                        T.C. Memo. 2006-34



                      UNITED STATES TAX COURT



             ESTATE OF LORRAINE C. DISBROW, DECEASED,
   MARTHA D. JOHNSON, EXECUTRIX, Petitioner v. COMMISSIONER OF
                   INTERNAL REVENUE, Respondent



     Docket No. 6739-04.               Filed February 28, 2006.



     Terrence E. Smolev, for petitioner.

     Marie E. Small, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:   Petitioner petitioned the Court to redetermine

a $426,377.57 deficiency that respondent determined in the

Federal estate tax pertaining to the Estate of Lorraine C.

Disbrow, Deceased (decedent’s estate).    Following concessions, we

decide whether the fair market value of the residence (residence)
                                -2-

of Lorraine C. Disbrow, Deceased (decedent), is includable in her

gross estate under section 2036(a)(1).1   Decedent gave the

residence to a newly formed, assetless general partnership whose

partners were decedent, her children, and her children-in-law

(i.e., her daughters-in-law and sons-in-law, collectively).

Shortly thereafter, decedent gave all of her interest in the

partnership to the other partners.    Decedent continued to live at

the residence until she died, paying the partnership less than

fair rental value (FRV).   Respondent determined that the fair

market value of the residence is includable in decedent’s gross

estate because decedent until her death retained the “possession”

and “enjoyment” of the residence within the meaning of section

2036(a)(1).   We sustain that determination.   We decide this case

as the parties framed it, and we express no opinion on the

validity of the partnership, which, as we find below, conducted

no business and was not operated with an intent to make a profit.

Nor do we consider respondent’s alternative determination that

decedent’s estate is not entitled to annual exclusions from gift

tax pursuant to section 2503(b) because decedent’s gifts were of

a future interest.




     1
       Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code. Rule
references are to the Tax Court Rules of Practice and Procedure.
                                -3-

                         FINDINGS OF FACT2

1.   Preface

      Some facts were stipulated.   We incorporate herein by this

reference the parties’ stipulation of facts and the exhibits

submitted therewith.   We find the stipulated facts accordingly.

Martha Johnson is the executrix of decedent’s estate.   Martha

Johnson resided in Hampstead, New Hampshire, when the petition in

this case was filed.

2.   Decedent and Her Family

      Decedent was born on January 14, 1922, and she died at

7:22 a.m. on February 9, 2000, at the age of 78.   She was a U.S.

citizen and a resident of the State of New York.   She died



      2
       During trial, petitioner elicited testimony from two
partners of the partnership and the attorney who recommended and
implemented the transaction in issue. We have evaluated the
testimony of each of these witnesses by observing his or her
candor, sincerity, and demeanor and by assigning weight to the
elicited testimony for the primary purpose of finding disputed
facts. See Neonatology Associates, P.A. v. Commissioner, 115
T.C. 43, 84 (2000), affd. 299 F.3d 221 (3d Cir. 2002). Our
perception of these witnesses while viewing them testifying at
trial, coupled with our review of the record and our finding that
each of these witnesses has a pecuniary interest in the outcome
of this case, leads us to discount much of their uncorroborated
testimony as unreliable. We are not required to, and we do not,
rely on that discounted testimony to support petitioner’s
positions herein. See, e.g., Brookfield Wire Co. v.
Commissioner, 667 F.2d 551, 552 (1st Cir. 1981), affg. T.C. Memo.
1980-321; Haffner’s Serv. Stations, Inc. v. Commissioner, T.C.
Memo. 2002-38, affd. 326 F.3d 1 (1st Cir. 2003). See also Kenney
v. Commissioner, T.C. Memo. 1995-431, where the Court declined to
rely upon most of the testimony of the taxpayer and a long list
of relatives and close friends who testified in support of her
claim for innocent spouse relief.
                                -4-

testate, having executed a last will and testament on August 24,

1978.   Pursuant to that document, decedent bequeathed her estate

to her children in equal shares.    Decedent’s estate, as reported

on the Federal estate tax return, consisted primarily of cash,

stocks, bonds, and annuities, and the reported bequest to each

child was $118,000.

     Decedent’s husband, John Disbrow, had died on February 23,

1993.   He and decedent had five children:   Martha Johnson, Nancy

Kerrigan, Linda Labet, Sarah Disbrow, and David Disbrow.   When

decedent died, she also had four children-in-law:   Robert Johnson

(married to Martha Johnson), Patrick Kerrigan (married to Nancy

Kerrigan), Michael Labet (married to Linda Labet), and David

Wishart (married to Sarah Disbrow).   At the time of the

partnership agreement discussed infra, Martha Johnson and her

husband lived in Hampstead, New York; Nancy Kerrigan and her

husband lived in San Jose, California; Linda Labet and her

husband lived in New Milford, Connecticut; Sarah Disbrow and her

husband lived in Lincoln, Nebraska; and David Disbrow lived

unmarried in Fort Lauderdale, Florida.   Decedent’s children and

children-in-law all survived her.
                                 -5-

3.   The Residence

      The residence is at 224 Little Neck Road, Centerport, New

York,3 and includes a two-story, single-family house (house) and

landscaped grounds.    The house is approximately 2,400 square feet

and has two bedrooms and a bathroom on the second floor and

three bedrooms and two bathrooms on the first floor.     The house

was built in or around 1955 and has a waterview and a private

beach.    The house is set in a private wooded area.   On

September 1, 1993, decedent had the residence valued through a

comparative market analysis, which concluded that the residence

was marketable at $350,000.

