                        T.C. Memo. 2001-229



                      UNITED STATES TAX COURT



ESTATE OF PATTIE WELDER EDWARDS, DECEASED, OAKES DAVID EDWARDS,
 JR., AND PATRICIA EDWARDS CARSON, CO-EXECUTORS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10172-99.                     Filed August 23, 2001.



     Terrell W. Dahlman and Frederick F. Rogers, Jr., for

petitioner.

     Gerald L. Brantley, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     COHEN, Judge:   Respondent determined a deficiency of

$523,771 in the 1994 Federal estate tax of the estate of Pattie

Welder Edwards (the estate).   After concessions, the issue for

decision is whether the ranch properties owned by decedent at her
                                 - 2 -

date of death were encumbered by oral options that extended the

existing leases on the ranch properties and, if so, whether the

oral options or the existing leases were a restriction on the

sale or use of the ranch properties that should be disregarded

for estate tax valuation purposes under section 2703.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect on the date of decedent’s

death, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

                          FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.

     Pattie Welder Edwards (decedent) died on December 20, 1994.

At the time of her death, decedent was a resident of Nueces

County, Texas.    Decedent’s children, Oakes David Edwards, Jr.

(Edwards), and Patricia Edwards Carson (Carson), are the

coexecutors of the estate.    At the time of filing of the

petition, Edwards resided in Sinton, Texas, and Carson resided in

Mountain Home, Texas.

     Decedent devised her jewelry, personal property, and the

remainder of her estate to her children, Edwards and Carson, in

equal shares.    The last will and testament of decedent dated

July 27, 1988, states in part:

          I GIVE, DEVISE and BEQUEATH all the rest, residue
     and remainder of my estate, whether real, personal or
                               - 3 -

     mixed, and wheresoever situated, including all property
     which I may acquire after the execution of this Will,
     to my children, O.D. EDWARDS, JR. and PATRICIA CARSON
     EDWARDS [sic], in equal shares, per stirpes.

     On the date of decedent’s death, decedent owned 8,728.75

acres of land located in San Patricio, Texas (the Sinton Ranch)

and an undivided 50-percent interest in 11,751 acres of land

located in La Salle County, Texas (the Cotulla Ranch).   Edwards

and Carson each owned an undivided 25-percent interest in the

Cotulla Ranch.

     Prior to decedent’s death, decedent executed written lease

agreements to lease the Sinton Ranch to Edwards.   On May 16,

1985, decedent, individually and as trustee, leased the Sinton

Ranch to Edwards for a duration of 1 year, with four 1-year

renewal options.   On October 19, 1989, decedent executed a lease

(the existing lease) on the Sinton Ranch with Edwards for a

duration of 1 year, with five 1-year options to renew.   The

existing lease was effective on decedent’s date of death and

would have expired on October 31, 1995.   The existing lease

provided for ranching lease payments in the amount of $65 per

year per bull or cow, or cow and calf unit, pastured on the land,

with a minimum total payment of $15,300, and a rental payment of

$20 per acre (3,243.06 acres) for farmland.   The terms also

prohibited amendment, modification, or alteration unless written

and signed by the party against whom enforcement would be sought.
                                 - 4 -

     Prior to decedent’s date of death, decedent executed written

lease agreements to lease her undivided 50-percent interest in

the Cotulla Ranch to Carson and her husband (the Carsons).    On

March 1, 1985, decedent, Edwards, and Carson, as co-owners,

leased the Cotulla Ranch to the Carsons and Fred M. Rhodes for a

duration of 1 year, with four 1-year options to renew.   On

March 1, 1986, the Cotulla Ranch was leased to the Carsons for a

duration of 1 year, with four 1-year options to renew.   On

August 24, 1994, decedent executed a lease (the existing lease)

on the Cotulla Ranch with the Carsons that had an effective date

of March 1, 1993, and provided for a duration of 2 years with

three 1-year options to renew.    The existing lease was effective

on decedent’s date of death and would have ended on February 28,

1998.   The existing lease provided for ranching lease payments in

the amount of $60 per year per bull or cow, or cow and calf unit,

pastured on the land, with a minimum total payment of $20,000.

