                         T.C. Memo. 1995-537



                       UNITED STATES TAX COURT



                S. VICTORIA WELLS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 16962-93.                 Filed November 13, 1995.



     Carl F. Agren, for petitioner.

     Maria D. Murphy, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:    Respondent determined a deficiency in

petitioner's 1989 Federal income tax in the amount of $150,027

and an accuracy-related penalty under section 6662(a)1 in the

amount of $30,005.    The issues for our consideration are:    (1)

     1
       All section references are to the Internal Revenue Code in
effect for the taxable year under consideration, and all Rule
references are to this Court's Rules of Practice and Procedure,
unless otherwise indicated.
                                - 2 -


Whether petitioner was the sole owner of a residence for Federal

income tax purposes and, thus, required to recognize 100 percent

of the gain on its disposition; and (2) whether petitioner is

liable for the accuracy-related penalty for substantial

understatement of income tax.

                         FINDINGS OF FACT

     S. Victoria Wells (petitioner) resided in Balboa Island,

California, at the time her petition in this case was filed.    On

August 25, 1968, petitioner married Thomas F. Wells (Mr. Wells)

in the State of California.   On May 28, 1987, petitioner and Mr.

Wells separated.   On August 6, 1987, petitioner commenced a

proceeding for divorce in the Superior Court of the State of

California for Orange County (Superior Court).   A divorce decree

was filed on May 17, 1990, dissolving the marriage.   The Superior

Court retained jurisdiction to decide child custody and division

of marital property issues, and its judgment was filed on June

12, 1991.

     While petitioner was married to Mr. Wells, they purchased,

as joint tenants, a residence located at 10902 Paddock Lane,

Santa Ana, California (Paddock Lane property).   Their property

deed was recorded on April 25, 1978.    From April 25, 1978, until

May 28, 1987, when petitioner and Mr. Wells separated, the

property was their primary residence.   Petitioner continued to

reside there after the separation from Mr. Wells.
                                - 3 -


     In or about March 1985, petitioner and Mr. Wells jointly

obtained a $190,000 second mortgage on the Paddock Lane property.

The mortgagee/lender was American State Bank.

     On June 30, 1988, petitioner and Mr. Wells jointly obtained

a $200,000 loan from Community Home Loan, Inc.    The loan proceeds

were used to repay, in full, the prior loan from American State

Bank.   Surplus loan proceeds of $30,672.40 were distributed to

petitioner and Mr. Wells.    The surplus loan proceeds were used to

satisfy Mr. Wells' outstanding liability for Federal payroll

taxes incurred after the separation.

     Mr. Wells signed a quitclaim deed (deed) for the Paddock

Lane property.   The execution date on the deed, June 30, 1988, is

the same date as the issuance of the second mortgage.

Ultimately, petitioner's attorney obtained and held the deed.

     The deed is entitled "Quitclaim Deed" in bold black letters.

It provides that "For A Valuable Consideration" Mr. Wells hereby

remises, releases, and forever quitclaims to petitioner the

Paddock Lane property.    The deed is shown as recorded and

stamped with the date of June 1, 1989, by the Official Records of

Orange County, California.    In the upper left corner and the

bottom of the instrument, it states that "tax statements" will be

mailed to petitioner.    In all other respects, the deed is

unconditional and regular on its face.
                                - 4 -


     In February 1989, petitioner and Mr. Wells jointly listed

for sale the Paddock Lane property with real estate agents.      Mr.

Wells actively participated in attempting to sell the Paddock

Lane property through:    (1) Painting the property; (2) selecting

the real estate agent; (3) signing the listing agreement; and (4)

being involved in the negotiations when an offer was received.

During that time, Mr. Wells did not represent or indicate to

petitioner that the house was solely her property.

     The first real estate listing agreement expired on May 17,

1989, and petitioner listed the property for sale with another

realtor.    Petitioner wanted to be "in control" of the sale of the

Paddock Lane property.    On August 17, 1989, the Paddock Lane

property was sold for $630,000.    Petitioner received a prerelease

payment of $25,000 and a check in the amount of $37,249.53 in

sale proceeds.    Mr. Wells did not receive any of the proceeds

from the sale of the Paddock Lane property.

