitioner classified the cost of the 14 houses on the Beaumont

Property under cost of houses sold, and classified income from

their sale as ordinary income.

     Exchange Property--Tract No. 22332

     The tentative map for Tract No. 10018 expired in 1983. In

regard to the remaining 48 lots of the Beaumont Property

(hereinafter referred to as the Exchange Property4) in Tract No.

10018, petitioner resubmitted a tentative map in March 1986.




     4
        Exchange Property is the Beaumont Property minus the 14
lots created by the final map of Tract No. 10018-1.
                               - 9 -


     In March 1986, petitioner prepared a Parcel Map/Tract Map

Application Form and a City of Beaumont Environmental Review &

Processing Application Form for the Exchange Property.   During

May 1986, public hearings involving the Planning Commission

occurred in regard to the "proposed forty-eight (48) lot

subdivision for construction of single family homes."

     On May 6, 1986, the city conditionally approved the

tentative map for the Exchange Property.   On June 9, 1986, the

city approved the tentative map for the Exchange Property, Tract

No. 22332, and subsequently extended the approval of the map

until June 9, 1989.

     Garner, Troy & Associates prepared a draft tentative map,

dated July 1987, for Tract No. 22332.   Between January 1987 and

May 1989, Garner, Troy & Associates prepared the final map and

portions of the improvements plans for Tract No. 22332 in

accordance with the conditions, as revised, imposed by the city

of Beaumont.

     At that time, petitioner worked with James Dotson, the

engineer for the city of Beaumont, to revise the conditions on

the Exchange Property.   For petitioner, Mr. Dotson was able to

lock-in the city's prices for its fees before the city

implemented Resolution No. 1988-10.

     While petitioner never obtained a feasibility study of off-

site improvements regarding the Exchange Property, Garner, Troy
                              - 10 -


and Associates prepared a Quantity and Cost Estimate

(Preliminary) for Tract No. 22332, dated January 16, 1987,

stating costs of $389,435.81 for the Exchange Property.    Later,

in a Quantity and Cost Estimate (Preliminary) for Tract No.

22332, dated February 3, 1988, Garner, Troy and Associates

estimated the costs were in the amount of $490,560.    The Quantity

and Cost Estimate was approved by Mr. Dotson for the city of

Beaumont on March 18, 1988.   On February 1, 1988, the city

approved a grading plan for Tract No. 22332.

     Petitioner made no improvements on the Exchange Property.



     Exchange

     In 1988, Gold Coast Development, Inc. (Gold Coast),

approached petitioner with an offer of $650,000 to purchase the

Exchange Property.   Petitioner indicated that it was unwilling to

sell the Exchange Property, but would be willing to exchange the

Exchange Property.   On April 5, 1989, petitioner entered into an

exchange agreement with Empire Realty Exchange, Inc. (Empire).

The conveyance of the Exchange Property was contingent upon the

following:

     (1) Petitioner's house plans being approved for construction
     by the city of Beaumont;
     (2) Gold Coast being able to secure building permits for the
     houses;
     (3) Gold Coast verifying with the city that all necessary
     approvals to enable Gold Coast to record a final subdivision
     map for 48 single family lots have been obtained;
                              - 11 -


     (4) Securing 48 sewer permits for the project from existing
     treatment plant's capacity; and
     (5) Securing 48 water connections.

     Pursuant to the exchange agreement, Empire agreed to acquire

and convey to petitioner one or more parcels of property to be

designated by petitioner.   On May 16, 1989, Empire arranged for

the sale of the Exchange Property to Ameriasian (successor in

interest to Gold Coast) for $674,000.   A grant deed conveying the

Exchange Property from petitioner to Ameriasian was recorded the

same day.   Petitioner did not receive any proceeds from the sale

of the Exchange Property.   Petitioner received a $584,800

exchange credit with Empire for acquiring property yet to be

designated.

     Pursuant to the exchange agreement, petitioner designated

the following four properties to Empire, within 45 days after May

16, 1989:   (1) An undivided 7.87-percent interest in a parcel of

vacant land located along Phelan Road in Phelan, California; (2)

four lots with a house located along Mentone Boulevard in

Mentone, California; (3) three lots with a fast-food store

located along Mount Vernon in Colton, California; and (4) parcels

of vacant land located along Palm Avenue in Highland, California.

All four properties were commercial properties suitable for

constructing fast-food stores.   Empire purchased the four

designated properties within 180 days after May 16, 1989.    Grant

deeds conveying the four designated properties from the
                              - 12 -


respective sellers to petitioner were recorded within 180 days

after May 16, 1989.

     Development of Exchange Property by Elkhorn

     Around March/April 1989, Gold Coast approached Elkhorn

Development Company (Elkhorn) and proposed that they jointly

build 48 houses on the Exchange Property.   Elkhorn was not

interested in a joint venture.   Subsequently, Gold Coast offered

to sell the Exchange Property to Elkhorn.

     In regard to the Exchange Property, Elkhorn discussed with

Robert Bounds, the city manager for Beaumont, topics such as the

water connections, sewer connections, the city conditions, and

the market. Elkhorn knew that the city had a limited number of

sewer permits. Elkhorn also discussed with Mr. Garner,

petitioner's engineer, the tentative map conditions and easements

on the Exchange Property.   Deciding it would be profitable to

purchase the Exchange Property, on April 13, 1989, Elkhorn agreed

to purchase the Exchange Property from Gold Coast/Amerasian.     On

May 16, 1989, Elkhorn purchased the Exchange Property from

Amerasian for $776,000.

     In Resolution No. 1989-21, dated April 24, 1989, the city of

Beaumont authorized and consented to the filing of the Final Map

for Tract No. 22332.   On May 16, 1989, Elkhorn recorded the final

subdivision map for Tract No. 22332, creating 48 lots in the
                               - 13 -


Exchange Property.   The subdivision agreement for Tract No. 22332

was approved by the Beaumont City Council on February 13, 1990.

     Around June/July 1989, Meadowlark Homes, a successor in

interest to Elkhorn, began to install the off-site improvements

for the Exchange Property.    Meadowlark Homes initially estimated

$480,000 ($10,000 per lot) as the cost for off-site improvements.

     In a letter dated June 14, 1989, the Beaumont-Cherry Valley

Water District informed Meadowlark Homes of a proposed increase

in water connection fees, but gave Meadowlark Homes an

opportunity to obtain the connections at the existing rate.     On

June 20, 1989, Meadowlark Homes purchased the water connections

at the existing lower rate.

     Around September/October 1989, Meadowlark Homes began

construction of the 48 houses.   Meadowlark Homes first built 24

houses, which were sold for an average price of $140,000.    Next,

Meadowlark Homes built the second set of 24 houses, but sales of

these houses were slower then the first 24 due to a drop in the

market at the end of 1990.    Ultimately, Meadowlark Homes made a

profit of about $630,000 on the sale of the 48 homes.

Tax Return and Accounting Information

     Petitioner realized a $428,806 gain from the sale of the

Exchange Property.   This gain was reported on line 7 of Schedule

M-1 attached to petitioner's 1989 return.   Respondent in his
                              - 14 -


notice of deficiency dated July 13, 1995,5 determined that the

exchange did not qualify as a nontaxable exchange under section

1031(a).

