                               T.C. Memo. 2013-28


                         UNITED STATES TAX COURT



       JESSIE G. YATES III AND MELISSA LONG YATES, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 3685-11.                            Filed January 24, 2013.



      Jessie G. Yates III and Melissa Long Yates, pro sese.

      Olivia H. Rembach, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      GOEKE, Judge: Respondent determined a $123,648 deficiency and a

$24,729.60 accuracy-related penalty under section 6662(a)1 for petitioners’ taxable


      1
       Unless otherwise indicated, all section references are to the Internal Revenue
Code (Code) in effect for the year in issue. All Rule references are to the Tax Court
Rules of Practice and Procedure.
                                             -2-

[*2] year 2006. Following concessions, the remaining issues for decision relate to

petitioners’ section 1031 like-kind exchange. In particular, we must determine:

          (1) whether petitioners held real property at 831 Memorial Drive, Warsaw,

North Carolina (Memorial Drive property), either for productive use in a trade or

business or for investment at the time of the section 1031 exchange. We hold that

petitioners did not hold the Memorial Drive property for either purpose;

          (2) whether petitioners properly allocated fair market values to certain real

properties for purposes of determining gain recognized in the section 1031

exchange. We hold that respondent has failed to satisfy his burden of proof on this

issue; and,

          (3) whether petitioners are liable for an accuracy-related penalty under

section 6662(a). Subject to a Rule 155 computation, we hold that petitioners are so

liable.

                                   FINDINGS OF FACT

          Petitioners resided in North Carolina at the time the petition was filed.

I. Properties at Issue

          In 1992 petitioners purchased an empty lot at 8212 Lakeview Drive,

Wilmington, North Carolina (Lakeview property), for $27,000. Thereafter,

petitioners constructed a residential home on the property. The property was next
                                         -3-

[*3] to a golf course and near a beach. While it is unclear from the record,

petitioners apparently used the home as their primary residence for an indeterminate

time, as well as for business purposes in the period leading to the exchange at issue

in 2006. In January 2006 petitioners entered into an exclusive right to sell

agreement for the Lakeview property with a local realtor. The listing price in the

agreement was $419,000. Petitioners adduced no evidence at trial indicating that

there were bids on the property at that price. The agreement terminated on July 13,

2006.

        Petitioners also purchased oceanfront real estate at 100 Harper Avenue,

Carolina Beach, North Carolina (Harper Avenue property), in 2003 for $403,000.

Thereafter Mr. Yates, through his wholly owned corporation, Quality Pharm Group,

Inc. (Quality Pharm Group), operated a restaurant on the property which he named

the Hula Grill. On February 8, 2005, petitioners entered into an exclusive right to

sell agreement for the Harper Avenue property with a local realtor. The listing price

was set at $2,499,000. No evidence was submitted indicating that there were bids

on the property at that price. The agreement terminated on August 4, 2005.

        Petitioners also had the Harper Avenue property appraised during this

period. The appraiser estimated that the fair market value of the property as of
                                          -4-

[*4] March 15, 2005, was $1.8 million.2 Mr. Yates indicated at trial that at

unspecified dates he received two separate bids of $1.5 million for the Harper

Avenue property; however, one bid called for the deferral of payment, and Mr.

Yates was leery of the creditworthiness of the second bidder. Given Mr. Yates’

aversion to investment risk, he rejected both bids.

      For comparative purposes, a 2003 appraisal of 201 Harper Avenue, a nearby,

similarly zoned property, performed by a different appraiser, was entered

into evidence at trial.3 The appraisal report listed that property’s estimated market

value as of December 3, 2003, at $656,000.

      2
         The appraisal report indicates that the real estate market in the relevant area
for the 24 months preceding the appraisal had been experiencing rapid growth. As a
result, the appraiser, in comparing the Harper Avenue property to other properties
sold in the area, adopted a 7% per month upward adjustment. However, the
appraiser presciently admonished: “Obviously, these exorbitant rates cannot be
indefinitely sustained.”

      The appraisal report also notes that the Harper Avenue property is 3,111
square feet (0.076 acres). The restaurant facility on the property was identified as
an approximately 7,307-square-foot wood-framed building. The property had been
previously appraised for ad valorem tax purposes as of January 1, 1999, at
$396,884. Of that amount, $329,360 was attributed to the facility on the property
and $67,524 was attributed to the land.
      3
       The owner of 201 Harper Avenue had purchased the property in June 2002
for $488,500. The parcel was approximately 3,500 square feet and was appraised
under the assumption that it would be “renovated into a combination
residential/office unit, 6,000 square feet of residential and 900 square feet of office
space.”
                                         -5-

[*5] On February 2, 2006, petitioners entered into another exclusive right to sell

agreement with a separate realtor for the Harper Avenue property. The listing price

set in that agreement was $3.1 million. Again, petitioners adduced no evidence

demonstrating that any bids were submitted on the property at that price, and the

agreement terminated on August 2, 2006.