      John Disbrow purchased the residence on March 1, 1956, and

he and decedent lived there until he died.    Decedent acquired

sole ownership of the residence upon his death, and the residence

was her principal residence until she died.    When John Disbrow

died, decedent’s health was failing, and her health continued to

be poor until she died.    Among other things, decedent during the

time after her husband’s death suffered a kidney failure and was

under kidney dialysis; she was affected by a severe case of

peritonitis; she fractured her pelvis; she fractured her hip; she

broke both of her legs (getting out of bed); and she had multiple

heart attacks, the last of which resulted in her death.     During


      3
       Centerport, New York, is on Long Island, New York, near
Huntington Bay of the Long Island Sound. See Rand McNally Road
Atlas 73 (Millennium ed. 2000).
                                 -6-

that time, decedent also was feeble from age and mentally

unstable.    After John Disbrow died, decedent did not always stay

at the residence because, for a significant period of time, she

was hospitalized, in rehabilitation, or living with David Disbrow

as his home in Florida.    When decedent was at the residence, she

generally confined herself to the first floor because she could

not get up the stairs by herself.      Decedent generally lived at

the residence without anyone to assist her except to the extent

that a family member was there also.      One or more of decedent’s

children frequently visited or stayed with decedent to assist

her.

4.   Funny Hats Partnership (Funny Hats)

       In addition to her health complications, immediately

following John Disbrow’s death decedent questioned whether she

wanted to keep living at the residence with all of her memories,

and she was unsure of the financial aspects of her life and how

she would handle the ownership responsibilities associated with

the residence (primarily, its maintenance). (John Disbrow had

always handled the financial aspects and ownership

responsibilities.)    Decedent hired a legal team to advise her on

her finances.    One of her advisers was Anthony Curto (Curto), the

attorney whom she had recently retained to probate John Disbrow’s

estate.    Curto advised decedent on the application to her of the

probate and estate tax laws, and he advised her that she should
                                     -7-

respond to those laws by transferring the residence to a family

general partnership.        According to Curto, decedent could then

give all of her interest in the partnership to her family,

continue to live at the residence as a tenant of the partnership,

and remove the residence from the reach of the Federal estate

tax.

       Decedent followed Curto’s advice.        On December 10, 1993, at

almost 72 years of age, decedent (together with her children and

children-in-law) executed a general partnership agreement

(partnership agreement) forming Funny Hats.4           Curto and his firm

prepared all of the documentation for that purpose.           As stated in

the partnership agreement, the partners of Funny Hats and their

partnership interests were as follows:

                  Partner           Partnership Interest

             Martha Johnson                  7.1875%
             Robert Johnson                  7.1875
             Nancy Kerrigan                  7.1875
             Patrick Kerrigan                7.1875
             Linda Labet                     7.1875
             Michael Labet                   7.1875
             David Wishart                   7.1875
             Sarah Disbrow                   7.1875
             David Disbrow1                 14.3750
             Decedent                       28.1250
                                           100.0000
              1
              David Disbrow was decedent’s only unmarried
       child at the time Funny Hats was formed, and he
       received an interest in Funny Hats equal to the
       interest of each married couple.


       4
           The record does not explain the reason for the name “Funny
Hats”.
                                  -8-

None of the partners of Funny Hats contributed any asset to Funny

Hats upon its formation.    Later on December 10, 1993, decedent

transferred her entire interest in the residence to Funny Hats

for no consideration.5    Immediately before that transfer,

decedent, in her capacity as executrix of John Disbrow’s estate,

had transferred the residence to herself from John Disbrow’s

estate.     As of the time of decedent’s transfer of the residence

to Funny Hats, the partners of Funny Hats had assured decedent

that she could continue to live at the residence as long as she

furnished the funds necessary to maintain it.

     By way of an agreement dated January 1, 1994, decedent gave

her 28.125-percent interest in Funny Hats to her children and

children-in-law (collectively, donees).       In accordance with that

agreement, the change to each partner’s interest in Funny Hats

was as follows:

                              Initial                Subsequent
         Partner       Partnership Interest     Partnership Interest

   Martha Johnson             7.1875%                   10%
   Robert Johnson             7.1875                    10
   Nancy Kerrigan             7.1875                    10
   Patrick Kerrigan           7.1875                    10
   Linda Labet                7.1875                    10
   Michael Labet              7.1875                    10
   David Wishart              7.1875                    10
   Sarah Disbrow              7.1875                    10
   David Disbrow             14.3750                    20
   Decedent                  28.1250                     0
                            100.0000                   100


     5
       As reported on the Federal estate tax return, decedent’s
adjusted basis in the residence was $350,000.
                                   -9-

     The partnership agreement of Funny Hats states that Funny

Hats was “created to establish and conduct the business of real

estate ownership and management” and that its place of business

was the address of the residence.        Funny Hats conducted no

business and was not operated with an intent to make a profit.

Decedent wanted to divest herself of the responsibility of

maintaining the residence, but the donees wanted her to keep the

residence.    The donees persuaded decedent to retain the residence

by telling decedent that they would maintain the residence as

long as decedent furnished the funds necessary to do so.        The

donees enjoyed the residence as a place to vacation, to get

together as a family, or simply to relax.

     The only assets of Funny Hats were the residence and a

checking account.    With four exceptions, the checking account of

Funny Hats was funded by $69,250 of transfers from decedent, a

$6,774 loan from her in 1999, and $1,712 of interest.        (We have

attached as an appendix our reconciliation of each year’s

beginning and ending cash balances of the Funny Hats checking

account.)    The exceptions are:   (1) Funny Hats deposited $348,600

at the end of 2000 from a sale of the residence to David Disbrow,

(2) each of the partners of Funny Hats, other than David Disbrow,

contributed to it $1,000 and $800 in 1995 and 1997, respectively,

(3) David Disbrow contributed to Funny Hats an additional $1,000

and $800 in 1995 and 1997, respectively, and he contributed
                                  -10-

$6,714 to Funny Hats in 2000, and (4) Funny Hats in 1995 and 2000

received from unspecified sources the proceeds of loans of $450

and $7,933, respectively.

      Decedent, when she was not a partner in Funny Hats, wrote on

her personal bank account eight checks that were payable to Funny

Hats and that she then endorsed and deposited into the checking

account of Funny Hats.      Six of those checks were for rent.

