                          T.C. Memo. 1995-589



                      UNITED STATES TAX COURT




             FRERES LUMBER CO., INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 16062-93.        Filed December 13, 1995.


     Philip N. Jones, Stephen J. Klarquist, and Richard W.

Miller, for petitioner.

     Brenda M. Fitzgerald, for respondent.


             MEMORANDUM FINDINGS OF FACT AND OPINION


     COLVIN, Judge:   Respondent determined that petitioner had

deficiencies in Federal income tax of $29,750 for 1988, $40,732

for 1989, and $51,119 for 1990.    In an amended answer, respondent

asserts that petitioner has deficiencies in Federal income tax of
                                 - 2 -


$43,787 for 1988, $64,689 for 1989, and $74,786 for 1990.      After

concessions, we must decide the following issues:

     1.     Whether the fair market value of three covenants not to

compete on March 1, 1988, is $1,650,000 as petitioner contends,

$403,000 as respondent contends, or some other amount.    We hold

that it is $930,000.

     2.     Whether the fair market value of certain land on

March 1, 1988, is $145,000 as petitioner contends, $200,000 as

respondent contends, or some other amount.    We hold that it is

$145,000.

     3.     Whether the fair market values of buildings and

improvments, equipment, and rolling stock on March 1, 1988, are

$283,000, $1.5 million, and $290,000, respectively, as petitioner

contends; or $195,000, $1.1 million, and $225,000, respectively,

as respondent contends and as petitioner reported on its return.

We hold that they are $384,608 for buildings and improvements,

$1.5 million for equipment, and $290,000 for rolling stock.

     4.     Whether the fair market value of goodwill on March 1,

1988, is zero as petitioner contends, $750,000 as respondent

contends, or some other amount.    We hold that it is zero.

     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.
                                - 3 -


                          FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

A.   Petitioner

     Petitioner is an Oregon corporation, the principal place of

business of which is in Lyons, Oregon.    Petitioner operated

sawmills and wood veneer mills in North Santiam Canyon in western

Oregon.   The Freres family owned a controlling interest in

petitioner.    The common stock of petitioner was owned as follows:

40.90 percent by Robert T. Freres, 29.69 percent by Theodore F.

Freres, and 29.41 percent by Doris Wipper (not otherwise

identified).   Robert T. Freres, Jr., son of Robert T. Freres,

began to manage petitioner in 1979.     He and petitioner's owners

were officers of petitioner.    Robert T. Freres, Jr., was the vice

president of petitioner in 1988.

     Robert T. Freres, Jr.'s grandfather established petitioner

in 1922 to operate a sawmill.   In the late 1950's, the Freres

family dismantled the sawmill and began to manufacture veneer.

They added a second veneer mill in 1963 and a stud mill in 1970.

In 1985, they leased a plywood mill and a veneer plant.    Before

March 1, 1988, they operated a large log veneer mill, a small log

veneer mill, and a stud mill.   These mills were in Lyons, Oregon,

about 5 miles from the Walker mills (see par. B-2, below).      They

own a trucking company to haul their products.
                                - 4 -


     Before March 1, 1988, petitioner bought 95 to 98 percent of

its lumber from public timber sales, primarily from the U.S.

Forest Service (Forest Service) and the Bureau of Land Management

(BLM).    Petitioner also bought timber from the State of Oregon.

Before March 1, 1988, petitioner had 10 major competitors for

public timber.    Petitioner's primary competitors were the Walkers

(see par. B, below) and Young & Morgan.

B.   The Walker Family and the Walker Business

     Until 1988, the Walker family owned and operated two forest

product companies in the North Santiam Canyon in Oregon.

     1.     The Walker Family

     References to the Walker family are to Donald Clayton Walker

(D.C. Walker), his wife, Mary Walker, and their daughter, Donna

Lee Bebout (Bebout).    The Walker family competed with the Freres

family in the forest products business in North Santiam Canyon.

On March 1, 1988, D.C. Walker was 62, Mary Walker was 65, and

Bebout was 37.    Each member of the Walker family was in good

health on March 1, 1988.

            a.   D.C. Walker

     D.C. Walker was born in 1925.      He graduated from high

school, but had no further formal education.      He ran his family's

business and made all of the important business decisions.       He

worked at least 60 hours per week on his family businesses.
                                - 5 -


     In 1959, D.C. Walker and two other people bought a sawmill,

moved it to Lyons, Oregon, and formed Cedar Lumber, Inc. (Cedar

Lumber).   D.C. Walker Enterprises, Inc., an S corporation, bought

Cedar Lumber in 1985.    D.C. Walker started the Lyons Veneer

partnership in 1981.    D.C. Walker had good relationships with

suppliers and customers.    We discuss D.C. Walker Enterprises,

Inc., and Lyons Veneer, further at par. B-2, below.

     Before March 1, 1988, D.C. Walker had a friendly but

competitive relationship with the Freres family.     He did not have

a social or business relationship with the Freres family after

March 1, 1988.

           b.    Mary Walker

     Mary Walker was born in 1922.      She went to business school.

She first worked as a secretary and bookkeeper.     She did

estimating for a Ford automobile agency and the U.S. Government.

She later did office work for a lumber mill and retail lumber

yard.   In 1959, she and her family founded Cedar Lumber.     She did

the office work, including the inventory, payroll, and books for

Cedar Lumber.    Mary Walker never bid for timber or sold products.

She did not routinely work for Lyons Veneer.     When she did, she

helped with log inventories.    By 1985, she had stopped working

full time because of her age.    She did not do much with her

family's businesses after 1985.    Mary Walker was not employed in

1994.
                                - 6 -


           c.   Donna Lee Bebout

     Bebout was born in 1951.   She worked for Cedar Lumber during

the summers when she was in high school.    Before 1978, she worked

as a secretary for the owner of Ruble Forest Products in Eugene,

Oregon.   She worked part time in the forest products industry

when her son Kyle was born.    She began to work for Lyons Veneer

in September 1980.   During the 5 years before March 1, 1988,

Bebout did the bookkeeping for Lyons Veneer in her home.    She had

Lyons Veneer's checkbook.   She did some management or supervisory

work for Lyons Veneer.   Lyons Veneer paid her about $3,500 to

$4,500 per month.

