                           T.C. Memo. 2001-2



                        UNITED STATES TAX COURT



          J. CLARK AND MARY R. BUNDREN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 14171-98.                      Filed January 5, 2001.



     James Clinton Garland, for petitioners.

     Brian A. Smith, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     THORNTON, Judge:    Respondent determined the following

deficiencies and penalties with respect to petitioners’ joint

Federal income taxes:

                  `                          Penalty
           Year          Deficiency        Sec. 6662(a)

           1995           $6,245               $1,249
           1996           48,448                9,690
                                - 2 -

     After concessions, the primary issues for decision are:

     1.    The adjusted basis of a rental property located at 3435

South 116th East Avenue in Tulsa, Oklahoma (the 116th East Ave.

property), immediately after petitioners acquired it in a section

1031 like-kind exchange in 1994.    Determination of this issue is

dispositive of the depreciation deduction allowable with respect

to the property for taxable year 1995 and of the amount of loss

petitioners realized on their sale of the property in taxable

year 1996; and

     2.    whether for taxable years 1995 and 1996, petitioners are

liable for accuracy-related penalties pursuant to section

6662(a).

     Section references are to the Internal Revenue Code in

effect for the relevant tax years.      Rule references are to the

Tax Court Rules of Practice and Procedure.

                          FINDINGS OF FACT

     The parties have stipulated some of the facts, which are so

found.    The parties’ stipulation of facts and the associated

exhibits are incorporated herein by this reference.

Petitioners

     At all times relevant to this proceeding, petitioners were

married.    J. Clark Bundren is a medical doctor practicing in the

fields of obstetrics/gynecology and infertility.      When

petitioners filed their petition, they resided in Tulsa,

Oklahoma.
                               - 3 -

Petitioners’ Purchase of the 84th Street Property

     On July 30, 1982, petitioners purchased a house at 4714 East

84th Street in Tulsa, Oklahoma (the 84th Street property), for

approximately $183,000.   Petitioners used the 84th Street

property as their primary residence until they converted it to

rental property in the spring of 1994.   Altogether, petitioners

spent approximately $50,130 on improvements to the 84th Street

property, thereby increasing their total investment in the

property to approximately $233,130.    All these improvements were

made while petitioners used the 84th Street property as their

primary residence.

     In October 1992, the Green Country Appraisal Service

appraised the 84th Street property as having a fair market value

of $150,500.

Conversion of the 84th Street Property to Rental Property

     In 1994, petitioners moved to a house located at 3120 East

87th Street in Tulsa, Oklahoma (the 87th Street property).

     Although petitioners preferred to sell the 84th Street

property, a rise in conventional mortgage rates during the summer

of 1994, coupled with the large number of houses on the market,

made the sale of residential property in Tulsa difficult.     The

Tulsa real estate market had been in decline since 1982.     In

1994, the Multiple Listing Service in Tulsa (a service which

listed real estate for sale) had essentially stopped taking
                               - 4 -

residential listings because the real estate market was very

slow.

     As a result, in the spring of 1994, after conferring with

their accountant, Mr. Patrick Walters (Walters), petitioners

decided to convert the 84th Street property to rental property.

From September to December 1994, petitioners rented the 84th

Street property for a few hundred dollars a month.

Exchange of the 84th Street Property

     Because of liability concerns associated with renting the

84th Street property, petitioners decided to dispose of it.

Petitioners listed the 84th Street property for sale at $134,500.

Petitioners’ goal, however, was to find a person willing to

exchange rental properties so that petitioners could obtain

property in a part of town they believed more suitable for rental

purposes.   Petitioners informed their real estate agent of their

desire to exchange rental properties.

     Through the efforts of their real estate agent, petitioners

were introduced to Ms. Delores Henson Youngblood (Youngblood),

who owned the 116th East Ave. property.   In September 1994,

Youngblood had listed the 116th East Ave. property for sale for

$67,500 with the realtor petitioners were using.     Youngblood was

interested in moving out of the part of town where the 116th East

Ave. property was located and into the part of town where the
                                - 5 -

84th Street property was located.   Youngblood is unrelated to

petitioners.

     On December 7, 1994, petitioners and Youngblood agreed to

exchange the 84th Street property for the 116th East Ave.

property (the exchange).    The exchange was finalized on December

30, 1994.   The exchange was treated as essentially one

transaction, but the terms were recorded as if the agreement

constituted a sale by petitioners of the 84th Street property for

$134,500 and a sale by Youngblood of the 116th East Ave. property

for $67,500.

     As part of the exchange, Youngblood paid the $134,500 sale

price for the 84th Street property, plus settlement charges,

taxes, and repair costs totaling $7,310.78, for a total of

$141,810.78.1   These funds were used in large part to retire a

$126,074.95 mortgage held by the Bank of Oklahoma with respect to

the 84th Street property.

     With respect to their acquisition of the 116th East Ave.

property in the exchange, petitioners paid $67,500, plus

settlement charges and taxes of $1,090.41, for a total of

$68,590.41, financed in part by a $50,625 mortgage loan from the

Bank of Oklahoma on the 116th East Ave. property.