5.   The Lease Agreements

     Curto and his firm also prepared annual lease agreements

(collectively, lease agreements) under which Funny Hats rented

the residence to decedent for each year from January 1, 1994,

through December 31, 2000.     Curto and his firm represented both

decedent and Funny Hats in preparing these agreements and other

documents.    Curto had recommended to the parties to the lease

agreements that the agreements be in writing, and the parties

followed that advice.    The lease agreements were all signed by

Linda Labet, in her capacity as a partner of the landlord Funny

Hats, and by decedent in her individual capacity as tenant.      None

of the lease agreements states the date on which it was signed by

either of those individuals, and none of the lease agreements

bears the signature of a witness to those individuals’

signatures.

     Curto’s firm prepared each of the lease agreements on the

the same form document that applies to house leases in general.
                                -11-

The form contains 30 paragraphs of pretyped provisions and

requires that a user supply only the following information:

(1) Name of landlord and the landlord’s address for notices;

(2) name of tenant; (3) identification of the premises;

(4) “Lease date”; (5), term of lease, including beginning and

ending dates; (6) amount of yearly rent; (7) amount of monthly

rent; and (8) amount of security.      The form also has two spaces

for the respective signatures of the landlord and the tenant, and

a single space for the signature of a witness.     Each of the lease

agreements as filled out by Curto and his firm is identical,

except for the last two numbers of the applicable year (in the

case of 2000, the “19" on the form is crossed out and “2000" is

typed above) and the amounts of monthly and yearly rents.

Pursuant to Curto’s advice, certain of the pretyped provisions of

the lease agreements were crossed out; i.e., provisions stating

that “These charges [cost of required maintenance service

contracts] will be added rent”, “Tenant may not alter, decorate,

change or add to the Premises”, and “Tenant may not sublet all or

part of the Premises, or assign this Lease or permit any other

person to use the Premises”.    Curto also advised the parties to

the lease agreements as to the amount of rent that decedent

should pay under each of the lease agreements, and the parties

followed that advice as well.
                               -12-

     The lease agreement for 1994 states that the lease is

between Funny Hats, as landlord, and decedent, as tenant, that

the lease is a 1-year lease of the “Premises” for $8,400, and

that the “Premises” are “224 Little Neck Road, Centerport,

New York 11721”.   The 1994 lease agreement also states that

decedent may pay this rent monthly in $700 installments and that

“The Premises must be used to live in only and for no other

reason.   Only a party signing this Lease, spouse and children of

that party may use the Premises.”     The 1994 lease agreement

requires as to the payment of rent that

          The rent payment for each month must be paid on
     the first day of that month at the Landlord’s address
     above. Landlord need not give notice to pay the rent.
     Rent must be paid in full and no amount subtracted from
     it. The first month’s rent is to be paid when Tenant
     signs this Lease. Tenant may be required to pay other
     charges to Landlord under the terms of this Lease.
     They are to be called “added rent”. This added rent is
     payable as rent, together with the next monthly rent
     due. If Tenant fails to pay the added rent on time,
     Landlord shall have the same rights against Tenant as
     if it were a failure to pay rent.

          The whole amount of rent is due and payable when
     this Lease is effective. Payment of rent in
     installments is for Tenant’s convenience only. If
     Tenant defaults, Landlord may give notice to Tenant
     that Tenant may no longer pay rent in installments.
     The entire rent for the remaining part of the Term will
     then be due and payable.

The 1994 lease agreement states that the failure to pay rent or

added rent on time is a “default”.

     The 1994 lease agreement allows decedent to alter, decorate,

change, or add to the residence, to sublet all or part of the
                                 -13-

residence, to assign the lease, and to permit other persons to

use the residence.    The 1994 lease agreement states that the

“Tenant may peaceably and quietly have, hold and enjoy the

Premises for the Term of this Lease”, and that the “Tenant has

read this Lease.    All promises made by the Landlord are in this

Lease.   There are no others.    This Lease may be changed only by

an agreement in writing signed by and delivered to each party”.

The 1994 lease agreement requires that decedent maintain,

continue, and pay for maintenance service contracts and indicates

that these payments are not considered added rent.    The 1994

lease agreement states that decedent must give to Funny Hats, as

landlord, keys to each lock in the residence.

     Each of the lease agreements for the years after 1994

contains the same terms as the 1994 lease agreement, except that

the post-1994 lease agreements require the payment of the

following annual rent and monthly installments:

             Year     Annual Rent    Monthly Installments

             1995       $8,700              $725
             1996        9,000               750
             1997        9,300               775
             1998        9,600               800
             1999        9,900               825
             2000       10,200               850

None of the lease agreements restricts decedent’s use of the

residence.    None of the lease agreements requires that decedent

pay a security deposit as to the residence, although each

agreement contains a provision as to security deposits.
                                -14-

6.   Annual and Monthly FRV of the Residence

      The annual and monthly FRVs of the residence were as

follows:

                   Year    Annual FRV      Monthly FRV

                   1994      $17,280         $1,440
                   1995       16,560          1,380
                   1996       17,160          1,430
                   1997       17,880          1,490
                   1998       19,020          1,585
                   1999       21,060          1,755
                   2000       26,400          2,200

7.   Decedent’s Payments as to the Residence

      During decedent’s leasehold, Funny Hats maintained the

residence and made capital improvements.    The dollar amounts of

the capital expenses attributable to the residence were reported

on the Federal estate tax return of decedent’s estate as $3,161

in 1995, $800 in 1996, and $4,225 in 1999, for a total of $8,186.

The reported maintenance expenses for each year from 1994 through

2000 are set forth infra and aggregate $21,657.

