                        T.C. Memo. 1997-10



                      UNITED STATES TAX COURT



                MARSHALL I. GORDON, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 4489-94.              Filed January 7, 1997.



     Nathan M. Sutton, Janice S. Martin, Lyle D. Pishny, for
petitioner.

     Charles M. Berlau, for respondent.



                        MEMORANDUM OPINION

     RAUM, Judge:   The Commissioner determined a $243,216

deficiency in petitioner's 1988 Federal income tax and a $60,804

section 6661(a) addition to tax for substantial understatement.

The issues are:   (1) Whether petitioner (petitioner or Marshall)

realized capital gain on the transfer of a 22.5-percent interest
                               - 2 -


in Blackbob, a Kansas property, and (2) whether he is liable for

a section 6661(a) addition to tax.     The facts have been

stipulated.   Unless otherwise indicated, all section references

are to the Internal Revenue Code in effect for the year in issue,

and all Rule references are to the Tax Court Rules of Practice

and Procedure.

     Marshall I. Gordon, petitioner, resided in Overland Park,

Kansas, when the petition in this case was filed.     Petitioner and

his sister, Suzanne Aron (Suzanne), were in dispute over the

estate of their late father, Milton Gordon, and assets owned by

Gordon Realty Company, Inc. (Gordon Realty).     They agreed to

submit all of their differences to binding arbitration.

     Gordon Realty owned an undivided 5/6 interest (83.333%) in

Blackbob, a plot of land located at 135th and Blackbob, Johnson

County, Kansas (Blackbob).   Of the 900 shares of common stock

outstanding in Gordon Realty, petitioner owned 486 shares,

Suzanne owned 269 shares, and their respective children owned the

remaining shares.   Pursuant to a plan of liquidation under which

it was required to distribute all of its property and assets,

Gordon Realty conveyed to petitioner, Suzanne, and their

respective children undivided proportionate ownership interests

in real estate (including Blackbob) of 45.001 percent, 24.907

percent, and 13.425 percent, respectively.     The remaining 1/6

interest (16.667%) in Blackbob was owned by Milton Gordon,
                               - 3 -

deceased.   On December 29, 1987, pursuant to a Journal Entry of

Final Settlement, 60 percent of that 1/6 interest was conveyed to

petitioner personally or for his benefit, and 40 percent to

Suzanne personally or for her benefit.

     In December 1986, petitioner's wife, Elaine Gordon (Elaine),

filed for divorce.   In a Memorandum Decision of March 13, 1987,

the divorce court ruled that Elaine and her husband, Marshall,

were "deemed to own 45% of [Blackbob]", one-half of which (22.5

percent) was allocated to Elaine.   The court ordered Marshall "to

obtain a deed from Gordon Realty to Mrs. Gordon, conveying to her

a 22.5% interest in the tract."   When he failed to deliver the

deed, Elaine filed a "Motion to Compel Defendant, Gordon Realty

Company, Inc., and Defendant, Gordon Financial Corporation, to

Transfer Real and Personal Property".

     On October 9, 1987, petitioner and Elaine met before the

district court judge and announced that they had reached a

compromise.   Elaine would receive $800,000 for her share of

Blackbob, "conditioned upon the * * * execution of the agreement

between Marshall Gordon and Suzanne Aron as set forth in the

arbitor's [sic] award."   The parties agreed to "formally prepare

a separation agreement and submit it to the Court for its

approval at a later date."

     In February 1988, the arbitration between petitioner and

Suzanne formally ended.   An award was entered requiring that the

ownership of all assets of the Estate of Milton Gordon and Gordon
                               - 4 -

Realty be adjusted.   Petitioner would be the owner of all the

interests held by the Estate of Milton Gordon and all interests

distributed by Gordon Realty in all of the property except

Blackbob, and Suzanne would be the sole owner of Blackbob.    As

part thereof, she was to pay petitioner the sum of $1,386,002.30.

     In July 1988, petitioner, Suzanne, and Elaine entered into

an "Exchange Agreement", under which they would transfer Blackbob

and other properties.   This agreement provided:

     At closing each of the parties shall deliver their
     respective deeds, conveyances or releases and any funds
     payable hereunder to Company [title company] with
     instructions to record the documents in accordance with the
     terms and provisions above set forth at such time as Company
     is in position to record same and has funds available to it
     for distribution to those parties entitled to payment
     hereunder, it being understood that the payment to Third
     Party [Elaine] shall be made out of the funds payable
     hereunder by Second Party [Suzanne] to First Party
     [Marshall], and that such payment shall be deemed as a
     payment made by First Party to Third Party.