     Prior to the taxable year 1985, the accounting firm of

Sauer, Dudley, McKenzie and Bovee prepared petitioner's financial

statements and tax returns.   After taxable year 1985, the

accounting firm of Eadie and Payne prepared petitioner's

financial statements and tax returns.

     From the time petitioner purchased the Beaumont Property

until the time petitioner disposed of the property in 1989,

petitioner classified the Exchange Property under work-in-

progress accounts.

     On its return for 1989, petitioner reported its business

activity as "RE SUBDIV & DEVELOP" and described the product or

service as "OPERATOR-DEVELOP."




                              OPINION

     Generally a taxpayer must recognize the entire amount of

gain or loss on the sale or exchange of property.   Sec. 1001(c).

Section 1031(a)(1) provides an exception to the general rule and

allows a taxpayer to defer gain or loss from exchanges of

     5
        Petitioner signed Form 872, Consent to Extend Time to
Assess Tax, extending the time for assessment for the period
ended March 31, 1990, until December 31, 1995.
                               - 15 -


property held for productive use in a trade or business or for

investment.6   However, the nonrecognition treatment of section

1031(a) does not apply to any exchange of "property held

primarily for sale".    Sec. 1031(a)(2)(A).   The test of whether

property is held primarily for sale or for investment is applied

at the time of the exchange.    See Cottle v. Commissioner, 89 T.C.

467, 487 (1987).   Petitioner bears the burden of proving that it

had the requisite investment intent.    Click v. Commissioner, 78

T.C. 225, 231 (1982).

     Respondent argues that the transaction fails to qualify

under section 1031 because petitioner held the Exchange Property

primarily for sale.7    Petitioner argues that it held the Exchange

Property for investment.    Consequently, our focus is solely upon

the characterization of the Exchange Property.

     For purposes of section 1031, neither the Code nor the

regulations define "held for investment."     The regulations

provide that "[u]nproductive real estate held by one other than a




     6
         Sec. 1031(a)(1) provides:

     In General--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 such property is exchanged
     solely for property of like kind which is to be held either
     for productive use in a trade or business or for investment.
     7
        Respondent has not challenged the applicability of sec.
1031 on any other ground.
                              - 16 -


dealer for future use or future realization of the increment in

value is held for investment and not primarily for sale".

Sec. 1.1031(a)-1(b), Income Tax Regs.   In Bolker v. Commissioner,

760 F.2d 1039, 1045 (9th Cir. 1985), affg. 81 T.C. 782 (1983),

the court stated that "a taxpayer may satisfy the 'holding'

requirement by owning the property, and the 'for productive use

in trade or business or for investment' requirement by lack of

intent either to liquidate the investment or to use it for

personal pursuits."

     For purposes of section 1031, neither the Code nor the

regulations define "held primarily for sale."   Whether property

is "held primarily for sale" is a question of fact.   In the

context of section 1221, the Supreme Court held that the term

"primarily" means "of first importance" or "principally."      Malat

v. Riddell, 383 U.S. 569, 572 (1966).

     In analyzing "primarily for sale," petitioner relies on the

factors established in section 1221 cases, which are used to

determine whether property was primarily held for sale to

customers in the ordinary course of business:

     (1)   The purpose for which the property was initially
           acquired;
     (2)   the purpose for which the property was subsequently
           held;
     (3)   the extent to which improvements, if any were made
           to the property by the taxpayer;
     (4)   the frequency, number, and continuity of sales;
     (5)   the extent and nature of the transactions involved;
     (6)   the ordinary business of the taxpayer;
                              - 17 -


     (7)   the extent of advertising, promotion, or other active
           efforts used in soliciting buyers for the sale of the
           property;
     (8)   the listing of property with brokers; and
     (9)   the purpose for which the property was held at the time
           of sale.

Maddux Constr. Co. v. Commissioner, 54 T.C. 1278, 1284 (1970).

None of the factors are conclusive standing alone, but rather all

of the factors taken as a whole govern.   Id.

     Respondent correctly points out that section 1221 applies a

different standard than section 1031.   See Black v. Commissioner,

35 T.C. 90, 96 (1960).   Section 1221(1) excludes from the term

"capital asset" property "held by the taxpayer primarily for sale

to customers in the ordinary course of his trade or business".

(Emphasis added).   Unlike section 1221, the qualifying language

of section 1031 omits the phrase "to customers in the ordinary

course of his trade or business".   Because section 1031(a)(2)(A)

deals only with property "held primarily for sale," this is the

only requirement for the applicability of the exception to

section 1031.   Id.; see Woodbury v. Commissioner, 49 T.C. 180,

197 (1967); Land Dynamics v. Commissioner, T.C. Memo. 1978-259.

     In determining whether the Exchange Property was "held

primarily for sale," the factors presented in section 1221 cases,

such as Maddux Constr. Co. v. Commissioner, provide guidance in

making this determination, but we are not concerned with factors

analyzing whether the property was sold "to customers in the

ordinary course of * * * business" or whether the property was
                              - 18 -


held in petitioner's "trade or business."    See Black v.

Commissioner, supra at 96 (Court rejected taxpayer's argument

that property acquired in a like-kind exchange but held primarily

for sale should come within section 1031 if the sale was not

within the taxpayer's ordinary course of business); Paullus v.

Commissioner, T.C. Memo. 1996-419.     As a result, the exclusion of

"property held primarily for sale" from nonrecognition treatment

in section 1031(a)(1) is broader than the exception to capital

gain treatment in section 1221(1).

     Purpose For Which Beaumont Property Was Initially Acquired

     Petitioner argues that its original intent in purchasing the

Beaumont Property was to construct duplex or four-plex rental

apartment units.   According to petitioner, its intent was to hold

such units for long-term investment.    Petitioner relies on Mr.

Baker's testimony regarding discussions with his broker Carl

Mellor about rezoning the property to multi-family use.

     We do not find Mr. Baker's statements regarding petitioner's

original intent persuasive.   In direct contrast with the

assertion that petitioner intended to hold the property for

construction of duplex or four-plex rental units, its purchase

was contingent upon the tentative subdivision map for the

Beaumont Property being approved by the city of Beaumont.    This

tentative map proposed to subdivide the property into 48 lots for
                                - 19 -


the construction of single-family residential houses.8

Petitioner did not make the purchase contingent on getting R-4

multi-family residential zoning.

     Further, when petitioner purchased the Beaumont Property on

March 10, 1978, the property was zoned R-1 for single-family

residential homes.    Afterwards, petitioner never made any

attempts to have the Beaumont Property rezoned to multi-family

residential use.    The Beaumont Property was not suitable for

commercial development (such as a fast-food location).

     From the evidence, we find that petitioner's initial purpose

in acquiring the Beaumont Property was to hold the property for

sale (subdivide the property into lots for single-family

residential houses).

     Intent After Acquisition

     "[W]hile the purpose for the acquisition must be given

consideration, intent is subject to change, and the determining

factor is the purpose for which the property is held at the time

of" the exchange.    Eline Realty Co. v. Commissioner, 35 T.C. 1, 5

(1960); see Cottle v. Commissioner, 89 T.C. at 487.    Thus, we

must decide whether petitioner abandoned its original intent and




     8
        At trial, Mr. Baker testified that the lot sizes and
configurations of the tentative map would be suitable for the
construction of duplexes. However, the tentative map
specifically proposed single-family residential houses.
                              - 20 -


thereafter at the time of the exchange held the property for

investment.