      Decedent paid (directly or indirectly) most of the expenses

connected with the residence.   The partners of Funny Hats did not

want to incur out-of-pocket costs as to the residence, and they

asked decedent to pay “rent” greater than that stated in the

lease agreements to the extent that the stated rent was

insufficient to pay expenses connected with the residence.
                              -15-

Decedent wrote the following personal checks to Funny Hats for

rent:6

  Date of Check     Amount of Check   Notation on Face of Check

  Mar. 31, 1994          $3,000        Rent Jan Feb Mar Apr
  May 6, 1994             1,500        May June
  July 25, 1994           2,250        Rent July Aug Sept
  Oct. 12, 1994           2,100        Rent
                          8,850
  Dec. 27, 1994           2,400        Rent   Jan Feb Mar
                         11,250

  May 20, 1995            2,400        Rent   Apr May Jun
  Aug. 14, 1995           2,400                ---
  Oct. 5, 1995            2,400        Rent   Oct Nov Dec
                          7,200

  Jan. 25, 1996           2,400        Rent   Jan Feb Mar
  Apr. 9, 1996            2,400                ---
  June 10, 1996           2,400        Rent   July Aug Sept
                          7,200

  Jan. 25, 1997           2,400                ---
  Apr. 8, 1997            2,400        Rent   Apr May June
  Oct. 8, 1997            2,400        Rent   July Aug Sept
                          7,200

  Feb. 7, 1998            3,000        Rent   Jan Feb Mar
  May 28, 1998            3,000        Rent   Apr May Jun
                          6,000

  Apr. 24, 1999           3,000        Rent Apr May Jun
  Aug. 20, 1999           3,000        3Q Rent
  Nov. 27, 1999           4,000        Rent Oct Nov Dec
                         10,000

Decedent also wrote the following three personal checks to Funny

Hats:




     6
       In addition to the checks listed below for 1996, decedent
made one other $2,400 payment of rent to Funny Hats sometime
during that year.
                                 -16-

   Date of Check      Amount of Check    Notation on Face of Check

   May 7, 1997            $4,000                 ---
   Dec. 5, 1997            3,000                 ---
   Jan. 11, 1999           7,000               Transfer
                          14,000

Decedent did not designate on the face of any of these three

checks that she was writing the check for “rent”, and the parties

have not stipulated that the check represented “rent”.     Nor do we

find that decedent gave any of these three checks to Funny Hats

as rent.

     Decedent’s bank also paid from decedent’s personal account a

$4,000 check that was dated February 7, 2000, and was payable to

Funny Hats.   The face of the check bears the signed name of

decedent on the signature line and contains no notation as to its

purpose.   Decedent did not write or sign this check.     The check

was written and signed by Linda Labet, and she gave it to another

individual (not decedent) to endorse and to deposit into the

checking account of Funny Hats.     As shown on the back of this

$4,000 check, the check was deposited into the checking account

of Funny Hats on February 11, 2000.

     In addition to the payments discussed above, during her

leasehold decedent directly paid the following expenses

associated with the residence:     Telephone, heating, water, and

cable.   Decedent also paid these same types of expenses before

she transferred the residence to Funny Hats.
                               -17-

8.   Decedent’s Use of the Residence

     Funny Hats did not treat decedent in her capacity as a

tenant the same way that Funny Hats would have treated a tenant

who was a stranger.   Decedent did not regularly pay her rent as

required by the lease agreements, she did not always pay the

amount of rent that was stated in the lease agreements, and she

often paid her rent later than the time required by the lease

agreements.   Funny Hats never mailed decedent a notice demanding

that she pay her rent, nor did Funny Hats ever send to decedent a

notice of eviction.   The donees knew that decedent would respect

the integrity of the residence, and they wanted her to live there

as long as she could.

     The donees also wanted decedent to continue to use the

residence after its transfer to Funny Hats, as she had before its

transfer.   Decedent always had the exclusive use and enjoyment of

the entire residence, and she always had the right to use the

entire residence.   There were no lease agreements with anyone

other than decedent with respect to the residence, and no

individual had a right superior to that of decedent to use the

residence from January 1, 1994, through decedent’s death.

Decedent permitted the donees and their families and friends to

visit and stay at the residence rent free during various times

from January 1, 1994, through decedent’s death.
                                         -18-

9.     Relevant Financial Information

        Funny Hats filed a Form 1065, U.S. Partnership Return of

Income, for each year from 1994 through 2000.                  These returns

state that the principal business activity of Funny Hats is

“rental” and that its principal product or service is “real

estate”.       According to the returns, Funny Hats received rent and

incurred related expenses, depreciation, and net losses as

follows:7
                      1994      1995    1996      1997     1998      1999     2000

Gross rents         $11,250   $7,200   $9,600   $10,200   $6,000   $17,000   $4,000
   Cash expenses:
    Insurance           -0-      -0-    2,279       100    1,203     1,208    1,208
     Legal fees         280      521      649       663      691       747      942
     Taxes              -0-    8,940    9,072     9,251    9,501     4,819   10,309
     Miscellaneous      -0-       19      -0-        33      -0-       -0-      -0-
     Travel             -0-      -0-      -0-       -0-      -0-       -0-    6,397
     Business meals     -0-      -0-      -0-       -0-      -0-       -0-      769
     Repairs & maint.8,663       401      238     2,265    4,216     5,343      531
     Exterminating      -0-       76       81       -0-       81       119      -0-
     Bank charges       -0-      -0-      -0-        13       10        96      100
                      8,943    9,957   12,319    12,235   15,702    12,332   20,256
   Depreciation1      8,364    8,773    8,921     9,003    8,947     9,022    7,975
                     17,307   18,730   21,240    21,328   24,649    21,354   28,231
   Net loss           6,057   11,530   11,640    11,128   18,649     4,354   24,231

        1
         Funny Hats claimed depreciation on the entire house and not just on the
     portion of the residence that was purportedly rented to decedent.

Funny Hats also reported for 1997 through 2000 that it had

received interest income of $529, $177, $73, and $580,

respectively.        Funny Hats also reported for 2000 that it had

realized a $51,418 “net section 1231 gain”.