     Bebout was a vice president of D.C. Walker Enterprises,

Inc., and was on the board of directors in 1988.   When her father

was out of town, Bebout sometimes answered questions about D.C.

Walker Enterprises, Inc., and signed papers for the corporation.

She also did some clerical work for D.C. Walker Enterprises, Inc.

     Bebout had no plans to compete against petitioner even if

she had not signed a covenant not to compete.   To compete with

petitioner, Bebout would need the help of someone more

knowledgeable about the forest products business than she is.

           d.   Brent Walker

     Brent Walker is the son of D.C. and Mary Walker.    He was

estranged from his parents in the 1980's.   Brent Walker operated

a company called Thomas Creek Lumber & Logging Co.   He previously
                                 - 7 -


had an interest in the Lyons Veneer partnership (described in

par. B-2-b, below) owned by the Walker family.      There was

litigation between Brent Walker and his parents and sister.      A

court (not specified in the record) decided that Brent Walker's

interest in the Lyons Veneer partnership had terminated in

September 1983.

     Thomas Creek Lumber & Logging Co. bid on public timber sales

but did not own a mill.    Brent Walker bought timber and paid

subcontractors to harvest it.    He sold some logs.    He also leased

manufacturing time at a veneer plant.      He milled lumber at the

Brazier Lumber Co. in Molalla, Oregon, into metric sizes for

export to Japan.

     2.   The Walker Entities

     Before March 1, 1988, the Walker family owned and operated

D.C. Walker Enterprises, Inc., and Lyons Veneer, a partnership,

in North Santiam Canyon.    We refer to D.C. Walker Enterprises,

Inc., and Lyons Veneer as the Walker entities.      The Walker

entities were in the business of logging, manufacturing veneer

and lumber, and related activities.      They bought and performed

timber contracts.    The Walker entities were smaller than the

companies with which they competed.

          a.      D.C. Walker Enterprises, Inc.

     D.C. Walker formed D.C. Walker Enterprises, Inc., in 1985.

D.C. Walker Enterprises, Inc., bought Cedar Lumber in 1985.
                                 - 8 -


On March 1, 1988, D.C. Walker, Mary Walker, and Bebout each

owned one-third of the stock of D.C. Walker Enterprises, Inc.

     Before March 1, 1988, D.C. Walker Enterprises, Inc.,

manufactured forest products.     It sold mostly soft white woods to

customers in the Orient.    It did not sell products in competition

with petitioner.    Customers from the Orient wanted high-quality

lumber cut to precise metric measurements.     Petitioner did not

have that capability.

            b.   Lyons Veneer

     D.C. Walker started Lyons Veneer in 1981.     On March 1, 1988,

Bebout owned 50 percent of Lyons Veneer, and D.C. and Mary Walker

owned the other 50 percent.     Lyons Veneer competed against

petitioner, Willamette Industries, and many others before March

1, 1988.    Petitioner, the Walker entities, Young & Morgan, and

Frank Lumber were the primary competitors.     Before March 1, 1988,

Lyons Veneer sold almost all of its finished product to Alpine

Veneer.    Lyons Veneer did not process soft white woods.

            c.   Sources of Timber for the Walker Entities

     The Walker entities obtained logs from the Forest Service,

BLM, the State of Oregon, and private sources.     Most of its logs

came from the Forest Service.     Lyle Sanders and D.C. Walker

managed timber procurement for the Walker entities.
                                  - 9 -


            d.     The Walker Entities' Employees

     D.C. Walker Enterprises, Inc., employed about 40 people

before March 1, 1988.      Lyons Veneer employed 25 to 40 people

before March 1, 1988.      There was no union representation at the

Walker entities before March 1, 1988.

C.   Sale of Public Timber in the North Santiam Canyon Area
     in the Mid to Late 1980's

     Generally, sales of public timber were advertised in

newspapers.      The Forest Service, BLM, and the State of Oregon

usually mailed prospectuses to persons and businesses in the

industry.    Timber offered for sale had a minimum bid price.

Buyers who submitted a sealed bid and submitted a bid bond or a

downpayment could bid at an oral auction.      It was not necessary

to own a sawmill or veneer mill to bid on public timber sales.

     The public agency offering the timber for sale conducted an

oral auction.      The highest bidder from the floor won the oral

auction.    If there were no oral bids, the highest sealed bid won

the auction.

     The Forest Service estimated the number of board feet in a

timber contract.      The winning bidder paid an amount based on the

volume of timber actually harvested.      The volume of timber sold

was normally measured in thousands of board feet (MBF).

     The BLM sold timber on a lump-sum basis.       Buyers bid on an

MBF basis.    The winning bidder applied the BLM volume estimate

and paid a lump sum.
                              - 10 -


     The State of Oregon sold its timber by oral auction until

around 1992.   Around 1992, the State switched to sealed bids.

The State sold timber primarily on a lump-sum basis, and

occasionally on a per-unit basis.

D.   North Santiam Canyon Timber Market in the Late 1980's

     The forest products industry is cyclical.    Timber prices

were high and contracts were for long terms in the late 1970's.

Prices fell in the early 1980's.    From 1983 to 1986 many mills

closed because they were saddled with commercially impractical

contracts.

     Timber costs rose in 1987 and 1988, foretelling increased

competition for timber.   The Federal Government issued forest

plans which stated the amount of timber it intended to harvest

each year for 10 years.   The draft plans in the late 1980's

showed 20 to 25 percent reductions.    It was widely known in the

industry that the northern spotted owl had been petitioned for

listing as an endangered species under the Endangered Species Act

of 1973, Pub. L. 93-205, 87 Stat. 884 (current version at 16

U.S.C. secs. 1531-1544 (1994)), late in 1986.    Many mills closed

in 1987 and early 1988.