The terms also prohibited amendment, modification, or alteration

unless written and signed by the party against whom enforcement

would be sought.

     After the death of decedent, Edwards and Carson, as

coexecutors, executed on behalf of decedent’s estate a

“Memorandum of Lease Agreement” (postdeath lease) on the Sinton

Ranch that states:

          WHEREAS, in reliance upon the representations and
     promises of Ms. Edwards, and with her specific
                               - 5 -

     knowledge and consent, the Lessee had, prior to her
     death, maintained a substantial cattle and farming
     operation and had, in addition, expended substantial
     sums of his own funds, as well as his time and effort,
     in erecting and maintaining permanent improvements on
     the Property without compensation from Ms. Edwards, all
     of which were intended to be used by the Lessee
     indefinitely; and

          WHEREAS, Ms. Edwards died on December 20, 1994, at
     which time the Lease was in full force and effect, and
     the Estate (in recognition of Ms. Edwards’ promise and
     commitment) and the Lessee now wish to memorialize the
     terms and conditions of the lifetime lease of the
     Property by the Lessee; * * *

Similar language was included in the lease agreement (postdeath

lease) executed on the Cotulla Ranch by Edwards and Carson, as

coexecutors, after the death of decedent.

     The terms of the postdeath lease on the Sinton Ranch

extended the existing lease for a period of 5 years, with

consecutive 5-year options to renew the lease at a fair market

rental value.   The terms of the postdeath lease on the Sinton

Ranch also provided for:   (1) Lease payments for ranchland in the

amount of 30 percent of the offspring of any cattle or other

livestock pastured on the property, (2) payments for use of

farmland in the amount of one-third of the grain and one-fourth

of the cotton and cottonseed produced therefrom, (3) payment in

kind, and (4) 25 percent of the gross hunting fees received by

the lessee from hunters.

     The terms of the postdeath lease on the Cotulla Ranch

extended the existing lease for a period of 5 years, with
                                - 6 -

consecutive 5-year options to renew the lease at a fair market

rental value.    The postdeath lease set the initial rent at $7.50

per acre annually and $12,000 annually per each residence located

on the land.    The postdeath lease on the Cotulla Ranch allowed

hunting on the leased properties with the express written consent

of the lessors.    Hunting had been prohibited in all prior written

leases because decedent was adamant that the ranchlands would not

be used for hunting.

     The estate reported the fair market value of the Sinton

Ranch at $2.6 million on its Form 706, United States Estate (and

Generation-Skipping Transfer) Tax Return, Schedule A, Real

Estate.   The real estate appraisal report that was prepared by

Thomas F. Dorsey (Dorsey) and submitted with the estate’s Form

706 concluded that the unencumbered fair market value of

decedent’s interest in the Sinton Ranch on decedent’s date of

death was $4,150,000 and that the fair market value of the Sinton

Ranch encumbered by the postdeath lease was $3,350,000.    In the

notice of deficiency, respondent determined that the fair market

value of the Sinton Ranch on the date of decedent’s death was

$4,150,000.    Respondent reduced the value by $750,000 for a valid

election under section 2032A.

     The estate reported the fair market value of the interest in

the Cotulla Ranch on Form 706, Schedule A, at $1,070,000.    The

real estate appraisal report that was prepared by Dorsey and
                              - 7 -

submitted with the estate’s Form 706 concluded that the

unencumbered fair market value of decedent’s interest in the

Cotulla Ranch on decedent’s date of death was $1,380,000 and that

the fair market value of the Cotulla Ranch encumbered by the

postdeath lease was $1,070,000.   In the notice of deficiency,

respondent determined that the fair market value of the Cotulla

Ranch on the date of decedent’s death was $1,380,000.