        7
       Funny Hats also filed a 1993 Form 1065 that did not report
any income or expense. The 1993 Form 1065 reported that the
residence was an asset of Funny Hats and that the principal
business activity of Funny Hats was “inactive”.
                                 -19-

      For each of the years 1994 through 1996 and for 1998, the

amount of gross rent reported for the year corresponds to the

amount of rent that decedent paid Funny Hats during that year.

The $10,200 reported for 1997 apparently corresponds to the

$7,200 of rent paid during that year plus the $3,000 payment that

decedent made to Funny Hats on December 5, 1997.8     The $17,000

reported for 1999 apparently corresponds to the $10,000 of rent

paid during that year plus the $7,000 payment that decedent made

to Funny Hats on January 11, 1999.      The $4,000 reported for 2000

apparently corresponds to the $4,000 check dated February 7,

2000, that was paid to Funny Hats from the checking account of

decedent.

10.   David Disbrow

      David Disbrow has worked as a commercial airline pilot since

1981, flying mostly international routes in and out of New York,

New York.   He lived at the residence from his birth in or around

1960 until approximately 1982.    He returned to the residence in

1985 and lived there through 1988.      He visited at the residence

periodically from 1988 through 1997.




      8
       The record does not explain the purpose of the $4,000
check that decedent wrote to Funny Hats on May 7, 1997, for other
than rent. It appears from our reconciliation in the appendix
that this $4,000, while deposited into the checking account of
Funny Hats, was withdrawn for use by someone other than Funny
Hats.
                                 -20-

      David Disbrow resided principally in Florida during some or

all of the time discussed herein.       In late 1997, after he was

reassigned to fly in and out of New York, New York, he began to

stay approximately 3 days a week at the residence with the

consent of decedent.     Also with her consent, he allowed his

girlfriend to stay periodically at the residence beginning in or

about January 1998.    The girlfriend worked out of New York, New

York, as a flight attendant, and she had recently been reassigned

there.   She was without any other place to stay, and she became

David Disbrow’s wife in late 1998 or early 1999.      When David

Disbrow and his girlfriend stayed at the residence, they slept on

the second floor of the house.     They did not pay any rent for

their use of the residence, and they did not pay any expense

connected with the residence.

11.   Sale of the Residence

      When decedent died on February 9, 2000, the fair market

value of the residence was $400,000.      On November 30, 2000, Funny

Hats sold the residence to David Disbrow for $350,000.      Funny

Hats sold the residence to David Disbrow upon his request and did

not attempt to obtain a second bid for the residence or otherwise

sell it in the market.

12.   2001 Through 2003 Forms 1065

      In addition to the Forms 1065 mentioned above, Funny Hats

filed 2001 through 2003 Forms 1065.      Each of the post-2000
                               -21-

returns reports that Funny Hats’ principal business activity was

“rental” and that its principal product or service was “real

estate”.   None of those returns reports any rent for those years.

The 2001 return reports that Funny Hats realized $277 of interest

income during 2001 and was entitled to claim $1,153 in

“miscellaneous” deductions.   The 2002 return reports that Funny

Hats realized $47 of interest income during 2002 and was entitled

to claim $843 in “miscellaneous” deductions.      The 2003 return

reports that this return was a final return and that Funny Hats

had realized $29 of interest income during 2003.

13.   Estate Tax Return and Notice of Deficiency

      On or about May 3, 2001, Martha Johnson filed a Federal

estate tax return for decedent’s estate.   The return reports in

part that decedent’s estate owes Funny Hats $8,500 for the

“Balance of annual rent due pursuant to lease agreement” and that

decedent’s estate incurred a $6,000 expense for the “Clean out

and removal of property re:   Decedent’s home”.    By notice of

deficiency dated February 10, 2004, respondent determined the

estate tax deficiency in issue.   The parties now agree that

decedent’s estate is not entitled to deduct any of the $8,500 as

rent payable to Funny Hats and that decedent’s estate is entitled

to deduct only $342.04 as a cleaning expense.
                               -22-

                              OPINION

     Respondent determined that the fair market value of the

residence is includable in decedent’s gross estate under section

2036(a)(1) because decedent until her death retained the

“possession” and “enjoyment” of the residence within the meaning

of that section.   Petitioner argues that section 2036(a)(1) does

not apply to this case because decedent paid FRV for her use of

the residence.   Petitioner asserts that decedent did not have to

pay FRV for the entire residence because she shared the residence

with the donees and their families and friends, including David

Disbrow’s girlfriend.   Petitioner recognizes that the 2000 lease

agreement required rent installment payments of $850 per month

but asserts that this amount was written erroneously into the

agreement.   Petitioner asserts that the parties to the 2000 lease

agreement modified the agreement orally to require that decedent

pay monthly rent of $1,333.33, which, petitioner claims, was no

less than the FRV for decedent’s “shared restricted use” of the

residence.

     The Federal estate tax is imposed on the transfer of the

taxable estate of every decedent who is a citizen or resident of

the United States.   See sec. 2001.   Decedent’s taxable estate

equals her gross estate less applicable deductions.    See sec.

2051.   Decedent’s gross estate includes the fair market value of

all property to the extent provided in sections 2031 through
                                -23-

2046.   See sec. 2031.   For purposes of this computation, the

parties dispute whether section 2036(a) applies to the residence.

In relevant part, section 2036(a) provides:

     SEC. 2036.   TRANSFERS WITH RETAINED LIFE ESTATE.