     In 1984, Congress passed the Timber Contract Payment

Modification Act, Pub. L. 98-478, 98 Stat. 2213 (1984), which

gave timber companies more time to harvest timber from the old
                               - 11 -


high price contracts of the late 1970's and the early 1980's

before timber prices fell.

E.   Petitioner's Purchase of the Walker Entities' Assets

     1.     Events Leading to the Sale of the Walker Entities'
            Assets

     In 1987, D.C. Walker told Mary Walker that he was getting

older and might like to do something else.     At that time, he had

no plans for his future, but he was not ready to retire.    In

1987, the Freres family and D.C. Walker discussed a sale of the

Walker entities, but did not agree.

     In February 1988, D.C. Walker believed that a shortage of

logs would cause trouble in the forest products industry in the

future.   He believed the industry was beginning to decline and

that it would be a good time to sell the Walker entities.

     Petitioner wanted to buy the Walker entities at that time.

Petitioner wanted to obtain a noncompetition agreement for D.C.

Walker from the first time it expressed an interest in buying the

Walker entities.    D.C. Walker handled the sale for the Walker

entities.    He had a price of $4.65 million in mind.   Petitioner

agreed to that price without negotiations.     D.C. Walker did not

care how the purchase price was allocated to the various assets

and did not negotiate those allocations with petitioner.

     2.     Petitioner's Valuation of Assets

     Without involvement by D.C. Walker, petitioner allocated the

purchase price to the various assets.    Robert T. Freres, Robert
                                - 12 -


T. Freres, Jr., and Theodore F. Freres allocated the purchase

price for petitioner.

     Petitioner carefully calculated the value of Forest Service

timber contracts it bought from the Walker family before it

agreed to the sale.   The fair market value of Forest Service

timber contracts that petitioner bought from the Walker entities

was $1.5 million on March 1, 1988.       Petitioner did not buy other

Walker timber contracts that it believed had an excessive

contract price.   Petitioner used the fair market value of the

timber contracts in its allocation.

     Before March 1, 1988, petitioner's owners and officers often

attended used equipment auctions and regularly reviewed sales

brochures for used equipment.    They knew the fair market values

of used equipment and rolling stock that were similar to the

equipment and rolling stock petitioner bought from the Walker

family.

     Petitioner examined the real property and estimated the

value of the land and buildings.    A solid waste disposal site was

on the premises, and part of the property was contaminated with a

toxic chemical.

     Robert T. Freres, Jr., told Larry Smith (Smith), Freres'

certified public accountant, the final purchase price allocation.

Smith then told the Freres' attorney, Richard Miller (Miller).

Miller inserted that allocation in the Walker sale agreement.
                              - 13 -


Neither party to the sale prepared a list of physical assets to

be sold.

     Petitioner allocated the purchase price to the assets in the

Walker sale agreement as follows:

           D.C. Walker Enterprises, Inc.
                Land                          $130,000
                Buildings and improvements     120,000
                Equipment                      850,000
                Rolling stock                  150,000

           Lyons Veneer
                Building and improvements       75,000
                Equipment                      250,000
                Rolling stock                   75,000

           Covenants not to compete
                D.C. Walker                  1,200,000
                Mary Walker                    150,000
                Donna Lee Bebout               150,000

           U.S. Forestry Service timber
           Sale contracts                    1,500,000
             Total                           4,650,000

     3.    Terms of the Agreement

     In the Walker sale agreement, petitioner bought most of the

assets used by the Walker entities for $4,650,000.   Petitioner

also bought other log inventories for an additional price.

Petitioner did not buy from the Walker entities accounts

receivable, cash, notes receivable, the business names of Lyons

Veneer and D.C. Walker, the corporate name of D.C. Walker

Enterprises, Inc., business records, certain vehicles, and some

unprofitable Forest Service timber sale contracts.
                                 - 14 -


     4.     Covenants Not To Compete

     The Walker family agreed to sign covenants not to compete

with petitioner.      The covenants prohibited D.C. Walker, Mary

Walker, and Bebout from participating or engaging in the same

business as or any business similar to petitioner's within 140

miles of Lyons, Oregon, for 5 years.      The covenants prohibited

the Walkers from encouraging any prior employees, suppliers, or

customers of Walker entities to curtail or reduce their

employment or business dealings with petitioner.

     Payments were combined into one payment schedule and

promissory note.      If petitioner did not make payments under the

agreement, the Walker family would not be bound by the covenant

until the price of the covenant was paid in full.

     5.     Payment

     Petitioner made a downpayment of $1 million and signed a

$3,650,000 note secured by a trust deed and Uniform Commercial

Code financing statements.      Petitioner made the promissory note

payable to D.C. Walker Enterprises, Inc.

     6.     Events After the Sale

     D.C. Walker had no future plans when he sold the Walker

entities.    He went to Washington State to bid on timber.    He also

unsuccessfully tried to buy a mill in Olympia, Washington.

     Buying the Walker entities' assets helped petitioner to

enter the export lumber market.      The Sumitomo Forestry Co.
                                - 15 -


(Sumitomo) was one of the Walker entities' customers.     Sumitomo

was not a customer of petitioner before the Walker asset sale,

but was after it.

     The Walker entities remained obligated to perform the timber

contracts that petitioner did not buy from them.     After the sale,

the Walker entities owed more than $4.65 million to the

Government for timber sales.     However, the Walker entities could

harvest the timber under those timber contracts and sell the

logs.

     The Walker entities agreed to terminate their employees the

day before the sale.    Petitioner rehired about one-half of the

employees from the Walker entities.

     7.      The Walkers’ Tax Court Case for Taxable Year 1988

        The Commissioner proposed adjustments to the individual tax

returns of D.C. and Mary Walker and Bebout for taxable year 1988.

The Commissioner determined that part of the value assigned by

each of them to the covenants not to compete should be

reallocated to land and going-concern value.     Each of them

contested the adjustments by petitioning the Tax Court, but later

conceded the adjustments in full.     They each later filed amended

returns to be consistent with the 1988 adjustments.     The tax

impact of the adjustments was essentially neutral.
                               - 16 -


F.   Petitioner's Income Tax Returns

     Petitioner timely filed its Federal income tax returns

for taxable years ending September 30, 1988, 1989, and 1990.