     In addition to respondent’s determination of the fair market

value of the ranch properties at decedent’s date of death,

respondent determined in the notice of deficiency:

     It is also determined that section 2703 of the Internal
     Revenue Code applies to any lease or lease options
     which the decedent may have had with her children on
     the ranches * * *. Accordingly, the values of Schedule
     A * * * should be determined without regard to such
     leases or lease options, if any. Furthermore, the
     leases and/or lease options were not valid under state
     law. Similarly, they were not bona fide business
     transactions but devices intended to avoid federal
     transfer taxes. In effect the alleged leases and/or
     options to lease were shams. Accordingly, the reported
     value of the gross estate is increased $1,110,000.00
     * * *.

                             OPINION

     The issue presented is whether the ranch properties that

were owned by decedent at her date of death were encumbered by

oral options that extended the existing leases on the ranch

properties and, if so, whether the oral options or the existing

leases were a restriction on the sale or use of the ranch
                               - 8 -

properties that should be disregarded for estate tax valuation

purposes under section 2703.

     The value of a decedent’s gross estate includes the value of

all of the decedent’s interest in property.   Secs. 2031, 2033.

The value of property is the fair market value at the date of the

decedent’s death.   Sec. 20.2031-1(b), Estate Tax Regs.    The fair

market value of property is defined as “the price at which the

property would change hands between a willing buyer and a willing

seller, neither being under any compulsion to buy or to sell and

both having reasonable knowledge of relevant facts”.      Id.

Intrafamily agreements must be subjected to greater scrutiny than

that afforded similar agreements between unrelated parties.     See

Harwood v. Commissioner, 82 T.C. 239, 259 (1984), affd. without

published opinion 786 F.2d 1174 (9th Cir. 1986); Estate of

Tiffany v. Commissioner, 47 T.C. 491, 499 (1967).

     Section 2703(a) provides guidance on the valuation of

properties that are subject to restrictions and states:

               SEC. 2703(a). General Rule.–-For
          purposes of this subtitle, the value of any
          property shall be determined without regard
          to–-

               (1) any option, agreement, or other right to
          acquire or use the property at a price less than
          the fair market value of the property (without
          regard to such option, agreement, or right), or

               (2) any restriction on the right to sell or
          use such property.
                               - 9 -

Section 25.2703-1(d), Gift Tax Regs., uses the following example

to illustrate that a lease constitutes a restriction on the use

of property under section 2703:

          Example (1). T dies in 1992 owning title to
     Blackacre. In 1991, T and T’s child entered into a
     lease with respect to Blackacre. At the time the lease
     was entered into, the terms of the lease were not
     comparable to leases of similar property entered into
     among unrelated parties. The lease is a restriction on
     the use of the property that is disregarded in valuing
     the property for Federal estate tax purposes.

     The estate contends that, prior to decedent’s death,

decedent granted oral options to Edwards and Carson that extended

the duration of the existing leases on the ranch properties and

that these oral options, as memorialized in the postdeath leases,

were a restriction on the sale or use of the properties at

decedent’s date of death that reduced the value of decedent’s

interest in the ranches for estate tax purposes.    The estate

asserts that the oral lease options were valid and enforceable

under Texas law on the date of decedent’s death.

     Respondent contends that decedent did not grant her children

the oral options, as memorialized in the postdeath leases, that

extended and modified the existing leases on the Sinton Ranch and

Cotulla Ranch.   Respondent argues:    (1) The estate has presented

no evidence that the oral options were granted by decedent;

(2) the oral options are contrary to decedent’s practice of

executing written leases with her children; and (3) the lease
                                - 10 -

terms of the existing leases and Texas law required extensions

and modifications of the lease agreement to be in writing.