          (a) General Rule. The value of the gross estate
     shall include the value of all property to the extent
     of any interest therein of which the decedent has at
     any time made a transfer (except in case of a bona fide
     sale for an adequate and full consideration in money or
     money’s worth), by trust or otherwise, under which he
     has retained for his life or for any period not
     ascertainable without reference to his death or for any
     period which does not in fact end before his death--

                (1) the possession or enjoyment of, or
           the right to income from, the property * * *

     Congress enacted section 2036 intending to bring within a

decedent’s gross estate “‘transfers that are essentially

testamentary–-i.e., transfers which leave the transferor a

significant interest in or control over the property transferred

during his lifetime.’”    Estate of Abraham v. Commissioner,

408 F.3d 26, 37 (1st Cir. 2005) (quoting United States v. Estate

of Grace, 395 U.S. 316, 320 (1969)), affg. T.C. Memo. 2004-39;

see also Mahoney v. United States, 831 F.2d 641 (6th Cir. 1987).

Pursuant to section 2036(a), decedent’s gross estate will include

the fair market value of the residence if decedent retained an

interest in the residence for her life or for any other period

that does not end before her death.

     In order not to have retained an interest described in

section 2036(a), decedent must have “absolutely, unequivocally,
                               -24-

irrevocably, and without possible reservations,” parted with all

of her title, possession, and enjoyment of the residence.

Commissioner v. Estate of Church, 335 U.S. 632, 645 (1949).

Decedent will have retained such an interest in the residence if

she transferred the residence to Funny Hats with an understanding

or agreement, express or implied, that the possession or

enjoyment of the residence would be for her pecuniary benefit.

See Guynn v. United States, 437 F.2d 1148, 1150 (4th Cir. 1971);

Estate of Rapelje v. Commissioner, 73 T.C. 82, 86 (1979); sec.

20.2036-1(b)(2), Estate Tax Regs.; see also United States v.

Byrum, 408 U.S. 125, 146 n.28 (1972) (in the context of section

2036(a)(1), the word “enjoyment” denotes the receipt of a

substantial present economic benefit); Estate of Maxwell v.

Commissioner, 3 F.3d 591, 593 (2d Cir. 1993) (in the context of

section 2036, the terms “possession” and “enjoyment” as applied

to real property denote “‘the lifetime use of the property’”

(quoting United States v. Byrum, supra at 147)), affg. 98 T.C.

594 (1992).   Such is so even if the retained interest is not

legally enforceable.   See Estate of Abraham v. Commissioner,

supra at 39; Estate of Maxwell v. Commissioner, supra at 593;

Estate of Reichardt v. Commissioner, 114 T.C. 144, 151 (2000);

Estate of Rapelje v. Commissioner, supra at 86.

     Whether decedent had an understanding or agreement to retain

possession or enjoyment of the residence following its transfer
                               -25-

to Funny Hats is determined from all of the facts and

circumstances surrounding both the transfer itself and the

subsequent use of the residence.   See Estate of Abraham v.

Commissioner, supra at 39.   We carefully scrutinize the facts and

circumstances of a case such as this that involves an intrafamily

transaction.   See Estate of Hartshorne v. Commissioner, 402 F.2d

592, 594 n.2 (2d Cir. 1968), affg. 48 T.C. 882 (1967); Estate of

Huntington v. Commissioner, 100 T.C. 313, 316 (1993); Estate of

Labombarde v. Commissioner, 58 T.C. 745 (1972), affd. per curiam

without published opinion 502 F.2d 1158 (1st Cir. 1973); cf.

Estate of Abraham v. Commissioner, supra at 39; Estate of Maxwell

v. Commissioner, 98 T.C. at 602.

     Section 7491 was added to the Code by the Internal Revenue

Service Restructuring and Reform Act of 1998, Pub. L. 105-206,

sec. 3001(c), 112 Stat. 727, effective for court proceedings

arising from examinations commencing after July 22, 1998.

Section 7491(a)(1) provides that the burden of proof is on the

Commissioner in specified circumstances.   While petitioner makes

no argument that section 7491(a)(1) applies here, we need not and

do not decide whether petitioner has met all of the prerequisites

for that section to apply.   See, e.g., sec. 7491(a)(2) (section

7491(a)(1) applies only when certain limitations are met).    We

decide this case without regard to which party bears the burden

of proof.   Specifically, on the basis of the record at hand, we
                               -26-

find that decedent made a transfer of the residence to Funny Hats

whereby she retained lifetime possession and enjoyment of the

residence pursuant to her express and implied understandings and

agreements with the donees.   It seems to us plainly inferable

that decedent’s children meant for her to stay at the residence

until she died, unless, of course, they had to put her in an

assisted living facility or a nursing home.

     The express understandings and agreements of retention are

memorialized in the lease agreements.   These agreements gave

decedent the right to the same quiet enjoyment of the entire

residence that she had enjoyed before transferring the residence

to Funny Hats.   The lease agreements stated specifically and

without reservation that the leased property was the address of

the residence, and they contained no relevant limitation on

decedent’s exclusive use of the leased property.   The lease

agreements also stated, specifically and without reservation,

that decedent might “peaceably and quietly have, hold and enjoy”

the residence for the term of the lease and allowed decedent to

further her possession and enjoyment of the residence by

altering, decorating, changing, or adding to it.   The lease

agreements even gave decedent the right to sublet all or part of

the residence, to assign the lease, or to permit any other person

to use the residence.   While the presence of a lease may

sometimes lead to a finding of a lack of retention for purposes
                                -27-

of section 2036(a)(1), see, e.g., Estate of Barlow v.

Commissioner, 55 T.C. 666 (1971) (possession and enjoyment of

real property pursuant to a lease was not a retention of the

possession or enjoyment of the property for purposes of section

2036(a) where the tenant paid FRV), such is not true where, as

here, the tenant pays less than FRV as to the lease of the

property.   Decedent’s rights under the lease agreements to the

exclusive possession and enjoyment of the residence triggers the

application of section 2036(a)(1) to the residence in that

decedent did not pay FRV for that possession and enjoyment.