     On August 2, 1989, Mr. Wells' attorney wrote a letter to

petitioner stating that the deed (from Mr. Wells to petitioner)

"had been tendered on a conditional delivery * * * [and] recorded

without Mr. Wells' knowledge or consent."    The letter further

stated:    "Also, please be advised that we reserve the right to

contest the legal effect of the delivery of the deed which was

apparently recorded with respect to the Paddock Lane property and

the overall consideration relating thereto."    On August 8, 1989,
                               - 5 -


petitioner's attorney acknowledged and agreed to Mr. Wells'

"reservation of the right to contest the legal effect of the

delivery and the overall consideration relating thereto."

     On Mr. Wells' 1989 Federal income tax return, he claimed the

deduction for the home mortgage interest and the real property

taxes on the Paddock Lane property.    The proceeds from the sale

of the Paddock Lane property were considered in the overall

settlement or distribution of the marital estate on June 12,

1991.

     Petitioner reported in her 1989 Federal income tax return

that she sold her home for $630,000.   She further reported

selling expenses of $58,933, which produced $571,067 as the

amount realized on the sale.   Petitioner then reported a long-

term capital gain of $10,199 on the sale.

     Petitioner's basis in the Paddock Lane property was $229,868

at the time of the August 17, 1989 sale.2   Selling expenses of

the Paddock Lane property were $50,884.3




     2
       Respondent apparently computed the deficiency without
taking into account petitioner's basis in the property. We will
give effect to the parties' stipulation as to the basis of the
Paddock Lane property.
     3
       As noted above, petitioner reported $58,933 as expenses
related to the sale of the Paddock Lane property. However, we
will give effect to the parties' stipulation that the selling
expenses were $50,884.
                                 - 6 -


                                OPINION

     Respondent determined that the recording of the deed from

Mr. Wells to petitioner caused her to be the sole owner of the

property.   As a result, respondent determined that petitioner

should have reported the entire net realizable gain on the sale

of the Paddock Lane property.    Petitioner contends that the deed

was invalid and of no effect because there was no specific intent

to transmute the Paddock Lane property to separate property.     As

a consequence, petitioner argues, even though formal title vested

in her, the Paddock Lane property was still community property.4

Thus, petitioner claims that she is not liable for the total

amount of gain on the sale of the property.    Petitioner bears the

burden of proving that respondent's determination is erroneous.

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

     Generally, sections 61 and 1001 require a taxpayer to

recognize income in the year the gain is realized.   The owner is

the person responsible for reporting the gain on the sale of

property.

     State law controls the nature of the legal interest of the

taxpayer.   Once ownership is decided under State law, Federal law


     4
       Under California law, joint tenancy property acquired
during the marriage is presumed to be a community property asset,
for purposes of division of such property in a marriage
dissolution proceeding. Former Cal. Civ. Code sec. 4800.1(b)
(West Supp. 1994), which was repealed and is now codified in Cal.
Fam. Code sec. 2581 (West 1994).
                                 - 7 -


is utilized to decide the tax consequences.    Aquilino v. United

States, 363 U.S. 509, 512-513 (1960).    In Commissioner v. Estate

of Bosch, 387 U.S. 456 (1967), the U.S. Supreme Court held that

pursuant to Erie R. Co. v. Tompkins, 304 U.S. 64 (1938), "state

law as announced by the highest court of the State is to be

followed."   Commissioner v. Estate of Bosch, supra at 465.

Moreover, the court explained:

     the underlying substantive rule involved is based on
     state law and the State's highest court is the best
     authority on its own law. If there be no decision by
     that court then federal authorities must apply what
     they find to be the state law after giving "proper
     regard" to relevant rulings of other courts of the
     State. In this respect, it may be said to be, in
     effect, sitting as a state court. [Id.; citation
     omitted.]

Thus, our inquiry here focuses on whether, under California law,

petitioner was the sole owner of the Paddock Lane property at the

time of the sale.

     California Civil Code section 5110.710 (West 1983) provides

that, subject to sections 5110.720 through 5110.730, inclusive,

married persons may, by agreement or transfer, with or without

consideration, do any of the following:   (a) Transmute community

property into separate property of either spouse; (b) transmute

separate property of either spouse into community property; or
                                 - 8 -


(c) transmute separate property of one spouse into separate

property of the other spouse.5

     California Civil Code section 5110.730(a) requires that a

valid transmutation be made not just in writing, but in "writing

[made] by an express declaration that is made, joined in,

consented to, or accepted by the spouse whose interest in the

property is adversely affected."

     The issue here is whether Mr. Wells validly transmuted his

one-half joint tenancy interest in the Paddock Lane property to

petitioner.