Petitioner's allocation of assets on its returns was consistent

with its allocation in the written agreement.

                               OPINION

A.   Fair Market Value of the Covenants Not To Compete on
     March 1, 1988

     1.     Positions of the Parties and Burden of Proof

     Respondent determined that the fair market value of the

covenants not to compete was $750,000 on March 1, 1988.    In an

amendment to answer, respondent asserts that the value was

$403,000.    Petitioner contends that the total value of the three

covenants was $1.5 million ($1.2 million for D.C. Walker,

$150,000 for Mary Walker, and $150,000 for Bebout) as allocated

by petitioner on the sale agreement and reported on its Federal

income tax returns.    Alternatively, based on petitioner's

expert's opinion, petitioner contends that the total value was

$1,650,000.

     Respondent's determination is presumed to be correct,

and petitioner bears the burden of proving that respondent's

determination is incorrect.    Rule 142(a); Welch v. Helvering,

290 U.S. 111, 115 (1933).    Thus, petitioner bears the burden

of proving that the covenants are worth more than $750,000.

     Respondent bears the burden of proving that the covenants
                               - 17 -


are worth less than $750,000 because that was the value of the

covenants not to compete respondent determined in the notice of

deficiency.   Rule 142(a).

     2.    Valuation of Covenants Not To Compete

     A taxpayer generally may amortize intangible assets over

their useful lives.    Sec. 167(a); Citizens & So. Corp. v.

Commissioner, 91 T.C. 463, 479 (1988), affd. without published

opinion 900 F.2d 266 (11th Cir. 1990).   To be amortizable, an

intangible asset must have an ascertainable value and a limited

useful life, the duration of which can be ascertained with

reasonable accuracy.    Newark Morning Ledger Co. v. United States,

507 U.S. 546, ___, 113 S. Ct. 1670, 1675, 1676 n.9, 1681-1683

(1993).   A covenant not to compete is an intangible asset that

has a limited useful life and, therefore, may be amortized over

its useful life.   Warsaw Photographic Associates, Inc. v.

Commissioner, 84 T.C. 21, 48 (1985).

     The amount a taxpayer allocates to a covenant not to

compete is not always controlling for tax purposes.    Lemery v.

Commissioner, 52 T.C. 367, 375 (1969), affd. per curiam 451 F.2d

173 (9th Cir. 1971).   We strictly scrutinize an allocation if the

parties do not have adverse tax interests because adverse tax

interests deter allocations which lack economic reality.      See

Wilkof v. Commissioner, 636 F.2d 1139 (6th Cir. 1981), affg. per

curiam T.C. Memo. 1978-496; O'Dell & Co. v. Commissioner, 61 T.C.
                              - 18 -


461, 468 (1974); Haber v. Commissioner, 52 T.C. 255, 266 (1969),

affd. 422 F.2d 198 (5th Cir. 1970); Roschuni v. Commissioner, 29

T.C. 1193, 1202 (1958), affd. per curiam 271 F.2d 267 (5th Cir.

1959); Baird v. Commissioner, 25 T.C. 387, 393 (1955); McDonald

v. Commissioner, 28 B.T.A. 64, 66 (1933).    A covenant not to

compete must have "economic reality"; i.e., some independent

basis in fact or business reality so that reasonable persons

might bargain for the agreement.    Patterson v. Commissioner, 810

F.2d 562, 571 (6th Cir. 1987), affg. T.C. Memo. 1985-53; Schulz

v. Commissioner, 294 F.2d 52, 55 (9th Cir. 1961), affg. 34 T.C.

235 (1960); O'Dell & Co. v. Commissioner, supra at 467-468.

     Courts apply numerous factors in evaluating a covenant

not to compete.   These include:   (a) The seller's (i.e.,

covenantor's) ability to compete, (b) the seller's intent to

compete, (c) the seller's economic resources, (d) the potential

damage to the buyer posed by the seller's competition, (e) the

seller's business expertise in the industry, (f) the seller's

contacts and relationships with customers, suppliers, and others

in the business, (g) the buyer's interest in eliminating

competition, (h) the duration and geographic scope of the

covenant, and (i) the seller's intention to remain in the same

area.   Kalamazoo Oil Co. v. Commissioner, 693 F.2d 618 (6th Cir.

1982), affg. T.C. Memo. 1981-344; Forward Communications Corp. v.

United States, 221 Ct. Cl. 582, 608 F.2d 485, 492 (1979);
                                - 19 -


Sonnleitner v. Commissioner, 598 F.2d 464, 468 (5th Cir. 1979),

affg. T.C. Memo. 1976-249; Fulton Container Co. v. United States,

355 F.2d 319, 325 (9th Cir. 1966); Annabelle Candy Co., Inc. v.

Commissioner, 314 F.2d 1, 7-8 (9th Cir. 1962), affg. T.C. Memo.

1961-170; Schulz v. Commissioner, supra; Peterson Machine Tool,

Inc. v. Commissioner, 79 T.C. 72, 85 (1982), affd. 54 AFTR 2d 84-

5407, 84-2 USTC par. 9885 (10th Cir. 1984); Major v.

Commissioner, 76 T.C. 239, 251 (1981); O'Dell & Co. v.

Commissioner, supra at 468-469; Rudie v. Commissioner, 49 T.C.

131, 139 (1967); Levinson v. Commissioner, 45 T.C. 380, 389

(1966).