     The property exchange took place on September 7, 1988.

Elaine executed a quitclaim deed transferring her interest in the

Blackbob property to petitioner.   The deed was entered into the

transfer record on September 8, 1988.    Petitioner's children

delivered their deeds to their interests in Blackbob to

petitioner.   Petitioner conveyed by deed to Suzanne his interest

in Blackbob, the interest formerly allocated to Elaine, and the

interests held by his children.    Suzanne delivered $1,386,002.30

to the title company.   The title company disbursed $800,000 as
                                - 5 -

"Payment to Elaine Gordon for Release of Judgment", $99,847.39 to

petitioner's children, and $484,658.91 to petitioner.

          On September 8, 1988, Elaine filed a "Release and

Satisfaction of Judgment" with the district court.    Bearing a

face date of September 7, 1988, this document provided:

          1.   The petitioner [Elaine] and respondent [Marshall]
     entered   into a Separation Agreement and under the terms
     thereof   * * * petitioner shall receive $800,000 in cash
     secured   by an equitable interest in the real property
     located   at 135th Blackbob, Johnson County, Kansas; and

          2. Respondent has paid to the petitioner the sum of
     $800,000; and,

          3. The judgment herein entered for the petitioner in
     the amount of $800,000 against the respondent should be
     released and fully satisfied and the petitioner's interest
     in the real property located at 135th and Blackbob, Johnson
     County, Kansas, should be released.


     On September 28, 1988, 3 weeks after the exchange took

place, petitioner and Elaine filed the Separation Agreement.

Under the terms of the agreement, Elaine was given, as her

personal property, "$800,000 in cash or other good negotiable

instrument, secured by equitable interest on the real property

located at 135th and Blackbob, Johnson County, Kansas."    This

provision was initialed by petitioner on July 22, 1988, and by

Elaine on September 2, 1988.    The first page states that the

agreement was made and entered into on October 9, 1987.    However,

the certification by the clerk of the district court attests that

the original document was filed on September 28, 1988.    The
                              - 6 -

Journal Entry approving the Property Settlement Agreement was

filed on September 7, 1988.

     On his 1988 income tax return, petitioner, as stipulated by

the parties, reported long-term capital gain of $486,002 (rounded

to the nearest dollar) with respect to the Blackbob exchange.    In

the statutory notice of deficiency, the Commissioner determined

that petitioner received unreported long-term capital gain of

$900,000 (the difference between the $1,386,002.30 cash paid by

Suzanne and the $486,002.30 reported by petitioner).   Upon

petitioner's showing that he paid $100,000 for his children's

ownership interests in Blackbob,1 which he transferred to

Suzanne, respondent has since conceded $100,000 of the $900,000

long-term capital gain ascribed to petitioner.2

     The Commissioner and petitioner agree that an exchange of

interests occurred between petitioner, Suzanne, and Elaine.   They

both agree that Elaine conveyed by deed her interest in Blackbob

to petitioner, which he subsequently transferred to his sister.

They agree that Suzanne provided $800,000, which was deemed a


     1
       Actually, the title company paid only $99,847.39 instead
of $100,000 on petitioner's behalf to his children, but nothing
here appears to turn upon the comparatively minor difference.
Perhaps it represents part of the title company's fee for its
participation as escrow agent.
     2
       The parties have stipulated with respect to a number of
issues not in controversy now, and the Commissioner has conceded
that petitioner is not liable for the section 6661(a) addition to
tax with respect to the items involved in the foregoing settled
issues.
                               - 7 -

payment by petitioner to Elaine.   However, they place different

interpretations upon these events.     The Government contends that

petitioner was the owner of the disputed 22.5 percent interest in

Blackbob and, as such, should be taxed on the $800,000 portion of

the cash supplied by Suzanne that was allocable to him.

Petitioner argues that, at the time of the exchange, although he

acted as a conduit between Suzanne and Elaine, Elaine was the

owner of 22.5 percent of Blackbob and, as the seller of that

22.5-percent interest to Suzanne, should bear whatever the

applicable tax burden might be.

     After the estate of his father was settled, petitioner

received 45 percent of Blackbob from Gordon Realty.    The divorce

court allocated 22.5 percent of Blackbob, half of that 45-percent

interest, to Elaine.   At the same time, petitioner and Suzanne

were having their interests in their father's estate and Gordon

Realty arbitrated.   The arbitration resulted in Suzanne's getting

all of Blackbob in exchange for $1,386,002.30.