     In an attempt to show its later intent, petitioner points

out that only after purchasing the Beaumont Property did its

broker Mr. Mellor inform petitioner that it would not be able to

get the Beaumont Property rezoned.     It is argued that at this

point petitioner decided not to subdivide the Beaumont Property,

but instead, decided merely to process a tentative map to

determine conditions for development of the property.     After

determining the conditions, petitioner would be able to analyze

the costs and feasibility of development.

     According to petitioner, after obtaining approval of the

1980 tentative map (which contained conditions for development of

the property), it was decided that development of the Beaumont

Property was not feasible because the cost of off-site

improvements was too high for the construction of entry-level

homes.   Petitioner asserts at this point it held "the property

without any specific plan of action."

     Other evidence indicates that petitioner had an intent to

subdivide the property (such as the discussion with C.H. J.

Materials Laboratory, Inc., regarding a soil investigation

report).   On April 23, 1979, petitioner's Board of Directors

authorized the preparation and filing of an application to the

Real Estate Commissioner of the State of California for a Public
                              - 21 -


Report in connection with the subdivision and sale of real

property on the 48 lots of the Beaumont Property.    This

reinforces the conclusion that as of April 23, 1979, the Board of

Directors decided to subdivide the Beaumont Property.    Also, Mr.

Baker testified that he felt that petitioner would go ahead and

try to subdivide it into single family houses, which resulted in

a series of changes in the tentative map over a period of several

years.

     Subsequent Intent in Regard to the 14 Lots vs. the 48 Lots

     Contemporaneous facts, not self-serving testimony given

years later, are important in establishing intent.    Philhall

Corp. v. United States, 546 F.2d 210, 215 (6th Cir. 1976);

Raymond v. United States, 511 F.2d 185, 190 (6th Cir. 1975).     In

establishing its intent, petitioner relies heavily on Mr. Baker's

statements.   In evaluating these statements, we examine them in

light of the events that transpired from 1978 until the exchange

in 1989.

     In particular, we examine petitioner's development of the 14

lots in Tract No. 10018-1 and petitioner's actions in regard to

the Exchange Property because intent may vary from tract to

tract.   See Mathews v. Commissioner, 317 F.2d 360, 361 (6th Cir.

1963).

     Based on the city of Beaumont's construction of improvements

along Pennsylvania Avenue in 1981 and 1982, petitioner asserts
                                - 22 -


that it changed its intent with respect only to the 14 lots

fronting Pennsylvania Avenue.    It contends that Mr. Baker made a

determination that the 14 lots could be inexpensively subdivided

and that entry-level houses could be profitably built on Tract

No. 10018-1.   From that time forward, petitioner's intent was to

hold the 14 lots for sale.   After obtaining the final map for

Tract No. 10018-1, petitioner ultimately subdivided the 14 lots,

constructed the 14 houses, and sold the 14 houses.

     Petitioner asserts that its intent in regard to Tract No.

10018-1, held for sale, differed from its intent in regard to the

Exchange Property.   Mr. Baker testified that at the time of the

filing of the final map for the 14 lots fronting Pennsylvania

Avenue, he had already decided that constructing homes on the

remaining portion of the property was not feasible.   Petitioner

contends that it partitioned the 48 lots constituting the

Exchange Property from the rest of the tract, as evidenced by the

recording of the final map relating only to the 14 Lots and

excluding the Exchange Property.9

     9
        The fact that the final map only pertained to the 14 lots
fronting Pennsylvania Avenue does not lead to the conclusion that
the Exchange Property was held for investment. It is possible
that petitioner partitioned the property for other reasons, such
as minimizing the bond to be posted for improvements on the
property.
     We note that a letter, dated Sept. 28, 1983, written by
Garner, Troy & Associates, Inc., and signed by Mr. Baker, implied
that petitioner would undertake in stages the development of the
entire tract:
                                                   (continued...)
                              - 23 -


     Petitioner primarily relies on Mr. Baker's statements to

determine its intent at the time of the exchange.   In support of

its intent not to subdivide the Exchange Property, petitioner

lists several factors:   (1) Cost of off-site improvements,

(2) lack of housing market, (3) other obstacles, and (4) health

concerns.   According to petitioner, the primary reasons for not

subdividing the Exchange Property were the cost of the off-site

improvements and its unsuccessful sales record in selling the 14

lots in Tract No. 10018-1.

     (1) Feasibility of Development (Off-Site Costs)

     Petitioner claims that the cost of off-site improvements

prohibited development of the 48 lots in the Exchange Property.

As a result, petitioner argues that it held the Exchange Property

for investment.   In regard to the Exchange Property, petitioner

received an estimate of off-site costs in 1987 in the amount of

$389,435.81, and received another estimate in 1988 in the amount

     9
      (...continued)
     On behalf of our client Neal T. Baker Enterprises Inc. owner
     of approved Tentative Tract No. 10018 we hereby request
     permission to phase Tract 10018. Our client wishes to
     initially improve and build on lots adjacent to Pennsylvania
     Avenue (Lots 1-14 as shown on the attached print of a copy
     of the approved Tentative map from Tract 10018).
          Although it is the owner's intent to phase this Tract
     into two phases, defining the initial Tract by number 10018-
     1; subsequent phases, if any, would be defined as Tract No.
     10018-2, Tract No. 10018-3 etc., with the number 10018
     defining the last phase. Improvement plans, street, sewer,
     water grading etc. shall be modified to correspond and made
     compatible for any and all phases to the satisfaction of the
     city of Beaumont.
                              - 24 -


of $490,560.   Petitioner compares these estimates to the off-site

costs incurred in regard to the 14 lots of approximately $5,000

per lot.

     In regard to the off-site improvements, respondent submitted

an expert report, prepared by Donald Lohr, which estimated the

off-site improvement costs for the Beaumont Property.    Mr. Lohr

estimated off-site improvements for the 14 lots in Tract No.

10018-1 to be $5,821.82 per lot.   Using the 1987 cost estimate,

to which he then added costs of waterlines and appurtenances plus

costs for miscellaneous items, Mr. Lohr initially determined the

off-site cost in 1987 was $10,767.74 per lot for the Exchange

Property (the 1989 cost would be $11,198.45).    In light of

information available after filing his report (the 1988 cost

estimate), Mr. Lohr determined that the off-site costs were

slightly over $12,000 per lot for the Exchange Property.

Mr. Lohr stated that these costs associated with Tract No. 10018-

1 and Tract No. 22332 were not prohibitive.    According to Mr.

Lohr, "[t]he [costs] to develop Tract No. 10018-1 were below the

average cost to develop single-family lots at that time and the

[costs] to develop Tract No. 22332 were no more than average" in

relation to those prevailing in 1989.

     According to Mr. Kanengiser of Meadowlark Homes, the

off-site costs incurred by Meadowlark Homes in developing the

Exchange Property were not cost prohibitive.    Meadowlark Homes
                                - 25 -


estimated the off-site improvement costs to be $10,000 per lot.