II. Like-Kind Exchange

      By 2006 the Harper Avenue property had purportedly become a desirable

parcel of land. In particular, a local businessman, Russell Maynard, had

individually or through his company, Seaview Properties, LLC, purchased all

contiguous property. Mr. Maynard ultimately intended to construct a Hilton hotel at

the location and needed the Harper Avenue property to complete the project.

Fortunately for Mr. Maynard, he owned a parcel of land adjacent to the Hula Grill

which the Hula Grill had leased to serve as its parking lot. In an effort to induce

petitioners to sell the Harper Avenue property, Mr. Maynard terminated the parking

lot lease. Petitioners understood that without a viable parking lot their business

would suffer, perhaps irreparably.

      Petitioners, frustrated by Mr. Maynard’s efforts, begrudgingly began

negotiations for the sale of the Harper Avenue property. During the negotiations

petitioners indicated that they would sell the Harper Avenue property only if Mr.
                                         -6-

[*6] Maynard also purchased either the Lakeview property or their residence at

South Churchill Drive, Wilmington, North Carolina. While originally reluctant to

purchase either, Mr. Maynard recognized that petitioners were steadfast in

conditioning the sale of the Harper Avenue property on the corresponding sale of

one of the other offered properties. Eventually, Mr. Maynard agreed to purchase

the Lakeview property. At that point, petitioners intended the sale of the Harper

Avenue property and the Lakeview property to be pieces of a larger like-kind

exchange pursuant to section 1031.4

      The sale of the properties between petitioners and Seaview Properties, LLC,

was consummated in March 2006. The governing purchase agreement, in an

attached exhibit, provided:




      4
        The property exchanges at issue were not immediately contemporaneous;
however, pursuant to the regulations issued under sec. 1031, a “qualified
intermediary” with which the taxpayer has entered into an “exchange agreement”,
may be used to facilitate a nonsimultaneous exchange of property. See sec.
1.1031(k)-1(g)(4), Income Tax Regs. While the circumstances of the exchanges are
vague, we infer that respondent’s failure to raise an issue pertaining to the procedure
of the exchange indicates that petitioners appropriately used a qualified intermediary
in structuring the transfer of the properties.
                                          -7-

[*7] [Petitioners] will allocate the purchase price as follows:

             Hula Grill purchase price:                           $895,000

             Quality Pharm Group
             (to cease doing business at this said location
             100 Harper Avenue by September 15, 2006,
             purchase price of lease agreement [sic]:              505,000

             8212 Lakeview property                                750,000

               Total Purchase Price                               2,150,000

Mr. Maynard signed the purchase agreement twice: on March 16, 2006, and again

on March 25, 2006.

      A separate settlement statement for the U.S. Department of Housing and

Urban Development (HUD statement) also listed the contract sale price as

$2,150,000, with $505,000 due to “Quality Pharm Group”. Mr. Maynard’s

signature is readily apparent on this document.

      Following his purchase of the Lakeview property, Mr. Maynard spent

approximately $10,000 to $15,000 repairing it to make it suitable for

resale. In November 2006 Mr. Maynard sold the Lakeview property for $310,000.

      In February 2005 petitioners entered into an offer to purchase and contract for

the sale of the Memorial Drive property. The contract indicated that “The buyer is

doing a 1031 exchange. The buyer requests the seller apply to town for
                                         -8-

[*8] approval as [sic] use as bed and breakfast at buyer expense.” Petitioners

submitted no evidence indicating whether the seller of the Memorial Drive property

ever made such an application to the appropriate municipal body.

      On May 12, 2006, petitioners closed on the purchase of the Memorial Drive

property for $325,000. Three days later, on May 15, 2006, petitioners closed on the

sale of their then residence at South Churchill Drive, Wilmington. Petitioners

thereafter moved into the Memorial Drive property on May 16, 2006. Mr. Yates

still resided at the Memorial Drive property as of May 15, 2012.5

III. Return Position

      Petitioners filed a joint return for taxable year 2006. In reporting the like-

kind exchange on their return, they adopted the fair market values of the properties

reflected in the governing purchase agreement. The exchange was summarized on

petitioners’ Form 8824, Like-Kind Exchanges (and section 1043 conflict-of-interest

sales), as follows:




      5
       Petitioners received two other properties as part of their like-kind exchange:
(1) 5111 Carolina Beach Road, Wilmington, North Carolina; and (2) 5602 Fairfield
Fairy Road, Stantonsburg, North Carolina.
                                                    -9-

 [*9] 15.  Cash received, FMV of other property received, plus net liabilities assumed
     by other party, reduced (but not below zero) by any exchange expenses you
     incurred.                                                                              $1,080,060

 16. FMV of like-kind property you received.                                                   990,428

 17. Add lines 15 and 16.                                                                    2,070,488

 18. Adjusted basis of like-kind property you gave up, net amounts paid to other
     party, plus any exchange expenses not used on line 15.                                    576,036