     3.      D.C. Walker's Covenant Not To Compete

     D.C. Walker had the experience and ability to compete with

petitioner.     He had nearly 30 years of experience in the forest

products industry.     He had ably competed with petitioner since

1959.     He substantially contributed to the success of the Walker

entities.     D.C. Walker had good contacts and relationships with

suppliers and customers.     Robert T. Freres, Jr., credibly

testified that petitioner wanted to eliminate D.C. Walker from

competition.     He and D.C. Walker testified that competition from

D.C. Walker could damage petitioner.     We believe that their

testimony is substantially true and is generally supported by the

record.     D.C. Walker's covenant was limited to 5 years and to a

140-mile radius around Lyons, Oregon.     We think these limits were
                               - 20 -


reasonably intended to keep D.C. Walker from competing with

petitioner.    D.C. Walker intended to and did continue to live

and work in North Santiam Canyon.    D.C. Walker had financial

resources available to compete with petitioner.    Petitioner

paid the Walker family a $1 million downpayment with petitioner

owing them the balance.    The Walkers kept some high-cost timber

contracts that petitioner believed were money losers.    After the

sale, the Walker entities owed more to the Government for

timber contracts than the purchase price for the Walker assets.

However, the Walkers owned the timber in those contracts.

Respondent conceded that D.C. Walker's age and health did not

impede him from competing.1   He unsuccessfully bid on timber in

Washington State and tried to buy a mill near Olympia,

Washington.   These facts favor petitioner.

     Respondent points to the fact that D.C. Walker told Mary

Walker that he was getting older and might want to do something

different.    He testified that at the time of the Walker asset

sale he had no thoughts about what he would do after the sale.

He said that he would not retire, and he did not.    At the time

of trial, he had a partnership with Bebout which operated a

construction business and a sand and gravel pit.    We conclude



     1
       Respondent conceded that D.C. Walker was in good health
in 1988 even though he had had lung cancer surgery several years
before the Walker asset sale.
                              - 21 -


that the facts favoring petitioner outweigh the facts upon which

respondent relies.

     4.   Mary Walker's Covenant Not To Compete

     We believe Mary Walker lacked the technical expertise needed

to compete with petitioner.   She had done office work in the

forest products industry for many years, but she had not bid for

timber, sold products, or supervised operations.    Petitioner's

expert, Paul Clausen (Clausen) of Business Valuation Research,

Inc., of Portland, Oregon, testified that Mary Walker did not

contribute much to the Walker entities.   There is no convincing

evidence that Mary Walker's competition would damage petitioner,

or that she had the kind of business relationships with suppliers

and customers that would enable her to compete with petitioner.

There is no credible evidence that petitioner had a genuine

interest in eliminating Mary Walker as a competitor.    In 1988,

Mary Walker was no longer doing much with the Walker entities.

She did not say that she wanted to compete.   There is no

convincing evidence that she intended to compete.    These factors

favor respondent.

     Petitioner relies on the facts that in 1988, Mary Walker

was 65 and in good health, had financial resources, and had a

covenant that was limited to 5 years and to a 140-mile radius

around Lyons, Oregon.   We think these limits would have

reasonably kept Mary Walker from competing with petitioner.
                              - 22 -


She intended to live in the area.   These facts are not enough

show that her covenant not to compete had economic reality.

     5.   Bebout's Covenant Not To Compete

     In 1988, Bebout was 37 and in good health.    She had worked

in the forest products industry for many years.    She handled some

corporate business when her father was away.    She is in a

partnership with her father which now runs a construction and

gravel business.   Her brother entered the forest products

business without owning a mill.   We believe Bebout could have

competed with petitioner if she had been so inclined.    Bebout

owned the same amount of stock of D.C. Walker Enterprises, Inc.,

as D.C. and Mary Walker.   She owned 50 percent of Lyons Veneer

and had financial resources available to her.    Bebout's covenant

was limited to 5 years and to a 140-mile radius around Lyons,

Oregon.   We think these limits were reasonably drawn to keep

Bebout from competing with petitioner.   Bebout intended to remain

in the area.   These facts favor petitioner.

     Bebout's technical knowledge of the forest products industry

is not established by the record.   Clausen believed it was

unlikely that Bebout could compete with petitioner without D.C.

Walker's help.   Bebout made no statements when the family sold

the Walker assets indicating that she intended to compete.

Bebout testified that she had good contacts and relationships

with suppliers and customers, but could not identify any of them.
                             - 23 -


There is no evidence that petitioner had a bona fide interest in

eliminating Bebout as a competitor.    These facts favor

respondent.

     6.   Expert Opinions

     The parties relied on expert witnesses to prove the value of

the covenants not to compete on March 1, 1988.    Expert witnesses'

opinions can aid the Court in understanding an area requiring

specialized training, knowledge, or judgment.    However, as the

trier of fact, the Court is not bound by the experts' opinions.

Helvering v. National Grocery Co., 304 U.S. 282, 295 (1938).       The

opinions of expert witnesses are weighed according to their

qualifications and other relevant evidence.     Anderson v.

Commissioner, 250 F.2d 242, 249 (5th Cir. 1957), affg. in part

and remanding in part T.C. Memo. 1956-178; Johnson v.

Commissioner, 85 T.C. 469, 477 (1985).

     The testimony of each expert was generally helpful to our

overall understanding of the case.    However, we believe the

testimony of each expert was excessively favorable to the party

which called the expert.

          a.   Petitioner's Expert

     Petitioner relied on Clausen's expert testimony to value

the covenants not to compete, goodwill, and going-concern value.

Clausen concluded that the three covenants were worth $1,650,000.

Clausen used a method based on his estimate of how much
                                - 24 -


petitioner would save if the Walker entities stopped bidding on

public timber.   Clausen studied sales by the Forest Service, BLM,

and the State of Oregon to quantify how much direct competition

there was between the Frereses and Walkers during the 7 years

before the Walker asset sale.    He found nine sales in which

petitioner was the high bidder and Walker was the second high

bidder.   He assumed that petitioner could have been the high

bidder for slightly more than the third high bid for those sales

if Walker had not bid.   He subtracted the high bid from the third

high bid.   The difference is the "upbid".   In his opinion, the

upbid was the cost Walker imposed on petitioner.    He calculated

that the annual average upbid for the 7-year period was $524,400.

He applied that amount to each year from 1981 to 1987.    He

calculated the total present value of the upbids over the 7 years

to be $1,568,277 discounted by 20 percent and $1,757,870

discounted by 15 percent.   He averaged those two amounts and

concluded that the covenants were worth $1,650,000.