     Respondent further argues that the postdeath leases were

created to reduce the value of decedent’s assets for estate tax

purposes because Edwards and Carson were both the coexecutors and

devisees of decedent’s estate and, as the owners of the ranch

properties, would not have to lease the ranch property from

themselves to maintain control over the ranch properties and

continue their ranching operations.      The estate argues that there

was a bona fide business purpose in executing the leases, which

was to maintain managerial control over the ranch properties.

The estate explains that Edwards and Carson, the devisees of the

ranch properties, would have joint ownership of both the ranch

properties, as coexecutors and devisees, whereas the purpose of

the leases was to grant an exclusive possessory right to a

particular ranch property to each child.

     Based on the testimony offered by the estate, we are not

persuaded that decedent granted oral options that extended the

existing leases indefinitely.    In regards to the oral options,

Edwards testified on examination by the estate’s counsel:

          Q    Now, Mr. Edwards, * * * beginning in 1985 was
     there ever any discussions with your mother,
     Mrs. Pattie Welder Edwards, about who was going to
     ranch Cotulla and who was going to ranch Sinton?

          A    Well–-

          Q    And if so, when did it happen?
                        - 11 -

     A    The way I understood it, I think it was
always known that I was going to ranch Sinton because I
lived there, I’d lived there all my life basically, had
my home there, my wife had her studio, we were there
and that’s where I was ranching.

     My sister--and she was ranching--not my sister,
but Mother at that time was ranching Cotulla. When
she--when we bought her out–-when she was sold out at
Cotulla and they [the Carsons] took over Cotulla, the
main thing was that my mother was worried * * *
[Carson] felt like she’d been disenfranchised because
she didn’t have a place to go, and I was at Sinton, and
I’d been there all my life, so she had her first chance
to go and do Cotulla.

     At first I was a little anxious about it, but
after I-–I felt better about it and they went to–-they
started ranching there. And Mother’s concern and my
concern was if they like it–-it suited me fine because
I’d bitten off all I could chew right there at Sinton,
financially and–-A to Z at that time, and they were
happy at Cotulla. I was happy and I thought everything
was going pretty good.

     They’d come to Sinton and I’d go to Cotulla. We’d
meet going back and forth, and we weren’t having any
problems. As a matter of fact it was one of the best
things that we ever did as a family.

               *    *    *    *    *    *    *

     Q     Can you tell the Court the circumstances
surrounding the execution of the memorandum of lease
agreement?

     A    All I know is when she died the other lease
hadn’t-–I don’t know when it came due, the other lease,
but this is just a continuation of what had been going
on within the family for years.

               *    *    *    *    *    *    *

* * * And when she died then we put all this in
writing so my sister and I would understand, and
everything’s the way it was meant to be and I’m happy
and she’s happy * * *
                                - 12 -

          The legal stuff is the legal stuff but I know what
     my mother meant and I know what my sister and I meant.

                       *   *    *    *     *   *   *

          Q    And would it be fair to describe your
     understanding of this agreement with your mother that
     you can’t really put a specific date on when you--when
     the agreement was reached that you would be able to
     lease this for the rest of your life. It was just
     something that was understood by you and your sister
     and your mother?

          A    As far as putting an actual date * * *   No.

                       *   *    *    *     *   *   *

          A    It’s a family deal, and you know when you’re
     sitting and drinking coffee and whatever and talking to
     your mother you hear stuff.

          Q    Sure.

          A    And she says stuff, and I don’t know how else
     to say this, but a fact’s a fact.

On cross-examination, Edwards testified:

          Q    Well, you do agree, do you not, in connection
     with that last question that the terms of the
     memorialized post-death leases were substantially
     different from the existing leases and the alleged oral
     options, don’t you?

          A    Yes.

Edwards acknowledged that the terms of the postdeath leases

allowing hunting were not authorized by his mother and were

contrary to her long-held adamant opposition to the use of the

ranch properties for hunting.