In its development of the Exchange Property, Meadowlark Homes did

not encounter any unusual or exorbitant off-site improvement

costs, sewer permit costs, water connection costs or other costs

related to the construction of the 48 houses.

     Petitioner points out several weaknesses to Mr. Lohr's

report.     One weakness is that Mr. Lohr's report included only an

estimate for off-site improvements.10    Because Mr. Lohr's report

was not a full feasibility study, the report excluded

consideration of such items as land costs, financing costs, and

overhead costs.    However, prior to filing its post-trial briefs,

petitioner did not draw attention to those items and argued only

that the off-site costs made development of the Exchange Property

infeasible.    Even if petitioner may now extend its position, it

offered no evidence of the breakdown of the total costs (other

than the off-site costs) to show that total costs presented an

impediment to developing the Exchange Property.    As noted,

petitioner never obtained a feasibility study in regard to the

property.

     Petitioner also points out that Mr. Lohr's estimate of the

off-site costs for each of the 48 lots was roughly double his

estimate of the off-site costs associated with each of the 14


     10
        Off-site improvements include such things as grading,
utilities, electricity, sewer, water, and cable.
                                    - 26 -


lots.   Mr. Lohr noted that an estimate of the costs for 14 lots

in 1989 would have been $6,642.41 per lot.         Petitioner compares

this to the roughly $12,000 per lot for the 48 Lots in the

Exchange Property.      According to petitioner, the estimated profit

per home of about $8,000 per lot would be wiped out by the

increased off-site cost of $6,000 per lot.

     Our evaluation of petitioner's argument is restricted

because it did not submit any projected profit analysis for the

development (besides Mr. Baker's testimony).          In regard to the 14

lots, only after construction did Mr. Baker check the costs and

he felt there was a profit somewhere around "4- to 5-, $6,000 per

house, maybe a little higher."         Later, Mr. Baker testified that

petitioner made profit of around $8,000, maybe $8,000 to $10,000.

     The parties submitted a summary by petitioner's accountant

Eadie and Payne reflecting the following income on the sale of

the 14 houses:

Date of Sale             Address               Selling Price     Income
07/21/87         1202   E. 10th Street           $79,950       $17,812.74
09/30/87         1050   Pennsylvania Avenue       87,950        21,312.48
12/22/87         1070   Pennsylvania Avenue       77,950        13,469.04
01/08/88         1090   Pennsylvania Avenue       87,950        25,859.29
09/16/88         1010   Pennsylvania Avenue       89,500        23,297.54
09/23/88         1110   Pennsylvania Avenue       77,950        12,891.26
11/17/88         1202   E. 11th Street            79,950        13,133.62
11/22/88         1201   E. 11th Street            77,550        13,502.00
01/27/89         1130   Pennsylvania Avenue       80,950        13,403.44
02/10/89         1120   Pennsylvania Avenue       89,950        22,556.98
02/28/89         1030   Pennsylvania Avenue       77,000         2,875.26
03/06/89         1100   Pennsylvania Avenue       87,950        20,469.47
03/13/89         1140   Pennsylvania Avenue       89,950        23,236.19
03/31/89         1150   Pennsylvania Avenue       89,950        22,667.19
                              - 27 -


According to this, petitioner's income from the sale of the

houses averaged $17,606.18.

     Petitioner attempts to reduce the profit from the sale of

the 14 houses by pointing out that the following costs were not

allocated to its construction activities:11    (i) the cost of

overhead and supervision; and (ii) the interest costs associated

with the use of corporation capital to construct the homes.

Mr. Baker considered these costs in determining profit from

construction activities.

     However, Mr. Baker testified that he did not know the costs

until petitioner's accountant Eadie and Payne informed him.

Further, Mr. Baker testified that he did not know how the

accountants accounted for the cost of overhead and supervision.

Petitioner did not call its accountants to clarify or explain any

of petitioner's cost and profit analysis.     See Wichita Terminal

Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946) (drawing

negative inference if evidence is within possession yet it is not

introduced), affd. 162 F.2d 513 (10th Cir. 1947).    Petitioner

also did not incur significant interest costs because it

generally used cash on hand, avoiding construction financing.

     While petitioner criticizes Mr. Lohr for not preparing a pro

forma budget for the project, it provided no evidence to

     11
        Respondent suggested a profit of $17,606.18 per house,
while petitioner asks the court to accept an average net profit
of approximately $7,000 to 10,000 per home.
                               - 28 -


establish petitioner's projected budget for costs or its

estimated profit (or loss).   Additionally, petitioner argues that

Mr. Lohr's statement that the costs for the 48 lots were "no more

than average" does not change the fact that Mr. Baker believed

that the cost per lot was too expensive for building entry-level

homes.    However, petitioner provided no evidence to support Mr.

Baker's statements.   Petitioner acknowledges this:12   "The only

testimony before the court is the testimony of Baker who

testified that he concluded that it would not be profitable to

do so."   We are reluctant to accept Mr. Baker's conclusion.

     We find that the off-site costs for the Exchange Property

were not prohibitive in regard to petitioner's development of the

Exchange Property.




     12
        Mr. Garner, petitioner's engineer, mentioned a
conversation with Mr. Baker: "I don't know whether he used the
word 'horrendous,' but he used some terminology saying the this
was far, far more than the other 14 lots would cost him, and he
was discouraged at this amount." Petitioner uses the statement
to support its position that the costs were exorbitant, but the
statement merely shows what Mr. Baker told Mr. Garner about the
costs.
                               - 29 -


     (2) Housing Market and Sales

     Petitioner also asserts that another factor in petitioner's

determination not to develop the 48 lots was the unsuccessful

sales program for the 14 lots in Tract No. 10018-1.    In light of

the slow sales, petitioner concluded that a market for entry-

level homes in Beaumont did not exist.

     On or about October 1986, petitioner contracted for the

construction of 14 single family residences in Tract No. 10018-1.

The 14 houses were constructed in two phases, the first phase

consisting of 6 houses (construction commenced on October 17,

1986) and the second phase consisting of 8 homes (construction

commenced on June 25, 1987).

     Mr. Baker testified that the sales of the first six homes

were slow, at a rate lower than anticipated or acceptable to

petitioner.   Mr. Baker remarked that petitioner held the

completed homes for an average for 9 months.    The second phase

sold quicker, but sales were still unacceptable to petitioner.

Mr. Baker felt that it was not worth further subdividing the

property due to the slow sales, the amount of money expended, and

the trouble of building the 14 houses.

     In regard to the holding period, petitioner relies on the

fact that the 14 houses sold from July 21, 1987, to March 31,

1989, which is approximately a 20-month span.    Additionally,

petitioner points out that only three houses sold during 1987 and
                                   - 30 -


that the house located at 1030 Pennsylvania Avenue took

approximately 19 months to sell.

     However, petitioner's arguments oversimplify the facts.            In

determining the holding period, we need to know when the houses

were completed and compare this to the sales dates.            Examining

the record, we find the final inspection date of each of the 14

houses.   Mr. Baker stated that each house was completed (except

for the appliances, fixture, carpets) and ready for sale prior to

the final inspection date.     Due to problems in the area

(vandalism, etc.), in some instances the final inspection did not

occur until shortly before the house was sold.           But petitioner

presented no evidence to show when the houses were substantially

completed.