     As to the implied understanding and agreement between

decedent and Funny Hats as to her continued possession and

enjoyment of the residence following its transfer to Funny Hats,

we find such an understanding or agreement when we view the

conduct of the parties to the lease agreements, as well as the

lease agreements themselves.    See Estate of Reichardt v.

Commissioner, supra at 151; Estate of Rapelje v. Commissioner,

supra at 86.   We further find that the annual lease agreements

were a subterfuge to disguise the testamentary nature of the

transfer.

     First, Funny Hats was not a business operated for profit but

was a testamentary device whose goal was to remove the residence

from decedent’s gross estate.   During decedent’s life, Funny Hats

operated solely as a conduit for the payment of expenses related
                              -28-

to the residence and operated for the most part only to the

extent that decedent furnished it with funds.   Funny Hats used

the funds that it received from decedent to pay indirectly the

same types of expenses that she had paid directly before she

transferred the residence to Funny Hats.   Shortly after decedent

died, Funny Hats sold the residence and conducted no activity

except for limited tasks related to the liquidation of Funny

Hats.

     Second, decedent’s relationship to the residence following

its transfer to Funny Hats was not treated by either decedent or

Funny Hats as that of a tenant to leased property.    Decedent was

frequently delinquent in paying, or failed to pay, rent due under

the terms of the lease agreements.   Decedent also did not pay

rent every year upon signing the lease, as also was required by

the terms of the lease agreements.   Yet in no instance did Funny

Hats send decedent a late notice, accelerate her installment

payments, make a written demand for payment, seek her eviction,

or ask her to post a security deposit.   Nor did Funny Hats set

decedent’s rent at FRV; the rent was set at a lesser amount that

was considered necessary to maintain the residence.   It also

appears that decedent directly paid the taxes on the residence in

1994 and that she directly paid the insurance on the residence in

both 1994 and 1995.
                                 -29-

     Third, decedent transferred the residence to Funny Hats when

she was almost 72 years old and in poor health.    Following the

transfer, decedent continued to live at the residence until she

died, and Funny Hats never rented, or sought to rent, the

residence after decedent died.    Instead, Funny Hats sold the

residence to David Disbrow for $350,000 shortly after decedent’s

death, without attempting to sell the residence in the market for

a higher price.   The $350,000 sale price was $50,000 less than

the fair market value of the residence at the time of decedent’s

death, and we find nothing in the record that would account for

the purported 12.5-percent decline in the fair market value of

the residence from the time of decedent’s death until the time of

the sale.   We also note that the $350,000 sale price equaled the

market value of the residence as of September 1, 1993, as

ascertained through the comparative market analysis obtained by

decedent on that date.

     Fourth, as admitted at trial by a partner of Funny Hats, the

donees wanted decedent to continue to use and possess the

residence as she had before its transfer and wanted decedent to

live at the residence for as long as she could.    The substance of

this admission is not remarkable given that decedent was elderly

and infirm at the time of the transfer, that she had lived in the

residence for approximately 37 years before the transfer, and

that the donees were the natural objects of decedent’s affection
                                -30-

and bounty.   While petitioner places great weight on the fact

that Funny Hats could have theoretically evicted decedent from

the residence at the end of a year by not renewing her lease for

the next year, we do not.   As stated above, lifetime enjoyment

and possession may be retained by implied agreement even though

not legally enforceable.    In addition, from a factual point of

view, the partners of Funny Hats were all members of decedent’s

immediate family, and the record gives us no reason to find that

they would have evicted decedent from the residence.   Such is

especially so given our finding that many of the children

traveled from afar to visit decedent both before and after the

transfer.   We also add that decedent during her leasehold

retained much wealth in her name and that the children were the

equal beneficiaries of that wealth.

     Fifth, decedent transferred the residence to Funny Hats on

the advice of counsel to minimize the tax on her estate.

Decedent appears to have understood that transferring the

residence to Funny Hats and executing the lease agreements with

Funny Hats was merely a mechanism for removing the residence from

her gross estate while allowing her to retain beneficial

ownership of the residence.   As the beneficial owner of the

residence, but not as a partner of Funny Hats, decedent

constantly wrote checks to Funny Hats and personally cashed those
                               -31-

checks to generate funds that were used to maintain the

residence.

     Petitioner attempts to equate decedent’s payment of rent

with FRV by arguing that decedent shared the residence with

others.   As we understand petitioner’s argument, Funny Hats

retained a right under the lease agreements to use (or designate

who could use) the residence in derogation of decedent’s wishes

and without the payment of rent in that (1) the agreements stated

that the “children of the party [decedent] may use the premises”,

(2) the partners of Funny Hats were decedent’s children and

children-in-law, and (3) the partners, as effective owners of the

residence through their interests in Funny Hats, did not have to

pay themselves rent for their (or their designated person’s) use

of the residence.   As we further understand petitioner’s

argument, Funny Hats, pursuant to these retained rights, allowed

David Disbrow to possess all of the residence, except for

decedent’s bedroom which decedent possessed under the lease

agreements, and decedent, therefore, was required to pay only the

portion of the FRV of the residence that corresponded to the

portion of the residence that she possessed.   As we understand

the conclusion of petitioner’s argument, decedent paid FRV for

her “shared usage” of the residence in 2000 in that she paid

Funny Hats $4,000 in rent for the first quarter of that year.
                               -32-

     We find petitioner’s argument unavailing.   We find no

credible evidence in the record to establish that someone other

than decedent was entitled to use the residence without

decedent’s consent.   The record contains no agreement (with the

exception of the lease agreements) that governs the use of the

residence, and the lease agreements contain no provision

permitting any individual to use any part of the residence in

derogation of decedent’s wishes.   Although we find that

individuals other than decedent visited and stayed at the

residence after the transfer, most of these individuals also

visited and stayed with decedent before the transfer.   As was

true in both cases, the individuals who visited and stayed with

decedent were obviously there with decedent’s consent, express or

tacit.   In fact, although we find that legal title to the

residence changed on account of the transfer, we find no

substantial change in the way that decedent possessed and enjoyed

the residence.