 19. Realized gain or (loss). Subtract line 18 from line 17.1                                1,101,307

 20. Enter the smaller of line 15 or line 19, but not less than zero.                          686,915

 21. Ordinary income under recapture rules.                                                     -0-

 22. Subtract line 21 from line 20.                                                            686,915
 23. Recognized gain. Add lines 21 and 22.                                                     686,915
 24. Deferred gain or (loss). Subtract line 23 from line 19.                                   414,392
 25. Basis of like-kind property received. Subtract line 15 from the sums of lines
     18 and 23.                                                                                576,036

        1
         Petitioners made a notation on line 19 reporting a $393,145 sec. 121 exclusion from income.

IV. Notice of Deficiency

        Respondent’s position reflected in the notice of deficiency is that petitioners

artificially inflated the fair market value of the Hula Grill while simultaneously

deflating the fair market value of the Lakeview property to avoid recognition of

income (discussed further infra). Accordingly, respondent adjusted the values of

petitioners’ exchanged properties as follows:
                                          - 10 -

[*10]         Hula Grill purchase price                          $1,295,000

              Quality Pharm Group                                    505,000

              8212 Lakeview property                                350,000

                Total purchase price                               2,150,000


                                       OPINION

I. Legal Background

        The issues for decision in this case emanate from petitioners’ like-kind

exchange. The general rule regarding recognition of gain or loss on the sale or

exchange of property is that the entire amount of the gain or loss is recognized.

Sec. 1001(c). An exception to this rule prescribed in section 1031 is that no gain

or loss shall be recognized on the exchange of property held for productive use in

a trade or business or for investment if the property is exchanged solely for

property of a like kind that is to be held either for productive use in a trade or

business or for investment. Sec. 1031(a). If, however, money or unqualified

property is received in an otherwise qualifying like-kind exchange, a taxpayer’s

realized gain is recognized to the extent of the sum of such money and the fair
                                        - 11 -

[*11] market value of such unqualified property (boot). Sec. 1031(b); sec.

1.1031(a)-1(a)(2), Income Tax Regs.6

      A typical like-kind exchange requires a “property-by-property” comparison

for computing gain recognized in the transaction. Sec. 1.1031(j)-1(a)(1), Income

Tax Regs. However, if multiple properties are transferred in a like-kind exchange,

the properties are separated and arranged for analysis into “exchange groups”

based on shared characteristics. Sec. 1.1031(j)-1(b)(2)(i), Income Tax Regs.7

Money and boot are placed in a separate “residual group”. Sec. 1.1031(j)-

1(b)(2)(iii), Income Tax Regs.8 A main contention of respondent is that the

Memorial Drive property should be characterized as boot, resulting in a




      6
        In determining the amount realized from the like-kind exchange at issue,
petitioners appear to have merely aggregated the fair market values of all properties
and cash received, $2,070,488. They then subtracted from that amount the
aggregate bases of properties transferred, $576,036, to compute the tentative gain
recognized, $1,494,452. Petitioners aver that sec. 121 entitles them to exclude
$393,145 of that amount from income.
      7
        “Each exchange group must consist of at least one property transferred and
at least one property received in the exchange.” Sec. 1.1031(j)-1(b)(2)(i), Income
Tax Regs.
      8
       Generally, a “residual group” is created if the aggregate fair market value of
the properties transferred in all of the exchange groups differs from the aggregate
fair market value of the properties received in all the exchange groups. Sec.
1.1031(j)-1(b)(2)(iii), Income Tax Regs.
                                          - 12 -

[*12] reallocation of the properties in the relevant exchange and residual groups.

This would affect petitioners’ gain recognized on the exchange, discussed further

infra.

         Taxpayers must also net any liabilities assumed as part of the exchange with

any liabilities relieved as part of the exchange. Sec. 1.1031(j)-1(a)(2), Income Tax

Regs. If, as in this case, the amount of liabilities for which the taxpayer is relieved

in the exchange exceeds the amount of liabilities he assumes, the excess is allocated

to the “residual group” as well. Sec. 1.1031(j)-1(b)(2)(ii)(C), Income Tax Regs.

         Thereafter, the fair market values of the properties received and the

properties exchanged in each exchange group are compared. Sec. 1.1031(j)-

1(b)(2)(iv), Income Tax Regs. If the aggregate fair market value of the properties

received in an exchange group exceeds the aggregate fair market value of the

properties transferred in the same exchange group, the excess is considered an

“exchange group surplus”. Id. Conversely, if the aggregate fair market value of

the properties transferred in an exchange groups exceeds the aggregate fair market
                                          - 13 -

[*13] value of the properties received in the same exchange group, the excess is

considered an “exchange group deficiency”. Id.9

      A taxpayer’s amount of gain or loss realized with respect to each exchange

group and the residual group is the difference between the aggregate fair market

value of the properties transferred in that exchange or residual group and the

properties’ aggregate adjusted basis. Sec. 1.1031(j)-1(b)(3)(i), Income Tax Regs.