     1
       Youngblood paid $55,830.78 in cash at closing and financed
most of the balance with funds borrowed from First Mortgage Corp.
                                 - 6 -

Petitioners’ Sale of the 116th East Ave. Property

      On August 23, 1996, petitioners sold the 116th East Ave.

property for $61,600.   Petitioners incurred closing costs of

$10,668 on this sale.

Petitioners’ Federal Income Tax Returns

      With respect to the exchange, petitioners reported neither

gain nor loss, nor did they mention the exchange on either their

1994 or 1995 Federal income tax return.    On their 1995 Federal

income tax return, petitioners claimed depreciation of $5,186 on

the 116th East Ave. property.2    On their 1996 Federal income tax

return, petitioners claimed a $159,820 loss on the sale of the

116th East Ave. property.

                              OPINION

A.   Petitioners’ Basis in the 116th East Ave. Property

      Respondent determined that petitioners’ adjusted basis in

the 116th East Ave. property immediately after the exchange was

$67,500, rather than $147,206, as asserted by petitioners.    Using

this redetermined basis, respondent determined that petitioners

are entitled to depreciation deductions with respect to the 116th

East Ave. property of $1,650, rather than the $5,186 that they




      2
       Apparently, on their 1994 Federal income tax return,
petitioners claimed a $1,512 depreciation deduction with regard
to the 116th East Ave. property. This deduction is not in
dispute here.
                               - 7 -

claimed on their 1995 Federal income tax return,3 and that their

deductible loss on the sale of the 116th East Ave. property was

$13,406, rather than the $159,820 that petitioners claimed on

their 1996 Federal income tax return.    Determination of the

correct adjusted basis of the 116th East Ave. property

immediately after the exchange will be dispositive of these

issues, as the parties have raised no other dispute about the

computation of petitioners’ 1995 depreciation deduction or the

amount of petitioners’ loss on the 1996 sale of the 116th East

Ave. property.

     The parties have stipulated that the exchange qualified for

treatment as a like-kind exchange under section 1031.

Consequently, petitioners’ adjusted basis in the 116th East Ave.

property immediately after the exchange was:

(1) Petitioners’ carryover basis in the 84th Street property

immediately before the exchange, decreased by (2) any money

(boot) they received in the exchange, and adjusted for (3) any

gain or loss that was recognized on the exchange.    See sec.

1031(d).   The parties agree that petitioners recognized no gain

or loss on the like-kind exchange.4    Accordingly, the relevant


     3
       On brief, respondent concedes that, because of a
computational error in the statutory notice, the proper
depreciation deduction allowable to petitioners is $1,687.50
     4
       Respondent concedes, however, that petitioners’ adjusted
basis in the 116th East Ave. property immediately after the
                                                   (continued...)
                                - 8 -

issues are those described in (1) and (2) above.   We address each

of these issues in turn.

     1.   Petitioners’ Carryover Basis in the 84th Street Property

     The parties appear to agree that petitioners’ basis in the

84th Street property immediately before the exchange in December

1994 was unchanged from the time the property was converted from

personal to business use in the spring of 1994.    At the time of

the conversion, petitioners’ basis in the 84th Street property

was the lesser of the then fair market value or the adjusted cost

basis.    See Heiner v. Tindle, 276 U.S. 582 (1928); Higgins v.

Commissioner, T.C. Memo. 1995-139; Frahm v. Commissioner, T.C.

Memo. 1974-138; sec. 1.165-9(b)(2), Income Tax Regs.   Respondent

contends, and petitioners do not dispute, that the fair market

value of the 84th Street property at the time of conversion was

less than cost, which was at least $233,130.5   The question,

then, is what the fair market value of the 84th Street property

was when petitioners converted it from personal to business use.

     “Fair market value” is defined as “the price at which

property would change hands between a willing buyer and a willing

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


     4
      (...continued)
exchange includes $10,668 in closing costs.
     5
       This amount represents petitioners’ total investment in
the 84th Street property (i.e., the $183,000 paid by petitioners
to purchase the property plus the approximately $50,130 they
spent to improve the property).
                               - 9 -

both having reasonable knowledge of relevant facts.”     Gresham v.

Commissioner, 79 T.C. 322, 326 (1982), affd. 752 F.2d 518 (10th

Cir. 1985).   The burden is on petitioners to prove that

respondent’s determination of fair market value is incorrect.

See Rule 142(a).

     Respondent contends that the fair market value of the 84th

Street property at the time of the conversion (and also on the

date of the exchange) was $134,500.    As support for this

position, respondent notes that this was the contract price for

the 84th Street property as specified in the September 2, 1994,

like-kind exchange with Youngblood only a few months after the

conversion.   Respondent also notes that the $134,500 figure is

consistent with the gradual downturn in the Tulsa real estate

market from the time petitioners purchased the property in 1982

for $183,000, until it was appraised for $150,500 in October

1992, until it was converted to rental property in 1994.

     Petitioners contend that the fair market value of the 84th

Street property was either $217,450–-as reflected in their 1995

Federal income tax return--or alternatively, $200,000.