     We believe Clausen significantly overstated his conclusion.

He assumed that the upbid is the difference between the highest

and third highest bid.   Clausen did not adequately explain why he

subtracted the upbid resulting from two bidders to estimate the

effect on the contract price of one bidder.    He did not explain

why it is reasonable to assume that a bidder could count on

beating the third highest bidder by an insignificant amount.
                               - 25 -


     Clausen did not use a weighted average of upbids to

calculate the value of the covenants.    However, he used weighted

averages in other parts of his report.    He believed that more

weight should be given to recent events in analyzing the forest

products industry because the industry was highly cyclical.      He

weighted earnings as 5 for 1987, 4 for 1986, 3 for 1985, 2 for

1984, and 1 for 1983.    Thus, he gave more weight to the years

immediately before the sale when he evaluated earnings.     On the

other hand, Clausen's method of evaluating upbids minimized the

bids from the 3 years immediately before the sale, even though,

according to Clausen, the earlier years should be given less

weight.

     Clausen assumed that no other bidder would take the Walkers'

place.    However, he estimated that Brent Walker cost petitioner

$1,169,400 in upbids.    This shows that others can cause

substantial upbids for petitioner on timber contracts.      Clausen

listed 10 entities in the North Santiam Canyon that competed for

timber.    Robert T. Freres, Jr., testified that petitioner's

principal competitors for public timber in the North Santiam

Canyon area during the 1980's were Cedar Lumber, Lyons Veneer,

Young & Morgan, and Frank Lumber.    Petitioner also competed,

for example, with Avison Lumber, Frasier Lumber, Vanport

Manufacturing, Boise Cascade, Willamette Industries, and Bohemia.

Clausen did not discuss whether any of these companies would
                               - 26 -


replace the Walkers in bidding for timber.   Clausen testified

that whether a bidder drops out depends on each bidder's backlog

of stumpage, market for their product, need for the timber, and

many other variables.

     Clausen believed that there were few bids between petitioner

and the Walkers in the 3 years immediately before the Walker

asset sale because the Walkers had a large volume of timber

contracts remaining from the early 1980's.   The Walkers kept

timber contracts after the Walker asset sale.   Petitioner made

clear that one of the reasons for the covenants not to compete

was to eliminate the Walkers from bidding for timber.   However,

Clausen did not explain why the timber contracts that the Walkers

kept and the continued decreased bidding activity would not

affect the value of the covenants not to compete.

     There is no doubt that D.C. Walker affected petitioner's

cost for timber; however, we believe Clausen's analysis

significantly overstates the value of the covenants not to

compete.

           b.    Respondent's Expert

     Respondent's expert witness was D. Alan Hungate (Hungate)

of the First Princeton Corp. in Portland, Oregon.   He concluded

that Mary Walker's and Bebout's covenants not to compete had no

value and that D.C. Walker's covenant was worth $403,000 on

March 1, 1988.
                               - 27 -


     Hungate assumed that the fair market value of the covenants

not to compete is the sum of the present value of lost cash-flow

that would occur if there were no covenants not to compete and

tax savings from amortizing the value of the covenants.    He

computed the lost cash-flow by analyzing the volume of timber

available to petitioner.    Hungate estimated that petitioner could

buy 14 percent more timber with the covenants not to compete.      He

believed that petitioner's cash-flow would have been cut by about

15 percent if the Walkers could compete.    He computed the present

value of that amount and divided it by 3 because he believed that

there was a one-third chance that D.C. Walker would have competed

against petitioner if there had been no covenant.    He calculated

the tax savings and added that amount to the lost cash-flow

total.   He concluded that the covenants not to compete had a fair

market value of $403,000 on March 1, 1988.

     We have very little confidence in Hungate's value of the

covenants not to compete.    We are not convinced that there was

only a one-third chance that D.C. Walker would compete without a

covenant not to compete.    Hungate ignored significant facts.   One

of the primary reasons that petitioner wanted the covenants not

to compete was to eliminate the Walkers from bidding on timber.

Hungate ignored this fact.    On several occasions, D.C. Walker bid

a Forest Service sale to an inflated level, then dropped out,

leaving petitioner to buy the timber at a higher price.    Hungate
                               - 28 -


conceded that his method could not account for this situation

because he only analyzed available timber volume and not the

prices of timber.   The Walkers competed with the three mills that

petitioner owned.   Hungate ignored this fact and only measured

the cash-flow of the two mills that petitioner bought from the

Walkers.   Hungate testified that petitioner and the Walkers

bought timber from the Forest Service, BLM, and the State of

Oregon.    Hungate ignored timber sales from BLM and the State of

Oregon.

     Hungate evaluated the volume or market share of timber.     To

select a dollar value, he assumed that the available volume of

timber had a direct relationship with cash-flow.     He assumed that

each percentage increase of available volume of timber resulted

in about the same percentage increase in cash-flow.    He did not

support that assumption.   Hungate testified that the Court should

use caution in relying on his method.   He admitted that it is

very difficult to analyze the direct relationship between the

volume of timber and cash-flow because many factors affect cash-

flow.   However, he did not explain those factors.   We also

disagree with Hungate's conclusion that Bebout's covenant not to

compete had no value.   We do not find Hungate's estimates of the

value of the covenants not to compete to be very convincing.
                              - 29 -


     7.   Conclusion About the Value of the Covenants Not
          To Compete

     We conclude that D.C. Walker's covenant not to compete had a

fair market value of $900,000 on March 1, 1988.     Because Mary

Walker had less experience in the timber industry and no stated

intent to compete and posed no credible threat to petitioners, we

conclude that the fair market value of her covenant not to

compete was zero on March 1, 1988.     While Bebout lacked

experience in certain aspects of the timber industry, we think

her knowledge, the fact that her brother competed effectively,

and her subsequent work history show that her covenant had some

value, which we conclude was $30,000.

B.   Fair Market Value of Land

     Petitioner reported that the fair market value of the land

belonging to the Walker entities was $130,000 on March 1, 1988.