     Carson testified, in response to the estate’s counsel:

          Q    Have you been able to and can you identify a
     specific date certain or dates certain that you and
                                  - 13 -

     your mother discussed these options to continue leasing
     the properties?

          A    Well, as the years went on and Mother was
     getting older and as a mother myself, my mother as I
     would, want my children to always be equal. I would
     want to be equal. She wanted to be equal and fair with
     David and I. So she was very pleased at this point
     that we had a fair, equal operation, each of us, and
     she was happy that as she got older up until the last
     year before she died she said, This is something I
     would like to see you and your brother do for the rest
     of your lives.

                  And--

                          *   *   *    *   *   *    *

               But it was an agreement, verbal agreement,
     but we were a close family. David and I were very
     close and my mother and I and David were very close,
     and this was her wish.

     The estate asserts that Edwards and Carson “understood” from

their discussions with decedent prior to her death that each had

received a definite right and commitment from decedent to

continue to lease their respective ranch properties for an

indefinite time and each committed substantial resources to their

ranching operations based on their understanding.   The belief of

Edwards and Carson as to what may have been the desire of their

mother is not an oral option to lease land for an indefinite

period of time.    Decedent’s desire to have her children continue

the ranching operations on the Sinton Ranch and Cotulla Ranch is

not equivalent to the granting of an oral option to her children

to lease the ranch properties for an indefinite time.   Decedent’s

desire to have her children continue the ranching operations was
                              - 14 -

provided for by decedent in her last will and testament that

appoints her children to serve as coexecutors and devises her fee

interest in the ranch properties to her children.

     There is no persuasive evidence that decedent granted oral

options to extend or to modify the existing lease terms or that

the postdeath leases reflect the terms of oral options.   The

testimony does not identify any specific discussion among

decedent, Edwards, and Carson where decedent granted the right to

lease the ranch properties indefinitely to Edwards and Carson.

Our conclusion that no oral agreement was made is supported by

the following:   (1) Decedent and her children had a history and

pattern of executing written leases, (2) the postdeath leases

contained different terms from existing leases, (3) the existing

leases, including one executed only 4 months before decedent’s

death, required extensions and modifications to be in writing,

and (4) decedent’s children continued to maintain control over

the ranch properties as the coexecutors and devisees of

decedent’s estate.

     Because we have concluded that no oral options existed at

the time of decedent’s death, the postdeath leases are only

agreements executed by Edwards and Carson as the coexecutors of

decedent’s estate subsequent to the date of decedent’s death.

The postdeath leases reflect only the arrangement between Edwards

and Carson regarding the use of the ranch properties.   Because
                               - 15 -

the oral options did not exist for the purpose of estate tax

valuation, we need not address the parties’ arguments regarding

the validity and enforceability of the alleged oral options under

Texas law or the impact of section 2703.

     Decedent did not grant oral options prior to her death, and

the postdeath leases were executed subsequent to decedent’s

death.    The postdeath leases do not justify a discount on the

ranch properties because the postdeath leases were not an

encumbrance that existed at the moment of decedent’s death.     Cf.

Estate of Proctor v. Commissioner, T.C. Memo. 1994-208.

     Respondent argues that the existing leases must also be

disregarded in determining the value of the properties on

decedent’s date of death under section 2703(a)(2).    We need not

address this argument because:    (1) The estate does not identify

the amount of the discount attributable to the existing leases on

the ranch properties when valuing the ranch properties on its

Form 706, (2) the various experts’ reports do not place a

separate value on the discount created by the existing leases,

and (3) the estate maintains the position that the oral options

were granted prior to decedent’s death and supersede the existing

leases.    Thus there is no evidence that any discount is

attributable to the existing leases.    The unencumbered fair

market values of the ranch properties at decedent’s date of death
                             - 16 -

are the amounts to be included in decedent’s gross estate under

section 2031.

     To reflect the foregoing and concessions of the parties,

                                        Decision will be entered

                                   under Rule 155.