     The final inspection date and the sale date for each house

are as follows:

Final Inspection Date   Date of Sale           Address                Phase

     07/10/87           07/21/87        1202   E. 10th Street          1
     07/23/87           09/30/87        1050   Pennsylvania Avenue     1
     07/23/87           12/22/87        1070   Pennsylvania Avenue     1
     07/23/87           01/08/88        1090   Pennsylvania Avenue     1
     07/23/87           09/16/88        1010   Pennsylvania Avenue     1
     08/23/88           09/23/88        1110   Pennsylvania Avenue     2
     08/23/88           11/17/88        1202   E. 11th Street          2
     10/31/88           11/22/88        1201   E. 11th Street          2
     01/23/89           01/27/89        1130   Pennsylvania Avenue     2
     02/06/89           02/10/89        1120   Pennsylvania Avenue     2
     07/23/87           02/28/89        1030   Pennsylvania Avenue     1
     10/21/88           03/06/89        1100   Pennsylvania Avenue     2
     02/23/89           03/13/89        1140   Pennsylvania Avenue     2
     02/27/89           03/31/89        1150   Pennsylvania Avenue     2
                              - 31 -


According to petitioner's records, the house at 1030 Pennsylvania

Avenue in Phase 1 (which was completed on or before 7/23/87 and

sold 2/28/89) was the model home; so the long holding period for

this house is not significant.   Treating the final inspection

date as the date of completion and the sale date and excluding

the sale of the model home, petitioner held the houses in Phase 1

for about 5.3 months apiece and held the houses in Phase 2 for

about 1.3 months apiece.   In light of the evidence, we are not

persuaded by Mr. Baker's testimony that sales of the 14 houses

were unacceptably slow.

     Meadowlark Homes' Success with the Exchange Property

     Respondent uses Howard Kanengiser's (of Meadowlark Homes)

testimony to establish the market for the development of the

Exchange Property.   Meadowlark Homes experienced brisk sales in

1989 in regard to the first 24 homes.   In 1990, due to the

recession, Meadowlark Homes experienced a drop off in sales in

regard to the second 24 homes.   Meadowlark Homes made

approximately $630,000 in profit on the development.     This was

approximately one-third less than Meadowlark had anticipated.

     In regard to Meadowlark's slower sales for the second phase,

petitioner argues that this supports its position that it held

the Exchange Property for investment because Mr. Baker foresaw

the poor sale of homes in Beaumont based on (i) the poor sales

record on the first 14 homes, (ii) the fact that Beaumont is a
                               - 32 -


low-income area that failed to share in the Southern California

housing boom, and (iii) his experience in the banking business.

However, Mr. Kanengiser's testimony indicated that the recession

was unforeseeable.

     In discounting the relevance of Mr. Kanengiser's testimony,

petitioner points out the difference between Meadowlark Homes'

development and petitioner's development:

     (1)    Meadowlark Homes built houses with an average selling
            price of $140,000 while petitioner built "entry level
            housing" in the $70,000 to $100,000 range; and
     (2)    Meadowlark Homes borrowed approximately $6,000,000 to
            finance the project while petitioner used working
            capital, borrowing no more than $400,000.

Mr. Baker testified that petitioner was not equipped for more

than entry-level houses.

     We know that petitioner's 14 houses in Tract No. 10018-1

sold in the price range of $77,000 to $89,950 and that Meadowlark

Homes upgraded petitioner's plan selling its houses for about

$140,000.   At trial, there was testimony presented regarding the

market in the city of Beaumont.    Mr. Dotson, the city's engineer,

and Mr. Bounds, the city's manager, testified to the increased

real estate market in Beaumont from 1985 until the recession in

1990.   Other than Mr. Baker's testimony, petitioner presented no

market data on sales in Beaumont.    Mr. Baker admitted he was

generally unaware of the general level of income in Beaumont and

had merely an impression of the market.    We are not convinced

that the market in Beaumont supported only the upgraded houses of
                                - 33 -


Meadowlark Homes and did not support petitioner's type of

development as well.

     Further, there was no evidence presented to establish that

petitioner was equipped only for entry-level houses.

     In regard to petitioner's second point, petitioner did not

establish that its borrowing policy limited the type of house

built and the number of houses built.13

     From the record, we find that a market for single-family

residential homes existed at the time of the exchange in 1989.

Petitioner has not persuaded us that the market did not support

its development of "entry-level low income houses."

     (3) Other Obstacles

     Petitioner also asserts that other obstacles arose in

connection with subdividing the 48 lots, which led to Mr. Baker's

conclusion that development of the Exchange Property would not be

profitable.

     First, petitioner points to the fact that Beaumont-Cherry

Valley Water District was increasing its water connection fee by

approximately $450 per lot.   However, in June 1989, Meadowlark

Homes was able to purchase the water connection at the existing

rate (prior to the increase).

     13
        Mr. Baker testified that the maximum loan obtained by
petitioner was $400,000. However, petitioner authorized its
officers to obtain construction financing. For example, in the
taxable year 1989, petitioner had a $700,000 construction line of
credit which expired in Feb. 6, 1991.
                                - 34 -


     Next, petitioner points to communications by the city of

Beaumont of a possible limitation in sewer permits.14    Sewer

permits play a necessary role because in order to begin

construction, building permits and sewer permits are both

required.    We note that there was concern about the city's sewer

capacity in 1988.    The city began to investigate the building of

a new sewer plant.    While the city manager Mr. Bounds was the

only person who knew the number of available permits, there was

no evidence presented regarding any discussion of sewer permits

between petitioner and him.    Meadowlark Homes was able to acquire

sewer permits for the 48 lots in the Exchange Property.    Further,

as of 1993, the city of Beaumont had not run out of sewer

permits.    In light of the above, we find that availability of

sewer permits was not an obstacle to petitioner's development of

the Exchange Property.15

     (4) Health Concerns

     At trial, petitioner introduced evidence of Mr. Baker's

health.     In November 1988, he was diagnosed with cancer. He had a


     14
        However, Mr. Baker testified that he decided not to
subdivide the Exchange Property before learning about the
potential of a moratorium.
     15
        In its reply brief, petitioner attempts to show that Mr.
Baker's decision to not record the final map in light of the
threat of a moratorium shows that it was petitioner's intent to
not develop the Exchange Property. However, we find little
significance to petitioner's characterization in light of the
lack of evidence regarding the threat.
                               - 35 -


fifty-fifty chance of survival.   In November 1988, Mr. Baker

underwent surgery, which was followed by chemotherapy.   Mr. Baker

testified that as a result of contracting cancer, he made a

decision that petitioner would discontinue subdividing land;

thereafter, petitioner built some homes on existing lots but no

longer subdivided raw land into lots.

     As petitioner's main decision maker, Mr. Baker's health

impacts petitioner, but we are examining petitioner's intentions

in regard to the Exchange Property in 1989 and not necessarily

petitioner's decisions regarding other aspects of its trade or

business.