Respondent determined that the fair market value was $200,000.

     The land consisted of the mill site and ancillary land.       The

mill site was the 35-acre area surrounding the mills.     The rest

of the land (about 93.5 acres) was ancillary land.     Darr Goss

(Goss), petitioner's expert real property appraiser, concluded

that the land was worth $145,000 based on six sales of land

comparable to the mill site and five sales of land comparable to

the ancillary land.   Respondent did not cross-examine Goss or

offer any evidence about the fair market value of the land.
                               - 30 -


     Respondent contends that Goss' sale 1 was not comparable

because it had a log pond, unlike the Walker's mill site.

Petitioner contends that the log pond served the same purpose as

the log deck for the Walker mill site.    Even if respondent is

correct about the log pond, respondent does not criticize Goss'

sales 2, 3, or 4.

     Respondent contends that the sale 5 site is not comparable

to the Walker site because the sale 5 site had potential

environmental cleanup problems.    Respondent alleges that the sale

5 mill site occupied only one-fifth of the land that was sold.

We disagree.    The Walker mill site had similar environmental

problems.   Respondent did not include the log deck area in

computing the sale 5 mill-site area.    We believe the sale 5 site

is comparable to the Walker mill site.    Respondent contends that

the sale 6 site is not comparable to the Walker site because the

sale 6 site was zoned for industrial and agricultural use.     We

disagree.   Goss reasonably concludes in his report that the

highest and best use of the Walker site was industrial and

agricultural.

     Respondent contends that Goss should increase his estimate

of the value of the ancillary land because the land includes a

solid waste disposal site.    We disagree.   The solid waste

disposal site had little value because a permit to establish such

a site was inexpensive and easy to obtain.     The site may contain
                               - 31 -


substances which could decrease its value.   We believe this is

quite possible because other parts of the property had been

contaminated with pentachlorophenol.

     Respondent criticizes Goss' conclusion that the highest and

best use of the ancillary land was agricultural development and

points out that it was zoned for industrial use.   We find Goss'

opinion that development of the entire site is unlikely because

part of it is zoned for farm/forest use to be reasonable.

Respondent offered no contrary evidence.

     Respondent criticizes Goss for failing to consider the

potential for planting timber on the ancillary land.   However,

Goss did just that in discussing the use and zoning of the land.

     We conclude that the fair market value of the land on

March 1, 1988, was $145,000.

C.   Allocation for Goodwill or Going-Concern Value

     1.    Section 1060 and the Parties' Contentions

     The parties agree that section 1060 applies to the Walker

asset sale.   Under section 1060, assets are divided into four

classes:   Class I (cash and demand deposits), class II

(certificates of deposit, Federal securities, readily marketable

stock and securities, and foreign currency), class III (includes

accounts receivable, equipment, buildings, land, and covenants

not to compete), and class IV (goodwill and going-concern value).

Sec. 1.1060-1T(a)(1), (b)(1), (d), Temporary Income Tax Regs., 53
                              - 32 -


Fed. Reg. 27039-27040 (July 18, 1988).   The total consideration

is allocated to class I assets in an amount equal to each asset's

face value.   The remaining consideration is then allocated to

class II assets in proportion to the fair market value of each

class II asset.   The remaining consideration is then allocated to

class III assets in an amount equal to the fair market value of

each class III asset.   Any residue is allocated to class IV.

Sec. 1.1060-1T(d), Temporary Income Tax Regs., supra.

     Petitioner argues that no value should be allocated to class

IV because the value of class III assets exceeds the sale price.

Respondent determined that the sale price exceeded the value of

the class III assets by $680,000 on March 1, 1988.   Respondent

contends that the sale price exceeded the value of class III

assets by $1,027,000.

     The parties agree that the value of the timber contracts was

$1.5 million on March 1, 1988.   We have decided that the values

of the land and covenants not to compete were $145,000 and

$930,000, respectively.   Petitioner contends that the fair market

values of building and improvements, equipment, and rolling stock

were as provided in the reports of its expert witnesses.   The

following chart shows the parties' positions relating to the

allocation for all assets:
                                     - 33 -


Class III Assets

                    Petitioner's
                     Purchase
D.C. Walker          Agreement     Petitioner's   Respondent's    Respondent's
Enterprises, Inc.    and Return       Brief       Determination      Brief
  Land               $130,000       $145,000       $200,000        $200,000
  Buildings and
   improvements       120,000        246,000       120,000         120,000
  Equipment           850,000      1,000,000       850,000         850,000
  Rolling stock       150,000        200,000       150,000         150,000

Lyons Veneer
  Buildings
   and improvements    75,000       138,608         75,000          75,000
  Equipment           250,000       500,000        250,000         250,000
  Rolling stock        75,000        90,000         75,000          75,000

Covenants
not to compete
  D.C. Walker      1,200,000       1,650,000       750,000         403,000
  Mary Walker        150,000                                        - 0 -
  Donna Lee Bebout   150,000                                        - 0 -

U.S. Forest
Service timber
  Sale contracts    1,500,000      1,500,000      1,500,000       1,500,000

Total Class III     4,650,000      5,469,608      3,970,000       3,623,000

Class IV Assets
  Goodwill/going-
  concern value       - 0 -          - 0 -         680,000        1,027,000


     2.    Petitioner's Evidence of the Value of Buildings and
           Improvements, Equipment, and Rolling Stock

     Petitioner introduced into evidence expert reports with

valuations of buildings and improvements, equipment, and rolling

stock which differ from those contained in the purchase agreement

and petitioner's tax return.         Respondent contends that we must

apply the rule in Commissioner v. Danielson, 378 F.2d 771 (3d

Cir. 1967), vacating and remanding 44 T.C. 549 (1965), or

alternatively, the strong proof rule.
                               - 34 -


          a.     The Danielson Rule

     In Danielson, the Court of Appeals for the Third Circuit

held that a party to a contract allocating part of the purchase

price to a covenant not to compete can challenge the tax

consequences of that agreement only by presenting proof which

would be admissible in an action between the parties to the

agreement to alter that construction or to show its

unenforceability because of mistake, undue influence, fraud, or

duress.   Commissioner v. Danielson, supra at 775.    Not all Courts

of Appeals have adopted the Danielson rule.    We do not apply it

unless the Court of Appeals to which a case could be appealed has

adopted it.    Elrod v. Commissioner, 87 T.C. 1046, 1065-1066

(1986); Coleman v. Commissioner, 87 T.C. 178, 202 (1986), affd.

without published opinion 833 F.2d 303 (3d Cir. 1987); Golsen v.