     The California Supreme Court in In re Estate of MacDonald,

794 P.2d 911 (Cal. 1990), considered the requirements of a

written transmutation under California Civil Code section

5110.730(a).   The MacDonalds had both previously been married and

had children from their prior marriages.   After several years of

marriage to Mr. MacDonald, Mrs. MacDonald discovered that she was

terminally ill.   Wanting to leave separate property to her

children, Mrs. MacDonald and her husband obtained legal and

financial advice and divided their property into separate estates

before her death.   One of the items that they did not address was

the husband's pension plan benefits in which Mrs. MacDonald


     5
       Former Cal. Civ. Code secs. 5110.710 through 5110.730
(West 1983) were in effect at the time of the transmutation in
this case. These statutes were repealed and are now codified in
Cal. Fam. Code secs. 850-853 (West 1994).
                                - 9 -


possessed a community property interest.     Upon retirement, the

husband deposited the funds from these plans into three

individual retirement accounts (IRA's).     The accounts were solely

in the husband's name, with the designated beneficiary of each

being a revocable living trust which had been created by the

pension plan.    The husband's children, in turn, were the

beneficiaries of that living trust.     The forms for the IRA

accounts contained a space for the signature of a spouse who was

not designated as the sole primary beneficiary to indicate the

spouse's consent to the designation.     Mrs. MacDonald signed the

consent form.    Upon her death, Mrs. MacDonald's estate petitioned

to establish its one-half interest in the IRA accounts.

     The issue in Estate of MacDonald was whether Mrs. MacDonald

had waived her community property interest or whether there had

been a transmutation of her community property interest in the

pension-IRA's.    The court held that Mrs. MacDonald's signature on

the space below the consent paragraph did not satisfy California

Civil Code section 5110.730(a).

     a writing signed by the adversely affected spouse is
     not an "express declaration" for the purposes of
     section 5110.730(a) unless it contains language which
     expressly states that the characterization or ownership
     of the property is being changed. [In re Estate of
     MacDonald, supra at 918.]

In other words, the defect in the writing in Estate of MacDonald

was its ambiguity:
                              - 10 -


     It is not possible to tell from the face of the consent
     paragraphs, or even from the face of the * * *
     [documents] as a whole, whether decedent was aware that
     the legal effect of her signature might be to alter the
     character or ownership of her interest in the pension
     funds * * * [Id.]

Thus, there was no "express declaration" as required by

California Civil Code section 5110.730(a).

     The California Supreme Court was aware that its interpre-

tation of California Civil Code section 5110.730(a) would

preclude the finding of a transmutation in a case where extrinsic

evidence of an intent to transmute existed.    The court stated

that "it * * * [was] such reliance on extrinsic evidence for the

proof of transmutations which the [California] Legislature

intended to eliminate in enacting the writing requirement of

section 5110.730(a)."   Id. at 919.    The court's construction of

California Civil Code section 5110.730(a) was explained as

follows:

          Our conclusion honors each of the principles of
     statutory construction we have discussed. First, it
     interprets "express declaration," so as to give
     significance to all the words of section 5110.730(a).
     Second, it effects the intent of the Legislature to
     create a writing requirement which enables courts to
     validate transmutations without resort to extrinsic
     evidence and, thus, without encouraging perjury and the
     proliferation of litigation. Third, it is consistent
     with our interpretation of the similar requirement in
     section 683. [Id. at 918; fn. ref. omitted.6]


     6
       In this allusion to California Civil Code sec. 683, the
California Supreme Court is referring to California Trust Co. v.
                                                   (continued...)
                                  - 11 -


       Although the writing need not contain the words

"transmutation", "community property", or "separate property",

there must be language that expressly states that the character

or ownership of the spouse's interest is being changed.       Id. at

919.       In addition, the court found that the decedent was the

party whose interest in the property was "adversely affected".

Id. at 918.       In the case before us, the "adversely affected"

person is Mr. Wells.       He transferred his one-half interest in the

Paddock Lane property when he signed and delivered the deed.         We

do not find persuasive petitioner's contention that she is the

"adversely affected" party because she bears the tax burdens of

the sale of the Paddock Lane property.

