                        T.C. Memo. 1995-579



                      UNITED STATES TAX COURT



            JAMES T. AND GOLDIE L. RYAN, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent




     Docket Nos. 14073-93, 23885-94.    Filed December 5, 1995.



     Karey A. Schoenfeld, for petitioners.

     Brenda M. Fitzgerald, for respondent.



                         MEMORANDUM OPINION


     COLVIN, Judge:   Respondent determined deficiencies in

petitioners' Federal income tax of $12,925 for 1989 and $13,294

for 1991.

     The sole issue for decision is whether petitioners may defer

the gain realized on the sale of their old principal residence
                               - 2 -


under section 1034.   We hold that they may not.   In so holding,

we conclude that petitioners failed to establish that they sold

their old residence less than 2 years after they bought their new

residence.

     The parties agree that, if petitioners must recognize gain

on the sale of the old residence, respondent erred in determining

a deficiency for 1989 and petitioners must recognize gain in

1991, the year they sold it.

     Unless otherwise indicated, section references are to the

Internal Revenue Code in effect for the years in issue.   Rule

references are to the Tax Court Rules of Practice and Procedure.

                             Background

     The facts have been fully stipulated under Rule 122 and are

so found.

A.   Petitioners

     Petitioners resided in Clackamas, Oregon, when they filed

the petition in this case.

     In 1988, petitioners owned a home at 740 Fifth Avenue, Blue

Lake, California (the Blue Lake residence, or Blue Lake

property).   The Blue Lake property was petitioners' principal

residence until August 5, 1988.   Petitioners had mortgages on

the Blue Lake property with Home Federal Bank in San Diego,

California, and Beneficial Finance in Eureka, California.
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B.   Petitioners' Purchase of the Portland Residence

     Petitioners bought a residence at 11425 S.E. Westgate Way,

Portland, Oregon (Portland residence), on July 19, 1989.

C.   Petitioners' Sale of the Blue Lake Residence

     1.     The Earnest Money Agreement

     On August 5, 1988, Robert and Jacqueline Soper (the Sopers)

leased the Blue Lake property from petitioners.     On May 29, 1989,

petitioners and the Sopers signed an earnest money agreement

under which they agreed to transfer the ownership of the Blue

Lake property for $85,000.    The Sopers paid $500 earnest money to

petitioners for the planned purchase under the agreement.     In the

earnest money agreement, the Sopers agreed to make a good faith

effort to arrange financing for their purchase of the house

within a reasonable time, including applying for an FHA loan.

If the Sopers could not obtain an FHA loan, petitioners agreed to

arrange financing for the house for 1 year.     After that time, the

Sopers were required to have arranged financing for the continued

mortgage.    Petitioners were ready and willing to sell the Blue

Lake property after May 29, 1989.      The Sopers intended to buy the

Blue Lake property at all times after May 29, 1989.

     2.     The Option Agreement

     On October 30, 1989, the title to the Blue Lake property

was held in escrow by the Eureka Title Co.     Because of financing
                                - 4 -


problems, the Sopers could not pay the full price for the

property.    On October 30, 1989, the Sopers agreed to pay

petitioners $10,000 for an option to buy the Blue Lake property

(the option agreement).    The $10,000 payment was creditable

toward the sale price; it was not refundable if the Sopers did

not buy the Blue Lake residence.    Thereafter, the Sopers

landscaped the exterior, installed a dog run, and redecorated the

interior of the house by doing such things as hanging wallpaper.

Under the option agreement, the Sopers were responsible for all

maintenance on the house.    Petitioners did not make or pay for

any repairs on the Blue Lake property after October 30, 1989.

The Sopers agreed to obtain liability insurance for the

residence.    After November 1, 1989, the Sopers made petitioners'

mortgage payments on the Blue Lake property to Home Federal Bank

and Beneficial Finance.    The payments to Home Federal Bank

included reserves for all property taxes and liability insurance

on the property.    The Home Federal Bank mortgage required

petitioners to maintain liability insurance on the Blue Lake

property.    Petitioners agreed to maintain fire insurance on the

residence.    The Sopers obtained renter's insurance for the Blue

Lake property.    They did not obtain title or hazard insurance for

the property.
                                 - 5 -


     The option agreement did not require the Sopers to buy the

Blue Lake residence.   The Sopers could exercise the option by

notifying petitioners in writing at any time before June 8, 1991,

the end of the lease term.   Petitioners and the Sopers intended

that title to the Blue Lake property would be held in escrow

until the Sopers exercised the option, and that the escrow would

close before July 8, 1991.