Any gain realized for each exchange group is recognized to the extent of the lesser

of the gain realized and the amount of the “exchange group deficiency”, if any. Id.

Regarding the residual group, the recognized gain or loss determined under the

general rules is prescribed by section 1001. Id.

      A separate provision, section 121, excludes from income gain realized and

recognized in certain property transfers. In particular, for taxpayers filing joint

returns, section 121 excludes from gross income up to $500,000 of gain from the

sale or exchange of property if, during the 5-year period preceding such transfer,




      9
       If the taxpayer assumed liabilities in excess of liabilities exchanged in the
transaction, any “exchange group surplus” or “exchange group deficiency” is
adjusted accordingly. Sec. 1.1031(j)-1(b)(2)(iv), Income Tax Regs. As noted
supra, petitioners were relieved of liabilities in the exchange in excess of liabilities
assumed.
                                         - 14 -

[*14] at least one spouse owned the property and both spouses used the property as

their principal residence for the aggregate of two or more years. Sec. 121(a),

(b)(2).10

       Respondent concedes that the Lakeview property qualifies as petitioners’

personal residence for purposes of section 121. Consequently, we are presented

with the simultaneous application of section 121 and section 1031 to the exchange

at issue. The Commissioner has indicated that in these circumstances “[s]ection 121

must be applied to gain realized before applying section 1031.” Rev. Proc. 2005-

14, sec. 4.02, 2005-1 C.B. 528, 529. Accordingly, any realized gain attributable to

the exchange of the Lakeview property as a distinct, discrete part of petitioners’

overall like-kind exchange is excluded pursuant to section 121.

       Respondent proffers that petitioners manipulated this statutory scheme by

artificially deflating and inflating the fair market values of the Lakeview property

and the Harper Avenue property, respectfully, in a purportedly misguided attempt to

exclude recognized gain from income. Therefore, our inquiry regarding

respondent’s assertion narrows to whether petitioners’ allocation of fair market


       10
        To be entitled to the entire $500,000 exclusion, neither jointly filing spouse
may have applied sec. 121 to exclude gain on property sold or exchanged within the
two years preceding the sale or exchange of the property at issue. Sec.
121(b)(2)(A)(iii), (3).
                                         - 15 -

[*15] values to the exchanged properties comports with the economic reality of the

transaction or simply represents petitioners’ specious attempt to limit their tax

exposure.

II. Burden of Proof

      Generally, the Commissioner’s determinations are presumed correct, and the

taxpayer bears the burden of proving that those determinations are erroneous. Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Nonetheless, if the taxpayer

produces credible evidence with respect to any factual issue relevant to ascertaining

his Federal income tax liability, the burden of proof shifts from the taxpayer to the

Commissioner as to that factual issue. Sec. 7491(a)(1). “Credible evidence” is

evidence that, after critical analysis, would constitute a sufficient basis for deciding

the issue in favor of the taxpayer if no contrary evidence were submitted. Ocmulgee

Fields, Inc. v. Commissioner, 132 T.C. 105, 114 (2009), aff’d, 613 F.3d 1360 (11th

Cir. 2010).

      The shifting of the burden of proof, however, is conditioned upon the

taxpayer’s first demonstrating that he or she met the requirements of section

7491(a)(2), including: (1) substantiating any item as required by the Code; (2)

maintaining all records required by the Code; and (3) cooperating with the

Commissioner’s reasonable requests for witnesses, information, documents,
                                         - 16 -

[*16] meetings, and interviews. While respondent does not concede that

petitioners have satisfied the requirements of section 7491(a)(2), at trial petitioners

convincingly testified regarding their substantial efforts to accommodate respondent

during audit. This testimony was uncontested. Indeed, there appears to be no

dispute that petitioners maintained all required documentation and allowed

respondent full access to all available records. Accordingly, we find that petitioners

have satisfied the preliminary requirements set forth in section 7491(a)(2).

      We now turn to whether petitioners have adduced credible evidence

regarding the two immediate issues for which the burden of proof may be shifted

pursuant to section 7491: (1) whether petitioners held the Memorial Drive property

either for productive use in a trade or business or for investment at the

time of the section 1031 exchange; and (2) whether petitioners properly allocated

fair market values to the exchanged properties in the purchase agreement.

      A. Memorial Drive Property--Business or Investment Intent

      Petitioners rely principally on their testimony at trial as evidencing their intent

to use the Memorial Drive property as a “bed and breakfast” at the time of the like-

kind exchange. However, self-serving testimony without corresponding objective

evidence is of negligible probative value and fails to meaningfully
                                         - 17 -

[*17] inform the Court as to any disputed issues. Accordingly, such testimony is

routinely rejected. See Shea v. Commissioner, 112 T.C. 183, 189 (1999); Tokarski

v. Commissioner, 87 T.C. 74, 77 (1986); Crispin v. Commissioner, T.C. Memo.