       Petitioner argues that there was no express recharacter-

ization or change of ownership of the interest in the Paddock

Lane property.       Specifically, she asserts the deed did not

satisfy the express declaration requirement of California Civil

Code section 5110.730(a) because it did not contain the phrase

"as her sole and separate property".       We do not find that phrase

to be necessary for purposes of transmuting a real property

interest under California Civil Code section 5110.730(a).         The



       6
      (...continued)
Bennett, 204 P.2d 324 (Cal. 1949), in which it determined that
parol evidence is not admissible when a statute requires the
formality of a writing for the creation of an interest in
property.
                              - 12 -


issuance of and the language contained within the deed was for

the purpose of and did cause the transfer of ownership in the

Paddock Lane property.7

     Petitioner additionally argues that there was no intent to

transmute the Paddock Lane property into petitioner's sole

property.   Under California law, we only consider the face of a

written instrument to determine whether the parties intended to

transmute property.   Extrinsic evidence is to be disregarded.

     "it is well settled that where a statute requires the
     formality of a writing for the creation of an interest
     in property, it must contain words indicating an intent
     to transfer such interest, and in the absence of words
     which could be interpreted to show such intent, no
     parol evidence will be admitted." [In re Estate of
     MacDonald, 794 P.2d at 918 (quoting California Trust
     Co. v. Bennett, 204 P.2d 324, 327 (Cal. 1949)).]

Within the four corners of the deed, we do not find any

conditional language regarding delivery of the deed or transfer

of the property.   Hence, we do not find persuasive petitioner's

argument in that regard.

     Petitioner's argument that she had no intention of assuming

sole ownership does not reconcile with the recording of the deed

on her behalf.   She wanted "control" of the property so it could

be sold without interference from her ex-husband.   The settlement

of marital property dated June 12, 1991, is premised on the fact


     7
       Petitioner was represented by two attorneys when Mr. Wells
quitclaimed his interest in the Paddock Lane property and when
the deed was filed.
                                 - 13 -


that petitioner owned and sold the property.     Having had the

advantages of ownership of the Paddock Lane property, we find it

inapposite for petitioner to deny the form of the transaction.

We hold, in accord with California law, that petitioner was the

sole owner of the Paddock Lane property at the time of its sale.

     We next consider whether petitioner is liable for the

accuracy-related penalty for substantially understating her

income tax.   Sec. 6662(b)(2).    A substantial understatement is

one that exceeds the greater of 10 percent of the tax required to

be shown or $5,000 (in the case of an individual taxpayer).       Sec.

6662(d)(1).   Any understatement is to be reduced by an item for

which there is substantial authority for its tax treatment or

adequate disclosure.

     Petitioner's failure to report the entire gain from the sale

of the Paddock Lane property resulted in a $150,027 understate-

ment of income tax.    This amount is in excess of $5,000, and it

exceeds 10 percent of the amount of tax required to be shown on

the return.   Petitioner has failed to show substantial authority

in support of her position that the Paddock Lane property should

be deemed community property and that the gain should be divided

between petitioner and her ex-husband.

     Section 6662(d)(2)(B)(ii) defines a disclosed item as one as

to which "the relevant facts affecting the item's tax treatment

are adequately disclosed in the return or in a statement attached
                                - 14 -


to the return".    Next, we must decide whether petitioner

adequately disclosed her tax position.     The statute does not

prescribe what constitutes adequate disclosure of relevant facts.

Schirmer v. Commissioner, 89 T.C. 277, 285 (1987).

     This Court has indicated that a taxpayer may satisfy the

requirements of adequate disclosure for purposes of section 6662

if he provides sufficient facts on the face of his return that

enable the Commissioner to identify the potential controversy

involved.   Id. at 286.    We hold that petitioner has satisfied the

adequate disclosure requirement.

     Petitioner disclosed on her 1989 Federal income tax return

the sale of the Paddock Lane property and reported long-term

capital gain.     She sold the property for $630,000 and reported

$58,933 in expenses related to the sale.     Consequently, the total

amount realized was $571,067.     Petitioner reported a basis of

$560,868 which, offset against the amount realized, generated a

gain of $10,199 on the sale of the Paddock Lane property.

Furthermore, petitioner reported she did not intend to utilize

the section 1034 basis rollover provision.     Petitioner did not

disclose any further information about the sale of the Paddock

Lane property.     It is likely that the large basis of the Paddock

Lane property resulting in a small long-term capital gain

generated respondent's audit.     The information reported was

sufficient to apprise respondent of, or to enable respondent to
                             - 15 -


identify, the potential controversy here; that is, the amount of

gain petitioner was required to report.    We hold that petitioner

has adequately disclosed the relevant facts relating to the sale

of the Paddock Lane property and that she is not liable for the

accuracy-related penalty under section 6662(a).

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