     The results of the divorce decree and the arbitration award

were mutually inconsistent, with 22.5 percent of Blackbob awarded

to Elaine by the divorce court, and, about a year later, 100

percent to Suzanne in the entirely separate arbitration

proceedings.   Petitioner, Elaine, and Suzanne resolved the

inconsistency by having Elaine yield her 22.5-percent interest in

Blackbob and accept $800,000, instead.    Elaine consented to this
                                - 8 -

in a 3-way agreement, and the parties exchanged their interests

using a title company as an escrow.

     Suzanne placed $1,386,002.30 in the escrow account.

Petitioner purchased the interests of his children in Blackbob

for $100,000.    The children transferred their interest to him,

and he, in turn, transferred that interest over to Suzanne.       The

$100,000 payable by petitioner to his children was paid to them

on his behalf by the title company out of the $1,386,002.30

supplied by Suzanne.3    As indicated above, the Government has

acknowledged petitioner's acquisition of his children's ownership

interest in Blackbob and conceded that $100,000 of the

adjustment.

     As we view this case, the controversy should be decided on

the basis of the substance of the matters affecting petitioner,

Elaine, and Suzanne.    In substance, Elaine was the true owner of

22.5 percent of Blackbob, and she in effect sold that interest to

Suzanne, using petitioner as a conduit to enable him to transfer

it to Suzanne along with his own 22.5 percent plus that which he

acquired from his children, thus enabling Suzanne to become the

sole owner of Blackbob.4

     To summarize:

     3
         See supra note 1.
     4
        To be sure, some portion of Blackbob was owned by
Suzanne's children, but no question has been raised with respect
thereto, presumably because Suzanne acquired her children's
interest or was otherwise content to treat it as her own.
                                 - 9 -

     1.   Petitioner's children transferred their interest in

     Blackbob for $100,000.

     2.   Petitioner acquired Elaine's 22.5-percent interest as a

     conduit to complete the sale to Suzanne.

     3.   Petitioner transferred to Suzanne his children's

     interest, his own 22.5-percent interest, and the 22.5-

     percent interest which he had simultaneously reacquired for

     that purpose from Elaine.

     4.   Petitioner did not in substance sell anything to Elaine,

     and did not realize any gain on the transaction with Elaine.



     Contrary to the Government's argument,   we find that Elaine,

not petitioner, was the owner of the disputed 22.5-percent

interest in Blackbob immediately prior to the tripartite

exchange.   The Government relies on the Separation Agreement,

which changed Elaine's interest from the right to ownership of

22.5 percent of Blackbob to "$800,000 in cash or other good

negotiable instrument, secured by equitable interest on

[Blackbob]."   The Government states in its reply brief that the

"Separation Agreement was made and entered into, and executed by

petitioner and Elaine Gordon on October 9, 1987."   Based on the

execution of the Separation Agreement on October 9, 1987, the

Government contends that at the time the exchange occurred,

Elaine no longer had an ownership interest in Blackbob; she held
                              - 10 -

only an equitable interest.   See Hill v. Hill, 185 Kan. 389, 345

P.2d 1015, 1023 (1959).

     The flaw in that argument is the contention that the

Separation Agreement was executed on October 9, 1987.   On that

date, petitioner and Elaine merely announced that they had

reached a potential compromise; they did not file anything with

the court.   In fact, petitioner and Elaine initialed the

Separation Agreement in the sections describing the equitable

interest as late as July 22, 1988, and September 2, 1988.    The

exchange actually occurred thereafter, on September 7, 1988.

Finally, the Separation Agreement was not filed until September

28, 1988, a fact to which the Government has stipulated.    At the

time immediately prior to the exchange, Elaine still held an

ownership interest.

     The Government makes an extended argument based upon Kansas

law and differences between warranty deeds and quitclaim deeds.

Of course, Kansas law is controlling as to the technicalities of

title relating to the property.   But such niceties in local law

(cf. Helvering v. Hallock, 309 U.S. 106, 114 (1940)) do not

detract from the substance of the transaction as we view this

record.

     We hold that petitioner did not realize any $800,000 capital

gain with respect to the transaction before us.   Since there is

no deficiency with respect to this $800,000, petitioner is not
                             - 11 -

liable for any section 6661(a) substantial understatement

addition in connection with this item.

                                         Decision will be entered

                                   under Rule 155.