     We also note inconsistencies between petitioner’s claim of

decedent’s shared usage and the manner in which Funny Hats and

decedent’s estate reported the rental for Federal tax purposes.

On its partnership returns, Funny Hats reported its rental of the

residence to decedent as that of the entire residence in that

Funny Hats deducted 100 percent of its related expenses and

claimed depreciation on the entire house.   The estate tax return
                               -33-

of decedent’s estate reports that decedent’s estate was entitled

to deduct a $6,000 expense for cleaning out “Decedent’s home”.

     We also find nothing credible in the record to persuade us

that decedent agreed to pay monthly installments of rent for 2000

in amounts other than the $850 shown in the 2000 lease agreement,

or that decedent was liable in 2000 for more than $850 per month.

Petitioner invites the Court to find that there was an oral

agreement modifying the 2000 lease agreement and to find that

decedent paid $4,000 of rent for the first quarter of 2000 by

means of the February 7, 2000, check.   We decline to make either

finding.   First, decedent’s estate admitted on the estate tax

return that it considered $8,500 of rent to be owing to Funny

Hats.   Decedent died in February 2000, and this $8,500

corresponds to the product of the remaining 10 months in that

year multiplied by the $850-per-month rate shown in the 2000

lease agreement.   The $850-per-month rate is also consistent with

each of the rates of rent set forth in the lease agreements for

prior years, although petitioner now asks the Court to find that

decedent’s rent for years after 1996 actually reflected

decedent’s shared use of the residence with David Disbrow and

others.

     Second, even if we were to assume arguendo that the parties

to the 2000 lease agreement could modify that agreement orally,

an assumption that we make with much reservation, the record does
                                -34-

not support a finding that the referenced $4,000 check was

decedent’s payment of rent for 2000.     In addition to the fact

that the check was not written by decedent, nor do we find that

it was written by another individual at the direction of

decedent, the check was written 2 days before decedent died and

was not deposited into the account of Funny Hats until 2 days

after decedent died.   We are skeptical of the legitimacy of that

check as one payable from decedent’s account.

     We hold for respondent.9   We have considered all arguments

by petitioner for a contrary holding and find those arguments not

discussed herein to be without merit.     Given respondent’s

concessions,


                                            Decision will be entered

                                       under Rule 155.




     9
       Petitioner also seeks a contrary holding relying upon
Estate of Barlow v. Commissioner, 55 T.C. 666 (1971); Estate of
Roemer v. Commissioner, T.C. Memo. 1983-509; Diehl v. United
States, 21 AFTR 2d 1607, 68-1 USTC par. 12,742 (W.D. Tenn. 1967);
and Stephenson v. United States, 238 F. Supp. 660 (W.D. Va.
1965). Each of those cases is factually distinguishable from the
case at hand mainly in that: (1) Decedent did not pay (nor did
she agree to pay) FRV for her use of the residence after its
transfer to Funny Hats and (2) decedent and the donees had an
understanding and agreement that she would retain possession and
enjoyment of the residence until she died.
                                                                -35-

                                                         APPENDIX

                                   1994      1995       1996       1997      1998      1999      2000       2001        2002      2003


Cash, beginning                     -0-    $2,307     $6,839     $3,320    $9,724      $199     $7,489    $354,292     $4,816    $4,020
Transfers by decedent
  Payment of rent               $11,250     7,200      9,600      7,200     6,000    10,000        -0-         -0-        -0-       -0-
  Other checks                      -0-       -0-        -0-      7,000       -0-     7,000      4,000         -0-        -0-       -0-
Partners’ contributions
  David Disbrow                     -0-     2,000        -0-      1,600       -0-       -0-      6,714         -0-        -0-       -0-
  Other 8 partners equally          -0-     8,000        -0-      6,400       -0-       -0-        -0-         -0-        -0-       -0-
Interest income                     -0-       -0-        -0-        529       177        73        580         277         47        29
Proceeds from loans
  From decedent                     -0-       -0-        -0-        -0-      -0-      6,774        -0-         -0-        -0-       -0-
  From unspecified sources          -0-       450        -0-        -0-      -0-        -0-      7,933         -0-        -0-       -0-
Proceeds from sale of residence     -0-       -0-        -0-        -0-      -0-        -0-    348,600         -0-        -0-       -0-
Payment of expenses              (8,943)   (9,957)   (12,319)   (12,325) (15,702)   (12,332)   (20,256)     (1,153)      (843)      -0-
Purchase of capital assets          -0-    (3,161)      (800)       -0-      -0-     (4,225)       -0-         -0-        -0-       -0-
Nondeductible portion of
  “business meals”                  -0-       -0-        -0-        -0-       -0-       -0-       (768)        -0-        -0-       -0-
Distributions to partners
  David Disbrow                     -0-       -0-        -0-        -0-       -0-       -0-        -0-     (72,058)1      -0-      (810)
  Other 8 partners equally          -0-       -0-        -0-        -0-       -0-       -0-        -0-    (261,384)       -0-    (3,239)
Repayment of loans                  -0-       -0-        -0-        -0-       -0-       -0-        -0-     (15,158)       -0-       -0-
Unaccounted withdrawal              -0-       -0-        -0-     (4,000)      -0-       -0-        -0-         -0-        -0-       -0-
Cash, ending                      2,307     6,839      3,320      9,724       199     7,489    354,292       4,816      4,020       -0-

    1
     We note that $72,058 equals $6,714 plus $65,344. Six thousand seven hundred and fourteen dollars corresponds to David
Disbrow’s contribution for 2000, and $65,344 approximates the product of David Disbrow’s 20-percent partnership interest in
Funny Hats and the difference between the total distributions for 2001 and $6,714 ($72,058 + $261,384 - $6,714 = $326,728;
$326,728 x .20 = 65,345.60).