2012-70, 2012 Tax Ct. Memo LEXIS 70, at *21. Notwithstanding petitioners’

largely uncorroborated testimony, they do refer the Court to a provision in the

Memorial Drive property sale contract where they “request[ed]” that the seller apply

to the appropriate town board to use the Memorial Drive property “as bed and

breakfast at buyer expense”. Nonetheless, petitioners provided no evidence

demonstrating that such a request was ever made or that they even inquired as to

whether the seller’s fulfilled this nonobligatory term of the contract. Furthermore,

the sale was not explicitly conditioned upon the seller’s successfully securing

municipal consent to use the Memorial Drive property as a bed and breakfast;

instead, the provision served as nothing more than a trivial addition inserted in the

contract for the purpose of securing petitioners’ desired nonrecognition treatment of

the exchange. Without the benefit of further objective evidence establishing

petitioners’ legitimate efforts to hold the Memorial Drive property as a business or

investment property, we cannot find that they have adduced credible evidence

warranting a shifting of the burden of proof pursuant to section 7491.
                                         - 18 -

[*18] B. Allocation of Fair Market Values

      Petitioners effectively submit that the purchase agreement represents a duly

bargained agreement between adverse parties and that the allocations therein

represent credible evidence sufficient to shift the burden of proof to respondent. To

be sure, this Court strictly scrutinizes an allocation if it does not have adverse tax

consequences for the parties; adverse tax interests deter allocations which lack

economic reality. Bemidji Distrib. Co. v. Commissioner, T.C. Memo. 2001-260

(citing Wilkof v. Commissioner, 636 F.2d 1139 (6th Cir. 1981), aff’g per curiam

T.C. Memo. 1978-496), aff’d sub nom. Langdon v. Commissioner, 59 Fed. Appx.

168 (8th Cir. 2003). Petitioners, however, correctly note that the purchaser, Mr.

Maynard, is an adverse party in the transaction.11 Any tax benefit to one party in


      11
         Respondent avers that the alleged qualification inserted in the purchase
agreement that the “Seller will allocate the purchase price” (emphasis added)
represents that there was no mutual agreement between the parties regarding the
allocations and that Mr. Maynard was free to deviate from the allocations “for taxes
or other purposes”. We are skeptical that respondent would maintain this position if
the allocations inured to the benefit of Mr. Maynard.

       Further, to accord any persuasive weight to respondent’s argument we would
have to accept that inserting the allocations into the document was a superfluous
exercise, similar to the provision in the Memorial Drive property contract, having no
affect on the parties. We do not interpret the purchase agreement in the manner
respondent suggests; rather, we find that the unambiguous language of the purchase
agreement engendered mutual obligations on the parties to report the sale prices in
                                                                        (continued...)
                                         - 19 -

[*19] the exchange was counterpoised by a tax detriment to the other. This is

highlighted by the fact that Mr. Maynard apparently treated the transaction, from his

viewpoint, as a section 1001 transaction. The allocations, therefore, were critical in

ascertaining Mr. Maynard’s cost basis in the properties he received in the exchange.

See sec. 1012(a) (“The basis of property shall be the cost of such property[.]”).

Therefore, the tax consequences of any subsequent sale of the

properties Mr. Maynard received in the exchange would be affected by the

allocations. See sec. 1001.

      Petitioners also assert that the price allocations in the purchase agreement,

when compared on a dollar-per-acre basis with those of the nearby properties,

exhibit competitive prices for real estate in the respective areas. To demonstrate

this point, petitioners submitted to the Court copies of various real estate deeds,

some reflecting purchase prices, for properties in the same localities as those at




      11
         (...continued)
accord with the specifically delineated allocations in the document. See, e.g., Elrod
v. Commissioner, 87 T.C. 1046, 1065-1066 (1986) (taxpayers attempting to
challenge a contractual allocation must adduce “strong proof”, meaning more than a
preponderance of the evidence, that the terms of the written instrument do not
reflect the actual intentions of the contracting parties). Mr. Maynard’s initialing of
the purchase agreement page at issue underscores that he, at least at one point,
recognized the economic consequence of the allocations.
                                         - 20 -

[*20] issue. While petitioners’ pricing methodology is both unorthodox and

unscientific, it at minimum slightly bolsters the credibility of their argument.12

      When the evidence is viewed in toto, we find that petitioners have submitted

credible evidence concerning the validity of the contractual sale price allocation

sufficient to shift the burden of proof pursuant to section 7491(a)(1). The burden of

proof rests with respondent on this issue.