Commissioner, 54 T.C. 742, 756-757 (1970), affd. 445 F.2d 985

(10th Cir. 1971).   This case is appealable to the Court of

Appeals for the Ninth Circuit.   That Court of Appeals has not

adopted the Danielson rule.2   Therefore, we do not apply it in

cases appealable to that Court of Appeals.



     2
       The Court of Appeals for the Ninth Circuit cited
Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), revg. and
remanding 44 T.C. 549 (1965), in Throndson v. Commissioner, 457
F.2d 1022, 1025 (9th Cir. 1972), affg. Schmitz v. Commissioner,
51 T.C. 306 (1968). In Throndson, the Court of Appeals did not
decide whether the Danielson rule applied because there was no
binding contract, which is required to apply the Danielson rule.
                               - 35 -


            b.   The Strong Proof Rule

     Alternatively, respondent contends that the strong proof

rule applies here.    Ullman v. Commissioner, 264 F.2d 305, 308 (2d

Cir. 1959); Meredith Corp. & Subs. v. Commissioner, 102 T.C. 406,

438 (1994); Elrod v. Commissioner, supra at 1066; Coleman v.

Commissioner, supra at 202 & n.17; G C Servs. Corp. v.

Commissioner, 73 T.C. 406, 412 (1979).      In Ullman, the Court of

Appeals for the Second Circuit held that a taxpayer-buyer had

to produce strong proof to overcome allocations of value in an

agreement it negotiated with a seller which had an adverse tax

position.    In Ullman, the Court of Appeals said that tax

adversity forces most buyers and sellers to use realistic values

when they allocate the purchase price in an agreement.       Ullman v.

Commissioner, supra at 308; see Schulz v. Commissioner, 294 F.2d

at 55 ("Generally speaking, the countervailing tax considerations

upon each taxpayer should tend to limit schemes or forms which

have no basis in economic fact."); UMCO Corp. v. Commissioner,

T.C. Memo. 1973-218 (conflicting tax interests are a prerequisite

to applying the strong proof rule).      The rationale for the strong

proof rule does not apply here because the seller did not care

about and the parties did not negotiate the allocations;

Schulz v. Commissioner, supra, Ullman v. Commissioner, supra.

Respondent has given no reason for it to apply beyond the
                                 - 36 -


context in which it was created.     We are inclined not to expand

it without a supporting rationale.

            c.    Weighing the Evidence

     The evidence of the value of the buildings and improvements,

equipment, and rolling stock consists of the opinions of

petitioner's experts and the amounts in the written agreement.

Donald Gwyther (Gwyther) prepared an expert report on the value

of the equipment and rolling stock.       Goss prepared an expert

report on the value of the buildings and improvements.

Respondent did not dispute either Gwyther's or Goss' expertise.

We admitted their reports as exhibits attached to the stipulation

of facts.    Respondent speculates that some of Gwyther's data may

be inaccurate.    However, respondent did not cross-examine Gwyther

or offer any evidence in response to his report.      We believe

Gwyther's and Goss' reports to be credible.

     Respondent contends that the contract allocation establishes

the value of the buildings and improvements, equipment, and

rolling stock.    We disagree.   We view the allocations in the

written agreement and on petitioner's income tax return as

evidence of the value of the disputed items analogous to an

admission under rule 801(d)(2) of the Federal Rules of Evidence,

which petitioner can overcome with cogent evidence.       See Waring

v. Commissioner, 412 F.2d 800, 801 (3d Cir. 1969), affg. T.C.

Memo. 1968-126.    The contract allocation was unilateral and made
                               - 37 -


without an expert appraisal.    Cf. Mooneyham v. Commissioner, T.C.

Memo. 1991-178.    The record does not show how the Freres family

chose the amounts they used in the agreement.    We believe

Gwyther's and Goss' opinions of value are entitled to

considerably more weight than the opinions of the members of the

Freres family.    We conclude that petitioner is entitled to

prevail on the allocations for buildings and improvements,

equipment, and rolling stock, even if a strong proof standard

applies.

     We conclude that the proper allocations of value under

section 1060 for the class III assets are $384,608 for buildings

and improvements, $1.5 million for equipment, and $290,000 for

rolling stock.

     3.    Calculation of Goodwill and Going-Concern Value Under
           Section 1060

     Petitioner paid $4.65 million for the Walker assets.      To

allocate the purchase price to assets under section 1060, we

subtract from that amount the following values for class III

assets:

           D.C. Walker Enterprises, Inc.
                Land                           $145,000
                Buildings and improvements       246,000
                Equipment                     1,000,000
                Rolling stock                   200,000

           Lyons Veneer
                Buildings and improvements      138,608
                Equipment                       500,000
                Rolling stock                    90,000
                               - 38 -


          Covenants Not To Compete
               D.C. Walker                    900,000
               Mary Walker                      - 0 -
               Donna Lee                       30,000

          U.S. Forest Service Timber
               Sale contracts               1,500,000

                 Total class III assets     4,749,608

     We allocate the consideration received in the Walker sale

under section 1060 as follows:

1.   Consideration received for purchase of assets      $4,650,000

2.   Allocation to class I and II                         - 0 -

3.   Allocation to class III

     a.   Amount available to allocate to class III     4,650,000
     b.   Class III assets                              4,749,608

4.   Allocation to class IV

     a.   Amount available to allocate to class IV
          is goodwill and going-concern value             - 0 -

     To reflect concessions by the parties and the foregoing,


                                                 Decision will be

                                          entered under Rule 155.