     The Sopers made a security deposit of $1,250 when they

rented the Blue Lake property.    Under the option agreement,

petitioners credited that amount to the purchase price of the

property.   As of October 30, 1989, the Sopers had paid to

petitioners $11,750 ($10,000 under the option agreement, $1,250

in security deposit, and $500 earnest money), which petitioners

later applied to the purchase price of the Blue Lake property.

If the Sopers did not buy the Blue Lake residence, $10,500 was

nonrefundable; this amount is 12.35 percent of the total price.

In addition, some or all of the security deposit was refundable

when and if the Sopers vacated the property.

     On June 22, 1991, the Sopers and petitioners amended the

option agreement to delete the provision which required the

Sopers' mortgage payments to be applied to the purchase price,

and to delete the provision which required the amount of interest

that would accrue on the principal amount of $20,000 to be
                                - 6 -


credited to petitioners from the date of the agreement until

the end of the lease.    The Sopers' mortgage payments were not

applied to the purchase price when they bought the Blue Lake

property.

     3.     Passage of Title to the Blue Lake Property

     For financial reasons, the Sopers could not complete the

purchase of the Blue Lake property until August 5, 1991.    On

August 5, 1991, Eureka Title Co. closed the escrow of the Blue

Lake property.    Around that time, the Sopers paid $1,900 for a

new roof and $2,404 for pest and damage repairs.

     Petitioners had about $30,000 equity in the Blue Lake

property when they sold it.

D.   Petitioners' Tax Returns

     Petitioners' accountant told them they should report the

mortgage payments made by the Sopers as rental income and deduct

the payment of property taxes and liability insurance as rental

expenses.    Petitioners reported rental income from the Blue Lake

property on their 1989, 1990, and 1991 income tax returns.

                              Discussion

     The issue for decision is whether the gain realized by

petitioners in 1989 from the sale of the Blue Lake property

qualifies for nonrecognition under section 1034.    Generally, a

taxpayer must recognize gain on the sale of a personal residence.
                                - 7 -


Sec. 1001(c).   However, if a taxpayer sells his or her principal

residence, and within 2 years of the date of the sale buys and

uses another principal residence, gain from the sale is

recognized only to the extent that the taxpayer's adjusted sale

price for the old residence exceeds the cost of the new

residence.   Sec. 1034(a).   The parties dispute whether

petitioners sold the Blue Lake property within 2 years of

July 19, 1989, the date that petitioners bought their Portland

residence.

A.   When Petitioners Sold the Blue Lake Property for Purposes
     of Section 1034

     Whether a sale is complete for Federal tax purposes depends

on all the facts and circumstances.     Derr v. Commissioner, 77

T.C. 708, 724 (1981); Baird v. Commissioner, 68 T.C. 115, 124

(1977); Clodfelter v. Commissioner, 48 T.C. 694, 700-701 (1967),

affd. 426 F.2d 1391 (9th Cir. 1970).    We consider the following

factors in deciding whether a sale occurred:    (a) Whether the

seller transferred legal title; (b) whether the benefits and

burdens of ownership passed to the buyer; (c) whether the owner

had a right under the agreement to require the other party to buy

the property; and (d) how the parties treated the transaction.

Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221, 1237-

1238 (1981); Derr v. Commissioner, supra at 724; Baird v.

Commissioner, supra at 124; Merrill v. Commissioner, 40 T.C. 66,
                               - 8 -


74 (1963), affd. per curiam 336 F.2d 771 (9th Cir. 1964); Haggard

v. Commissioner, 24 T.C. 1124, 1129 (1955), affd. 241 F.2d 288

(9th Cir. 1956).   We next consider each of these factors.

     1.   Title Passage to the Sopers

     Passage of title is normally the most important factor.

Baertschi v. Commissioner, 412 F.2d 494, 498 (6th Cir. 1969),

revg. and remanding 49 T.C. 289 (1967).   Title to the Blue Lake

property passed to the Sopers on August 5, 1991, more than 2

years after petitioners bought their new residence.

     2.   Whether the Benefits and Burdens of Ownership Passed
          to the Sopers

     Petitioners argue that they transferred the benefits and

burdens of ownership of the Blue Lake property to the Sopers on

or before July 19, 1991.

     To decide whether the Sopers acquired the benefits and

burdens of ownership in the Blue Lake property, we consider

whether the Sopers:   (a) Bore the risk of loss of the property

from all causes; (b) were obligated to pay all taxes,

assessments, and charges against the property; (c) had the duty

to maintain the property; (d) were responsible for insuring the

property; (e) had the right to possess the property and to enjoy

the use, rents, and profits thereof; (f) had the right to improve

the property without the sellers' consent; and (g) had the right
                               - 9 -


to obtain legal title at any time by paying the balance of the

full purchase price.