     We first consider Mr. Baker's statement that he spent only

20 percent of his time at the time of exchange working for

petitioner, while he spent the other 80 percent of his time

supervising the food operations of Baker's Burgers, Inc.    Mr.

Baker and Terry Talley managed petitioner's construction

activities.   Because petitioner subcontracted all of its

construction work, the actual number of permanent employees

employed by petitioner or Mr. Baker's diminished time with

petitioner is of little significance.

     Petitioner presented no evidence of actions of its Board of

Directors to corroborate Mr. Baker's statement that petitioner no

longer was subdividing land.   Instead, we note that on Form 1120,

for the taxable years 1988, 1989, 1990, and 1991, petitioner
                              - 36 -


listed "subdivider and developer" instead of "real estate

operator and lessor of building" as its principal business

activity.

     Additionally, the evidence shows that petitioner continued

its subdividing and developing activities.   For example,

petitioner continued to build houses on the 20-lot tract in

Yucaipa after petitioner allegedly discontinued developing,

recording the income from the sale of the houses as ordinary

income in 1990, 1991, 1992, and 1993.   In regard to these other

developments by petitioner, we know that it continued to hold

these properties for sale, rather than investment.   The record

does not substantiate petitioner's assertion that it built homes

on existing lots and no longer subdivided raw land into lots.

     Mr. Baker's mere statements that petitioner intended to

discontinue the development business are not enough to change the

characterization of the Exchange Property.   See Tollis v.

Commissioner, T.C. Memo. 1993-63, affd. per curiam without

published opinion 46 F.3d 1132 (6th Cir. 1995).   Petitioner

presented no objective and contemporaneous evidence to establish

its change in intent.   Considering petitioner's actions, Mr.

Baker's health concerns do not persuade us to accept petitioner's

conclusion that it stopped its subdividing and developing

activities.
                              - 37 -


Other Evidence--Petitioner's Actions

     While petitioner's intent at the time of the exchange is

critical, it primarily relies on Mr. Baker's statement to

establish its intent, without examining the actions of petitioner

as a corporation.   See Raymond v. United States, 511 F.2d 185,

190 (6th Cir. 1975).

     Ordinary Business

     Several courts have considered whether a taxpayer's real

estate operations were limited to the properties in question or

were engaged in as part of a general real estate business.     Eline

Realty Co. v. Commissioner, 35 T.C. at 5 (discussing this point

in the context of a predecessor of section 1221); Maddux Constr.

Co. v. Commissioner, 54 T.C. at 1284.    We recognize that a

taxpayer in the real estate business may also acquire and hold

real property for investment purposes.    Maddux Constr. Co. v.

Commissioner, supra at 1286 (dealing with section 1221).     The

taxpayer has the burden of proving that when dealing with the

property it was wearing the hat of an investor rather than that

of a dealer.   Pritchett v. Commissioner, 63 T.C. 149, 164 (1974).

In determining this, we accord greater weight to the objective

facts than to petitioner's statements regarding investment

intent.

     Further, "a subsequent sale is not conclusive on the

question of the primary purpose in acquiring and holding the real
                              - 38 -


estate."   Municipal Bond Corp. v. Commissioner, 382 F.2d 184, 188

(8th Cir. 1967), revg. in part and affg. in part 46 T.C. 219

(1966) (dealing with section 1221).    The fact that land was held

for many years does not, by itself, establish an intention to

hold the property for investment rather than sale.   See Stockton

Harbor Indus. Co. v. Commissioner, 216 F.2d 638, 655-656 (9th

Cir. 1954).

     In claiming that it held the Beaumont Property and the

Exchange Property for investment purpose, petitioner asserts that

its subdividing and developing activities were very limited.16

Petitioner points out that it sold all of its houses through

unrelated realtors and that it did not engage in any construction

activities, instead it used subcontractors.   Petitioner contends

that the heart and soul of petitioner related to the location,

development, and construction of fast food sites to be held for

investment.   Petitioner states that a majority of its income is

derived from the rental of fast-food locations17 (Mr. Baker


     16
        Petitioner also asserts that it had a history of holding
properties for investment, including properties that it at one
time intended to develop. However, the record does not support
petitioner's position.
     17
        At times, petitioner blurs the distinction between
petitioner and the separate corporation Baker Burger's Inc. When
petitioner spun off in 1969 the fast-food operations to Baker
Burger's Inc., Mr. Baker stated that the two businesses were for
all practical purposes totally unrelated, and that it had become
necessary to conduct the two businesses separately in order to
facilitate flexibility, expansion, cost control, proper
                                                   (continued...)
                                             - 39 -


       having been one of the originators of the fast-food concept in

       the United States) and other rental properties.

                The tax returns provide the following:
                      1984          1985       1986        1987         1988         1989

Gross Receipts      $184,528      $410,000   $927,000   $1,684,469   $1,253,850   $1,210,350
Cost of Goods Sold
(cost-houses & lots) 116,899       283,171    691,058    1,507,664    1,070,108    1,082,998
Gross Profits         67,629       126,829    235,942      176,805      183,742      127,352

Gross Rents          613,758       688,147    733,308      841,314    1,413,983    1,834,533

Net Capital Gain      58,536       694,880     16,774       18,545       20,351        -0-

Ordinary Gain          6,308         -0-        -0-          -0-          -0-          -0-

                Petitioner points out that the financial records divide its

       operations into rental activities and construction activities.

       It argues that its profits from construction activities range

       from 6.5 percent to 24.3 percent, indicating a trend of decreased

       profits from construction activities and of increased profits

       from rental activities over the period.            In making this argument,

       petitioner compared gross profits from construction activities to

       gross rents.          Presented with only petitioner's financial returns,

       we cannot accept its conclusion that construction of property

       held for sale was a minor portion of its activities, when

       petitioner had gross receipts of $1,253,850 in 1988 and

       $1,210,350 in 1989, compared to gross rents of $1,413,983 in 1988

       and $1,834,533 in 1989.




                17
             (...continued)
       management and the raising of capital.
                              - 40 -


     Furthermore, for each taxable year 1982 through 1991, on

Form 1120, petitioner listed "real estate subdivider and

developer" as its principal business activity.18   While "real

estate operator and lessor of buildings" is an option provided in

the Instructions to Form 1120, during 1981 to 1991, petitioner

never listed "real estate operator and lessor of buildings" as

its principal business activity.

     In taxable year 1987, on Form 3115, petitioner stated that

its business and principal income was "real estate subdivider and

developer, real estate rentals," and affirmatively answered that

it produced or acquired property for resale to which section 263A

applied.

     Mr. Baker testified that petitioner was in the business of

subdividing and developing prior to 1990.   However, petitioner

asserts that this is true only to the extent that the subdivision

and development activities related to the eventual construction

of fast-food stores or, in some circumstances, single-family

residences.   Mr. Baker stated that of the 80 fast-food locations

owned by petitioner, it built approximately 50 of them.    While

his testimony is unclear and undocumented, it seems that




     18
        Even though petitioner listed the wrong code number for
real estate subdivider and developer from 1982 through 1991,
petitioner specifically stated its business as real estate
subdivider and developer.
                               - 41 -


petitioner constructed the 50 locations over a period from prior

to its incorporation in 1957 to the date of the trial.    Besides

Mr. Baker's statement of constructing fast-food locations,

petitioner did not present any evidence regarding subdivision

activities on property on which fast-food stores were later

constructed.