Petitioners have offered no credible, admissible evidence,

however, to support either of their alternative positions.6


     6
       At trial, petitioners’ tax return preparer, Mr. Patrick
Walters (Walters), testified that in preparing petitioners’ tax
returns, he had relied on information from an appraiser regarding
the value of the 84th Street property. At trial, Walters’
                                                   (continued...)
                              - 10 -

Accordingly, we sustain respondent’s determination that

petitioners’ carryover basis in the 84th Street property was

$134,500.

     2.   Boot Received by Petitioners in the Exchange

     Respondent asserts that petitioners received $67,000 boot in

the exchange, representing the difference between the $134,500

sales price paid by Youngblood for the 84th Street property and

the $67,500 sales price paid by petitioners for the 116th East

Avenue property.   On their 1995 and 1996 Federal income tax

returns, petitioners’ tax treatment of the 116th East Avenue

property was predicated on the assumption that they received no

boot on the exchange.   On brief, without explanation, petitioners

compute the basis of the 116th East Ave. property by treating as

boot $70,244, representing the difference in petitioners’

$126,074 mortgage on the 84th Street property and the $55,830

cash payment that Youngblood made at the closing of the exchange.


     6
      (...continued)
testimony regarding the appraisal value was admitted over
respondent’s timely hearsay objection because petitioners stated
that they were offering the testimony not to prove the truth of
the matter contained in the statement (i.e., the fair market
value of the 84th Street property at the time of the conversion),
but merely to establish the manner in which Walters determined
the tax treatment of the 116th East Ave. property. For this
limited purpose, the testimony is not hearsay within the
definition of rule 801(c) of the Federal Rules of Evidence. On
brief, however, petitioners attempt to use Walters’ testimony to
evidence the fair market value of the 84th Street property. For
this purpose, the testimony is inadmissible hearsay. See Fed. R.
Evid. 801(c).
                                - 11 -

Without addressing the merits of either party’s position, we deem

petitioners to have conceded that they received as boot the

smaller amount of $67,000, as determined by respondent.    Cf.

Barker v. Commissioner, 74 T.C. 555 (1980).

     3.   Conclusion

     Petitioners’ adjusted basis in the 116th East Ave. property

immediately after the exchange was $78,168 ($134,500 carryover

basis in the 84th Street property less $67,000 boot received in

the exchange, plus the $10,668 in closing costs that respondent

concedes should be added to the basis).   The parties having

raised no other dispute regarding petitioners’ allowable 1995

depreciation deductions with respect to this property or

regarding the amount of petitioners’ loss on the 1996 sale of

this property, respondent’s determinations as to these issues are

sustained.

B.   Accuracy-Related Penalty

     Respondent determined that petitioners are liable for the

accuracy-related penalty under section 6662.   Section 6662(a)

imposes a 20-percent penalty on any portion of an underpayment

that is attributable to, among other things, negligence or

disregard of the rules or regulations.    Negligence is the lack of

due care or failure to do what a reasonable and ordinarily

prudent person would do under the same circumstances.   See Neely

v. Commissioner, 85 T.C. 934 (1985).
                                - 12 -

     No penalty shall be imposed under section 6662(a) with

respect to any portion of an underpayment if it is shown that

there was reasonable cause and that the taxpayer acted in good

faith.   See sec. 6664(c).   Whether a taxpayer acted with good

faith depends upon the facts and circumstances of each case.      See

sec. 1.6664-4(b)(1), Income Tax Regs.    Reliance on the advice of

a professional tax adviser constitutes reasonable cause and is in

good faith if, under all the circumstances, the reliance was

reasonable and the taxpayer acted in good faith.    See id.

Reliance on a tax adviser or return preparer may be reasonable

and in good faith if the taxpayer establishes:    (1) The adviser

or return preparer had sufficient expertise to justify reliance;

(2) the taxpayer provided necessary and accurate information; and

(3) the taxpayer actually relied in good faith on the adviser’s

or return preparer’s judgment.    See, e.g., Sather v.

Commissioner, T.C. Memo. 1999-309; Ellwest Stereo Theatres of

Memphis, Inc. v. Commissioner, T.C. Memo. 1995-610, and cases

cited therein.

     From 1982 through the years in issue, petitioners relied on

the accounting services of Walters, who has been a certified

public accountant since 1977.    Petitioners retained Walters to

prepare both their individual tax returns and tax returns for

their several business entities.    Walters’ experience and

qualifications were sufficient to warrant reliance upon his
                              - 13 -

judgment.   Walters was intimately involved with petitioners’

financial dealings, including the exchange.   He attended the

closing of the exchange and reviewed the documents.   Accordingly,

he was in possession of necessary and relevant information

regarding the exchange.   Clearly, petitioners relied on Walters’

judgment with regard to these matters.   On the basis of all the

evidence in the record, taking into account the relative

complexity of the tax issues involved and petitioners’ lack of

experience or training in such matters, we find that petitioners’

reliance was reasonable and in good faith.    We conclude that the

accuracy-related penalty should not be imposed.   See Coblenz v.

Commissioner, T.C. Memo. 2000-131; Sather v. Commissioner, supra.

     To reflect the foregoing,


                                         Decision will be entered

                                    under Rule 155.