III. Business or Investment Intent

      Whether a taxpayer intends to hold a property for productive use in a trade or

business or for investment is a question of fact that must be determined at the time

of the exchange. Bolker v. Commissioner, 81 T.C. 782, 804 (1983), aff’d, 760 F.2d

1039 (9th Cir. 1985); Click v. Commissioner, 78 T.C. 225, 231 (1982). The use of

property solely as a personal residence is antithetical to its being held for investment

or business purposes. See, e.g., Starker v. United States, 602 F.2d 1341, 1350-1351

(9th Cir. 1979).

      The record is devoid of objective evidence tending to shed light on the

circumstances surrounding petitioners’ acquisition of the Memorial Drive


      12
         Petitioners’ inartful attempt to compare relevant sale prices suffers, among
other reasons, from their inability to carefully delineate the proximity of the
properties reflected in the deeds with the exchanged properties. The vague record
limits the persuasiveness of petitioners’ argument.
                                          - 21 -

[*21] property. As noted supra, petitioners rely primarily on their testimony and the

provision inserted in the relevant sales contract requesting that the seller apply for

permission to use the property as a “bed and breakfast” to demonstrate their

business intent. It is undisputed, however, that petitioners moved into the Memorial

Drive property a mere four days after the close of the sale and treated the home as

their primary residence for an indeterminate time.13 In the light of two recent cases

of this Court, we remain unconvinced that these facts effectively establish that

petitioners intended to hold the property for business purposes at the time of the

exchange.

      In Goolsby v. Commissioner, T.C. Memo. 2010-64, 2010 Tax Ct. Memo

LEXIS 64, taxpayers entered into a like-kind exchange for the ostensible purpose

of using the real estate received in the transaction as a rental property. Citing,

among other factors, the taxpayers’ failure to research whether certain covenants

permitted the use of the real estate as rental property, their minimal efforts to

actually rent the property, and the fact that they moved into the property within


      13
          Petitioners testified that the unanticipated sale of their previous residence
required them to stay at the Memorial Drive property following the sale and that
they actively tried to find a new home in the interim. Ms. Yates also conceded at
trial that petitioners used the Memorial Drive property as their principal residence
for 14 of the first 24 months they owned the property.
                                        - 22 -

[*22] two months of the transaction, we found that the taxpayers failed to satisfy

their burden of demonstrating their investment intent at the time of the exchange.

Id., 2010 Tax Ct. Memo LEXIS 64, at *13-*14.

      Conversely, in Reesink v. Commissioner, T.C. Memo. 2012-118, 2012 Tax

Ct. Memo LEXIS 117, we upheld the validity of a section 1031 exchange by noting

that the taxpayers’ efforts to rent the home, including placing flyers in nearby areas

and showing the property to potential renters, demonstrated their intent to hold the

property for business purposes. Id., 2012 Tax Ct. Memo LEXIS 117, at *16. We

so held notwithstanding the fact that the taxpayers moved into the home eight

months after the exchange. Id.

      Similar to the taxpayers’ failures in Goolsby, petitioners’ failure to submit any

evidence into the record regarding their efforts to transform the Memorial Drive

property into a business enterprise underscores their lack of business motive in the

exchange. Indeed, it is unclear whether it was even possible to convert the

Memorial Drive property into a “bed and breakfast”. Further, petitioners’ use of the

Memorial Drive property as their personal residence, beginning a mere four days

following the close of the sale, creates a clear presumption of nonbusiness intent,

exceeding that of the taxpayers in either Goolsby or Reesink.
                                         - 23 -

[*23] Accordingly, we hold that petitioners must treat the Memorial Drive property

as boot for purposes of determining their gain recognized on the exchange.

IV. Allocation of Fair Market Values

      Neither the Commissioner nor this Court is bound to accept a contractual

allocation lacking substance. See, e.g., Schulz v. Commissioner, 294 F.2d 52, 56

(9th Cir. 1961), aff’g 34 T.C. 235 (1960); Landry v. Commissioner, 86 T.C. 1284,

1307 (1986). Rather, the economic realities of a transaction determine its tax

consequences irrespective of the form chosen by the parties. Hamlin’s Trust v.

Commissioner, 209 F.2d 761, 764 (10th Cir. 1954), aff’g 19 T.C. 718 (1953); see

also Landry v. Commissioner, 86 T.C. at 1307. This Court will generally uphold a

contractual allocation if it has “‘some independent basis in fact or some arguable

relationship with business reality such that reasonable men, genuinely concerned

with their economic future, might bargain for such an agreement.’” Landry v.

Commissioner, 86 T.C. at 1307 (quoting Schulz v. Commissioner, 294 F.2d at 55).