     On the other hand, we note that petitioner was engaged in

developing other properties (in addition to the Beaumont

Property) from 1978 to 1991.   Petitioner purchased 75 unimproved

lots in Pacific Street in Highland, California.   Petitioner built

25 houses, installed improvements on the remaining 50 lots, and

sold all the lots in 1980.   Petitioner also had development

projects in San Bernardino, Yucaipa (20 lots, which were

purchased in 1986 for the purpose of building houses thereon and

to sell the houses upon completion), and La Quinata (20 lots,

which were purchased in 1988).

     We agree with petitioner that it was engaged in several

activities, which included acquiring and holding real estate for

fast-food locations (which were later leased to Baker's

Burgers).19    At the same time, we find that petitioner also was


     19
          Petitioner states that:

     Its activities included the following (i) holding raw land
     for investment purposes, (ii) holding fee title to fast-food
     locations for rental to Baker's Burgers, (iii) acting as
     master lessor to Baker's Burgers with respect to fast-food
                                                   (continued...)
                                - 42 -


engaged in the business of subdividing and developing before and

during the taxable year 1989.20   We note that section 1031 use of

"held primarily for sale" does not require that the property be

sold in the ordinary course of petitioner's trade or business (as

provided in section 1221(1)).

     Books and Records

     Courts have used a taxpayer's books and records as evidence

of an intent to change the character of an asset.

     As of March 1979, petitioner classified the Beaumont

Property in Account No. 1160 for finished houses and work-in-


     19
      (...continued)
     locations which were leased from third parties, (iv)
     developing new fast-food sites for Baker's Burgers and
     leasing those new sites to Baker's, (v) leasing fast-food
     sites to third parties, and (vi) constructing homes for
     sale.
     20
        Respondent asserts that a real estate "subdivider" is
one that obtains land, goes through the process of filing a final
map to subdivide property into lots, and sells the lots. And
that a real estate "developer" is one that obtains the lots,
installs the improvements on the lots, builds houses on the lots,
and sells the houses.
     Petitioner contends that respondent's analysis of the term
"subdivider" and "developer" is inaccurate. Petitioner states
that: "With respect to the homes built by Enterprises, it was
its practice to either purchase subdivided land or to both
subdivide land and construct homes on the subdivided lots."
     Mr. Dotson testified that there is potential for overlap in
the terms "subdivider" and "developer."
     We need not worry about the exact definition of subdivider
and developer because we find that petitioner was engaged in the
business of both, depending on the development. To the extent
properties were subdivided, petitioner intended to build
improvements on these properties. Further, while petitioner
contends it no longer subdivided raw land into lots after 1988,
the record does not support this contention.
                                - 43 -


progress, with the following description "Beaumont Subdivision

(Tract 10018) 46 unimproved lots."       In regard to the 14 lots in

Tract No. 10018-1, the lots were recorded in work-in-

progress/construction-in-progress account and finished houses

account.    Petitioner never moved the property from these

accounts.    Petitioner also listed the Exchange Property, Tract

No. 22332, under the category of work-in-progress/construction-

in-progress (Account No. 1160), and never moved the Exchange

Property from that account during the period of 1978 to 1989.

     Petitioner asserts that the characterization of the Exchange

Property as work-in-progress was made by its accountants without

Mr. Baker's knowledge.    Mr. Baker claims that the accountants

incorrectly classified properties under work-in-progress

accounts.    Petitioner points out that many properties that were

clearly held for investment (such as fast-food stores) were

listed under the work-in-progress category.      It attempts to

categorize the work-in-progress category as a suspense account

used to keep track of expenses.    Petitioner concludes that the

Exchange Property was listed under the work-in-progress account

because the petitioner made expenditures for engineering costs

associated with the property.

     In its assertions that properties were listed

inconsistently, petitioner solely relies on Mr. Baker's

statements about its use of the properties and the
                                - 44 -


misclassification of its properties.     Even though petitioner's

accountants were listed as witnesses in the pretrial memorandum,

it never called the accountants to explain, verify, or discuss

why properties were recorded in a certain manner.     See Wichita

Terminal Elevator Co. v. Commissioner, 6 T.C. at 1165.      Further,

petitioner did not provide any other evidence to explain its

manner of accounting for the properties.

     We note that petitioner's characterization of the Exchange

Property in its records is consistent with its treatment of the

Pacific Street Subdivision in Highland, California.     In regard to

75 lots in the Pacific Street Subdivision, petitioner built 25

houses, and installed only improvements on the remaining 50 lots.

However, petitioner kept all 75 lots in the work-in-progress

account until they were sold in 1980.     Petitioner classified

income from the sale of the houses and the unimproved lots as

ordinary income.   Petitioner also listed its residential

development in Yucaipa under work-in-progress account No. 1160-

81, and its residential development in La Quinata under work-in-

progress account No. 1160-85.

     This is compared to petitioner's treatment of the Leedom

Tract, 41 unimproved lots.   While Leedom was initially in 1978

classified in the work-in-progress account, petitioner later in

1985 reclassified the property into the "unimproved land and

vacant lots" account No. 1280-31.    In regard to the Exchange

Property, which was unimproved land, petitioner never moved the
                               - 45 -


property from the work-in-progress account into the unimproved

land and vacant lot account.

     In regard to investment properties, petitioner listed the

properties (such as the Fontana drive-in, the Fontana coffee

shop, the Kendall drive-in, and the Banning drive-in) under the

land account no. 1210, under the building account no. 1220, or

under the undeveloped or vacant land account.   Some investment

properties were listed under the work-in-progress accounts

temporarily.   Later (after completion of the buildings, though

this is not entirely clear), the properties were moved to land

accounts, building accounts, or undeveloped land accounts.

     Presented only with the accounting records and Mr. Baker's

statements, we are not persuaded that Mr. Baker's conclusions

that petitioner's accountants misclassified properties on its

financial records are accurate.

     As with its other subdivision properties, petitioner listed

the Exchange Property in the work-in-progress account from 1983

to 1989.   Further, petitioner never moved the Exchange Property

out of the work-in-progress account (even though petitioner

alleges it decided in 1983, or later in 1987-88 after completion

of the 14 lots, not to subdivide the Exchange Property).   This

treatment reflects petitioner's intent to keep the inactive phase

of the 48 lots in the Exchange Property in the work-in-progress

account until development of the houses.
                              - 46 -


     Improvements

     We note that petitioner did not make any improvements on the

Exchange Property.   However, the fact that the property was not

developed when it was sold does not, standing alone, require a

conclusion that it was held for investment.     See Kesicki v.

Commissioner, 34 T.C. 675, 679 (1960).

     Activity: Map Process

     Petitioner contends that there were little or no activity in

regard to the Exchange Property.   See Olivieri v. Commissioner,

T.C. Memo. 1966-177.   We disagree.    In regard to the Exchange

Property, petitioner resubmitted the tentative map.     The

tentative map was approved on June 9, 1986.21    Afterwards,

petitioner proceeded to obtain a final map regarding the Exchange

Property.   Between May 6, 1986 and May 16, 1989, petitioner

worked with Mr. Dotson, the engineer for city, to revise the

conditions of approval, including the cost estimate.     During this

period, Dotson revised the conditions.     These discussions led to

petitioner being able to lock-in the lower city development fees

for the Exchange Property.