     The principal burdens of ownership the option agreement

shifted from petitioners to the Sopers were the burdens of

maintaining the property and paying property taxes.    The

agreement is silent as to who bore the risk of loss of the Blue

Lake residence.   The agreement required petitioners to maintain

fire insurance on the residence.   The Sopers did not obtain title

or hazard insurance for the property.    We conclude that

petitioners bore the risk of loss to the property.

     The Sopers were in possession of the Blue Lake residence

when they signed the option agreement.    This was a continuation

of their leasehold, which the Sopers had under the August 5,

1988, lease agreement.   Thus, the benefit of possession did not

pass to the Sopers under the option agreement.    The agreement is

silent as to whether the Sopers could make improvements to

the Blue Lake property without petitioners' consent.    After

petitioners and the Sopers signed the option agreement, the

Sopers could obtain legal title at any time by paying the

outstanding balance.

     In summary, the Sopers did not:    (a) Bear the risk of loss

of the property; (b) have the obligation to pay assessments and

charges against the property; or (c) have the responsibility
                                - 10 -


to insure the property against fire or other hazards.1    Although

the Sopers made some improvements, e.g., landscaping and new

wallpaper, they did not have the right to improve the property

without petitioners' consent.    The Sopers: (a) Had the duty to

maintain the property; (b) had the right to obtain legal title

upon payment of the full purchase price; and (c) had the duty to

pay property taxes.     The Sopers had possession of the Blue Lake

property under the 1988 lease.    Petitioners contend that this was

a benefit of ownership the Sopers enjoyed before title passed.

However, the Sopers obtained possession independent of the option

agreement.   Even if we treat the Sopers' possession of the Blue

Lake property under the lease as a benefit of ownership for

purposes of deciding whether a sale had occurred, an insufficient

range of benefits and burdens of ownership passed to the Sopers

before title passed on August 5, 1991, for us to find that the

date of sale preceded that date.    We conclude that the Blue Lake

property was sold to the Sopers on August 5, 1991.

     Petitioners rely on Baertschi v. Commissioner, 412 F.2d 494

(6th Cir. 1969), to support their position that the sale date is

determined by the date the benefits and burdens of ownership

passed to the Sopers.    In Baertschi v. Commissioner, supra, the



     1
       The Sopers did pay for liability insurance through their
mortgage payments to Home Federal Bank.
                               - 11 -


taxpayers/sellers of a residence argued that the date of sale

was the date they delivered the deed to the buyers.    Before

the sellers delivered the deed, the buyers had signed a

land contract, paid 29 percent of the purchase price, assumed

responsibility for taxes and insurance, and had the right to

improve the property without the sellers' consent and to receive

title on payment of the full purchase price.     Id. at 498.    The

sellers did not have the right to receive full payment if the

buyers defaulted.    Id. at 497.   The Court of Appeals for the

Sixth Circuit held that the sale of the residence was complete

when the benefits and burdens of ownership passed to the buyers,

rather than on the later date when the taxpayers delivered the

deed and received full payment of the purchase price.     Id. at

498.

       Petitioners' reliance on Baertschi is misplaced for several

reasons.    First, the parties there signed a land contract, which

was not considered by the purchasers to be an option agreement.

Id. at 496.   Under a land sale contract, the seller holds title

to the property as security for the payment by the buyer of the

remaining purchase price.   Cal. Civ. Code sec. 2985 (West 1993).2


       2
       Cal. Civ. Code sec. 2985 (West 1993) defines a land sale
contract as: "an agreement wherein one party agrees to convey
title to real property to another party upon the satisfaction
of specified conditions set forth in the contract and which does
                                                   (continued...)
                              - 12 -


Second, the court held that a sale occurred because the benefits

and burdens of ownership passed under the contract.   As discussed

above, petitioners did not pass sufficient benefits and burdens

of ownership to the Sopers under the option agreement to

constitute a complete sale until August 5, 1991.   Third, the

Court of Appeals in Baertschi reasoned that the sellers were not

entitled to section 1034 deferral because "income tax provisions

which exempt taxpayers under given circumstances from paying

taxes (or as here, postponing them) are strictly construed."

Baertschi v. Commissioner, supra at 498-499.   The circumstances

here are, from petitioners' standpoint, at best ambiguous.

Strict construction of the statutory requirement that petitioners

sell the Blue Lake property within 2 years of July 19, 1991,

requires us to conclude that they did not meet that requirement.