Conversely, “[a]n allocation by the buyer and the seller will be ignored if it is

unrealistic or is not a result of arm’s-length negotiations between parties with

adverse tax motivations.” Id. at 1307-1308 (citations omitted).
                                         - 24 -

[*24] As noted supra, we find that Mr. Maynard and petitioners were adverse

parties in the transaction at issue. Consequently, the allocations provided in the

purchase agreement are essentially afforded a presumption of business reality. See

Schulz v. Commissioner, 294 F.2d at 55 (“[C]ountervailing tax considerations upon

each taxpayer should tend to limit schemes or forms which have no basis in

economic fact. The Commissioner should be slow in going beyond the values which

the taxpayers state when such countervailing factors are present.”); Int’l Multifoods

Corp. v. Commissioner, 108 T.C. 25, 46 (1997); Landry v. Commissioner, 86 T.C.

at 1307; Buffalo Tool & Die Mfg. Co. v. Commissioner, 74 T.C. 441, 447 (1980).

We must therefore be circumspect to avoid altering their expectations without clear

evidence indicating otherwise.

      Respondent nonetheless disputes the characterization of the parties as

adverse and offers that Mr. Maynard’s ambivalence to the allocations in the

governing agreement allowed petitioners an opportunity to contrive unrealistic and

artificial values for the exchanged properties. In support of this proposition,

respondent relies on Mr. Maynard’s testimony in which he stated that he believed

the values of the Harper Avenue property and the Lakeview property were

$1,800,000 and $350,000, respectively, at the time of the exchange. Respondent
                                        - 25 -

[*25] further submits that the exhibit attached to the purchase agreement

establishing the allocations was manufactured solely by petitioners.

      Yet Mr. Maynard’s testimony was far more opaque regarding aspects of the

exchange than respondent suggests. The following colloquy demonstrates that time

has diluted Mr. Maynard’s memory regarding specifics of the transaction and that it

was likely that the parties collaborated on ascribing values to the exchanged

properties:

      MR. YATES: Q- So is it your testimony here today that you do not
      know who supplied Exhibit B or where it came from?

      MR. MAYNARD: A- That’s basically correct. To my best
      remembering, I honestly don’t remember who structured it. I        doubt
      - - I mean, I didn’t even know the name of your business was Quality
      Farm, so I would have needed some assistance in structuring that if - - I
      wanted to buy that property. Let me make it perfectly clear.
      Mr. Yates and I went back and forth with each other for six months or
      a year as adjoining property owners, and we could never work
      anything out. And finally we came to that $2.15 million price, and - -
      but as far as structuring the values in there, I wouldn’t have known
      how to do that, so I probably had some assistance from you.
      If I supplied that, then I was given some guidance by you, and I
      honestly can sit here with my hand on the Bible and say I don’t recall
      any of that. * * *

It is also uncontested that Mr. Maynard initialed the exhibit containing the

allocations and that his (HUD statement) listed the contract sale price as

$2,150,000, with $505,000 due to Quality Pharm Group. Therefore, Mr. Maynard
                                         - 26 -

[*26] at least at one point respected the allocated values established in the purchase

agreement. It also strains credulity to suggest that Mr. Maynard, a businessman

well versed in real estate sales, would not meticulously examine the purchase price

agreement to ensure that his interests were adequately represented. In sum, we

glean nothing from Mr. Maynard’s testimony persuading us to reallocate the agreed-

upon values of the properties in the purchase agreement.

      Respondent next proffers that (1) petitioners’ listing prices for the exchanged

properties, (2) the value assigned by the appraiser in his 2005 appraisal of the

Harper Avenue property, and (3) the sale price of Mr. Maynard’s subsequent

transfer of the Lakeview property more appropriately evidence the fair market

values of the exchanged properties than the allocations in the purchase agreement.

While respondent’s position has superficial merit, we find that in these

circumstances it would be unjustified to disturb the agreed-upon allocations.

      A. Harper Avenue Property

      Petitioners purchased the Harper Avenue property in 2003 for $403,000.

From February 8 to August 4, 2005, petitioners engaged a local realtor to sell the

property at its listing price of $2,499,000. The property was appraised in March

2005 at $1,800,000. Thereafter, in February 2006 petitioners engaged a separate

realtor to sell the property at an increased listing price of $3.1 million. Mr. Yates
                                          - 27 -

[*27] testified that he received only two separate bids on the property, both for $1.5

million. Both bids were rejected on the basis of what petitioners perceived as

inherent, unacceptable risks.14

      We believe that the aforementioned listing prices simply reflect petitioners’

unbounded and unfounded hope to receive a windfall profit on their investment.

Indeed, if petitioners had sold the Harper Avenue property at the listing prices, they

would have secured a return on investment approximating 500% or 669%,

respectively, in merely three years.15 While we are cognizant that real estate values

rise and fall, at times with great fluctuation according to the vicissitudes of the

relevant market, there is no evidence before us which would support the excessive

appreciation of the Harper Avenue property as implied in petitioners’ listing prices.

Correspondingly, we are not persuaded that the listing prices represent probative or

suggestive evidence of the fair market value of the Harper Avenue property.