     As of March 18, 1988, the final map on the Exchange Property

was approved and ready to be recorded once petitioner obtained

the required signatures.   As of the date of the exchange, the


     21
         A tentative map shows the design and improvement of a
proposed subdivision and the existing conditions, but it cannot
be recorded. Cal. Govt. Code secs. 66424.5(a), 66429 (West
1997).
                              - 47 -


final map had not been recorded by petitioner, but Elkhorn

recorded the final map regarding the Exchange Property on May 16,

1989 (the date of the exchange).

     While petitioner de-emphasizes its efforts from 1983 to

1989, petitioner spent time and money in getting the final map

ready to be recorded, from filing applications to discussions

with city employees regarding conditions.   The mapping process is

an involved and time-consuming process.22   While the tentative

map is only a conceptual plan, the final map is a legal document,

which gives the landowner the right to build under certain

conditions.

     In explaining petitioner's action regarding the map process,

it asserts that "[a]t the urging of his engineer, Baker

authorized the processing of a new tentative map (No. 22332)."

Later, petitioner asserts that it continued the process "because

that'd be about the only way [it] would ever sell [the property],

is to show someone what could be done on that property."

Petitioner viewed the process of obtaining a tentative map as a

method of determining the economic feasibility of developing

property.

     Petitioner notes that the only way a landowner can determine

the feasibility of developing a property is to process a


     22
        The process of obtaining a final map can take from
6 months to 17 years. It involves numerous stages of review,
comment, and revision until the final map and improvements plans
are approved.
                              - 48 -


tentative map.   We note Mr. Dotson's testimony that submitting a

tentative map is not required to determine costs and the

project's profitability.   However, using the process of tentative

maps is one means to determine costs and conditions for

development.

     In this case, the tentative map for the Exchange Property

was approved in June 1986.   Afterwards from 1986 to 1989,

petitioner spent 3 years to process the tentative map to the

point the final map was ready to be recorded in 1988.    Petitioner

states that this process indicated that the development would not

be profitable.   In attempting to establish its intent to not

develop the property, petitioner stresses the fact that the final

map was not recorded by petitioner, and that the final map would

have expired in June 1989.   Mr. Garner testified that Mr. Baker

"did not feel that he wanted to go ahead with the recording of

the map.   So we were never given instructions to finish

processing the final map and the street plans."   However, we

agree with Mr. Dotson's statement that he did not assign any

significance to petitioner's waiting to record the final map.

     In our view petitioner went further than merely determining

the feasibility of developing the Exchange Property.    Whether

petitioner would have let the tentative map on the Exchange

Property expire is subject to speculation.   However, we know that

petitioner's actions on the Exchange Property made the property

more marketable.   By 1988, the final map was ready to be
                               - 49 -


recorded.   Mr. Baker admitted at trial petitioner wanted to sell

the Exchange Property to get its money back.   While petitioner

categorizes this as a vague intent, we find that petitioner

expended substantial time, energy, and money in its efforts to

develop the Exchange Property.   Whether petitioner was going to

get its money back by subdividing and developing the property or

by selling the raw land, it indicates an intent to liquidate the

property.   See Bolker v. Commissioner, 760 F.2d 1039, 1045 (9th

Cir. 1985), affg. 81 T.C. 782 (1983).

     Extent of Marketing the Exchange Property

     Petitioner points out that it received an unsolicited offer

to purchase the Exchange Property through a broker.   Prior to

receiving the unsolicited offer for the purchase of the Exchange

Property, petitioner did not list the property with a broker for

sale, did not advertise it for sale in any way, and engaged in no

other marketing efforts relating to the Exchange Property.

     At the same time, in connection with the 14 lots, petitioner

did not actively market the development; instead, petitioner used

unrelated realtors.

     Paullus v. Commissioner

     In attempting to demonstrate its investment intent,

petitioner focuses on the fact that it never recorded the final

map of (i.e., never subdivided) the Exchange Property.

Petitioner cites Paullus v. Commissioner, T.C. Memo. 1996-419.

In Paullus, the Court found that the taxpayer held the property
                              - 50 -


for investment despite the fact that the taxpayer filed a final

map and constructed about $1,600,000 in off-site improvements

(with the sales price of $11,250,000) on the property.     Id.

Petitioner compares the facts in Paullus to its situation, where

it did not record a final map and constructed no improvements on

the Exchange Property.   Petitioner asserts that its activities

were minor and preliminary compared to those taken by Paullus.

     In making its decision, the Court in Paullus looked at

several factors, in addition to the fact of filing a final map

and constructing improvements.    Ridgemark, the taxpayer in

Paullus, segregated its business of operating Ridgemark Golf and

Country Club from the development and sales of lots, which were

done by two other corporations.    Ridgemark consistently reported

its business activity as the operation of a golf and country

club.   The Court noted that Ridgemark's actions (long holding

period, only limited sales to its related companies, paucity of

purchases and sales) indicated an investment motive in holding

the property.

     The Court's holding in Paullus was based on the specific

factual situation presented in that case.    While petitioner

argues that the Paullus and this case are similar, we find that

the instant case's factual situation is distinguishable from the

situation surrounding the taxpayer in Paullus.    In Paullus,

Ridgemark formed Ridgemark Financial Corp. and Ridgemark

Construction Corp. to carry on the residential lot activities.
                                 - 51 -


Ridgemark's main operations were its golf and country club

activities.    By contrast in this case petitioner was in the

subdividing and developing business, choosing to spin off its

fast-food operations to Baker's Burgers, Inc.    While petitioner

asserts its rental activities exceeded its development

activities, we do not find support for that assertion in the

record.   While petitioner did not record the final map, in 1988

it was ready to be recorded.23    As discussed above, petitioner

had taken substantial steps in the development of the Exchange

Property.

Conclusion

     Petitioner has been active as a subdivider and developer of

real estate.    It has the burden of proving that when it was

dealing with the Exchange Property it was wearing the hat of an

investor.

     Petitioner acquired the Exchange Property to construct

single-family houses for sale.     Considering all the factors, we

find that petitioner did not establish its investor status in

connection with its holding of the Exchange Property.    While

petitioner presented potential obstacles (high development costs,

slow sales, etc.), it did not establish that it discontinued its

plans to develop the 48 lots in the Exchange Property.    At the



     23
        In a letter by Elkhorn, dated Apr. 11, 1989, it stated
that petitioner was to sign and record the final map before the
exchange. In the end, Elkhorn recorded the final map.
                             - 52 -


time of the exchange, petitioner held the Exchange Property

primarily for sale (as evidenced, inter alia, by its effort to

make the final map ready to be recorded, its efforts to lock in

lower city development fees, and its treatment of the Exchange

Property in its books and records).    We conclude that the

Exchange Property was held by petitioner primarily for sale

within the meaning of section 1031(a)(2)(A) and therefore that

the exchange does not qualify for nonrecognition treatment under

section 1031(a).

     To reflect the foregoing,

                                           Decision will be entered

                                      for respondent.