     3.   Whether Petitioners Could Compel the Sopers To
          Exercise the Option

     Petitioners rely on Awalt v. Commissioner, T.C. Memo. 1987-

42, to support their position that we should treat the option

agreement as a sale.   In Awalt v. Commissioner, supra, the

taxpayer did not qualify for section 1034 treatment because the

sale of his residence in Hawaii occurred in 1972 when he received



     2
      (...continued)
not require conveyance of title within one year from the date of
formation of the contract."
                              - 13 -


the first payment and significant benefits and burdens of

ownership shifted from him to the buyer, rather than in 1980 when

he received the final payment.   The taxpayer delayed the transfer

of title to secure payment of the purchase price.3    We found that,

under the contract, the parties intended to shift the benefits

and burdens of ownership in 1972.    The buyer was liable for the

full purchase price if he defaulted.     In contrast, the Sopers

were not obliged to exercise the option or otherwise liable to

pay the full purchase price if they chose not to exercise the

option.

     Under California law, an instrument is a contract of sale if

the optionee has an obligation to buy which the owner can enforce

by specific performance.   Welk v. Fainbarg, 255 Cal. App. 2d 269,

63 Cal. Rptr. 127, 132-133 (1967).     Here, the option agreement

did not provide that petitioners could enforce it by specific

performance.   The Sopers believed the agreement was an option

agreement.   The fact that petitioners and the Sopers expected

that the Sopers would exercise the option does not change the

fact that it was an option.   At some time (not disclosed in the

record) on or around August 5, 1991, the Sopers exercised the



     3
       Under Hawaii law, an "agreement of sale" is a contract
which lets the seller keep title to property as a means of
securing the purchase price. Awalt v. Commissioner, T.C.
Memo. 1987-42.
                              - 14 -


option and bought the Blue Lake residence.   Until the Sopers

exercised the option, their payments of petitioners' mortgage

(including property taxes and liability insurance) were rent

payments on the leasehold.   They were not installment payments

under an installment land sale contract.   We conclude that the

option agreement was not an enforceable land sale contract.

     4.   Intent of the Parties

     Petitioners contend that the option agreement should be

treated as a sale contract because the Sopers paid a large amount

for the option.   Williams v. Commissioner, 1 F.3d 502 (7th Cir.

1993), affg. 94 T.C. 464 (1990) and T.C. Memo. 1992-269.   In

Williams, the parties signed an option contract, under which the

buyers paid $60,000 (12 percent of the purchase price) for the

right to buy property, and the seller waived any right to seek

specific performance or damages if the buyers defaulted.   The

Court of Appeals for the Seventh Circuit held that the possible

forfeiture of 12 percent of the purchase price did not convert

the option into a sale.   That court stated that "It is true that

as the amount to be forfeited creeps toward the purchase price of

the house, a point is reached at which the sale is not of the

call but of the house".   Id. at 507.   Petitioners' reliance on

Williams is misplaced because we do not view their circumstances,

where the Sopers paid a nonrefundable 12.35 percent of the
                              - 15 -


purchase price,4 as materially different from the 12 percent

in Williams.   We see no grounds for treating petitioners' and

the Sopers' option agreement as anything other than an option

agreement.

B.   Whether It Is Significant That the Sopers Occupied the Blue
     Lake Property Before Title Passed to Them

     Respondent argues in the alternative that petitioners' sale

of the Blue Lake property is ineligible for section 1034 because

they leased it to the Sopers before the Sopers bought it.   We

need not decide this issue because we hold that petitioners sold

the Blue Lake property more than 2 years after they bought their

Portland residence.

C.   Conclusion

     We conclude that, for purposes of section 1034, petitioners

sold the Blue Lake property to the Sopers on August 5, 1991.

They may not defer gain realized from the sale under section 1034




     4
       If we treat the Sopers' $1,250 security deposit as
nonrefundable, they paid 13.82 percent of the purchase price.
That percentage is not materially different from that in
Williams v. Commissioner, 1 F.3d 502 (7th Cir. 1993), affg. 94
T.C. 464 (1990) and T.C. Memo. 1992-269. Cf. Spyglass Partners
v. Commissioner, T.C. Memo. 1995-452 (purchase agreements were
enforceable obligations and not options; despite relatively small
downpayment, benefits and burdens passed to buyers in December
1983 when they had right to possess property, had obligation to
pay pro rata share of property tax, and bore risk of loss of
property).
                             - 16 -


because they had bought the Portland home more than 2 years

before on July 19, 1989.


                                        Decisions will be entered

                                   under Rule 155.