      14
      As noted supra, Mr. Yates testified that the first bid called for a deferral of
payment and the second bid was submitted by a purchaser with suspect credit.
      15
        While petitioners apparently renovated the building at some point,
respondent submits that petitioners’ adjusted basis after holding the property for
three years was $378,019. Clearly, then, the renovations were not so significant as
to validate petitioners’ excessive listing prices.
                                          - 28 -

[*28] Turning to the appraisal of the Harper Avenue property, we find that it also

does little to aid in our inquiry. Respondent uses the appraisal of the Harper

Avenue property as, essentially, an expert report in this case and in so doing

exposes the limitations of relying on specialized manufactured evidence without

affording the Court an opportunity to observe its creator and to question him as to

the accuracy of his conclusions.16 Indeed, when the appraisal of the Harper Avenue

property is juxtaposed with a contemporaneous appraisal of a nearby property, we

are left with diametrically different valuations without any means to reconcile the

two.

       The nearby property subject to the third-party appraisal, 201 Harper

Avenue, was purchased for $488,000, a year before petitioners purchased the

Harper Avenue property for $403,000. The two properties were similarly zoned

and similarly sized, and the structures on the respective properties were of similar

square footage.17 Consequently, without further facts to differentiate the two

       16
         In general, we will not admit an appraisal report as evidence of fair market
value unless the author of the report testifies at trial and is available for cross-
examination. Van Der Aa Invs., Inc. v. Commissioner, 125 T.C. 1, 7 (2005); see
also Evans v. Commissioner, T.C. Memo. 2010-207, 2010 Tax Ct. Memo LEXIS
242, at *17-*18; Droz v. Commissioner, T.C. Memo. 1996-81, 1996 Tax Ct. Memo
LEXIS 80, at *13-*14.
       17
            The building on the Harper Avenue property was somewhat larger than the
                                                                       (continued...)
                                         - 29 -

[*29] properties, one might reasonably infer that they would appreciate or

depreciate at congruent rates. An appraisal performed on 201 Harper Avenue

estimated the market value of the property as of December 3, 2003, at $656,000. In

contrast, petitioners’ Harper Avenue property was appraised 15 months later, at

$1.8 million. Respondent offers no explanation clarifying the discrepancies in the

separate appraisers’ estimates. Indeed, if we were to accept as accurate the 2005

Harper Avenue property appraisal, then we would have to concomitantly accredit

the correlative proposition that both the Harper Avenue property and the 201 Harper

Avenue property approximately tripled in fair market value in little over a year; we

cannot logically accept this conclusion. Accordingly, without further evidence

demonstrating that the two appraisals are compatible, we conclude that respondent

has failed to establish the accuracy or reliability of the 2005 Harper Avenue

appraisal.

      We can also disregard as irrelevant the two $1.5 million bids that petitioners

purportedly received on the Harper Avenue property. The record pertaining to these

bids consists entirely of petitioners’ brief trial testimony on the matter. As


      17
        (...continued)
presumably renovated building on the 201 Harper Avenue property. Nonetheless,
the 201 Harper Avenue property was a larger real estate parcel than the Harper
Avenue property.
                                         - 30 -

[*30] noted supra, petitioners indicated that one bid called for deferred payment and

the other was offered by a purchaser with questionable credit. In these

circumstances, it is plausible that such bidders might overbid on a property to

remain competitive. Consequently and on the basis of the unremarkable record at

hand, we find that the purported bids are inconsequential to our inquiry.

      B. Lakeview Property

      Discerning the fair market value of the Lakeview property at the time of the

exchange is more difficult. Petitioners purchased the property in 1992 for $27,000

and thereafter constructed a residence on the property. Petitioners continuously

improved the property through their period of ownership.18 The property was also

fortuitously next to a golf course and near a beach. In January 2006 petitioners

engaged a local realtor to sell the property at a listing price of $419,000.19


      18
         The parties disagree as to petitioners’ adjusted basis in the Lakeview
property. Petitioners’ assert that their adjusted basis is approximately $375,000,
while respondent’s statutory notice of deficiency indicates that petitioners’ adjusted
basis is $201,571. This issue was not presented for decision; however, in either
circumstance, petitioners’ adjusted basis evidences they made significant efforts to
improve the property.
      19
         This listing price of the Lakeview property does not approach the
unreasonableness of the listing prices for the Harper Avenue property. Indeed, the
listing price of the Lakeview property exceeds the amount that respondent submits
represents fair market value of the property at the time of the exchange by only
$69,000.
                                         - 31 -

[*31] Apparently, no bids were submitted at that price. Petitioners’ contract with

the realtor terminated on July 13, 2006. At trial Mr. Maynard testified that he

believed the property to be worth $350,000 at the point of exchange. Furthermore,

following his March 2006 purchase of the Lakeview Drive property, Mr. Maynard

spent approximately $10,000 to $15,000 repairing the property. Nine months later,

in November 2006 Mr. Maynard sold the Lakeview Drive property for $310,000.

      These facts, standing alone, suggest that the allocation of $750,000 to the

Harper Avenue property in the purchase agreement was excessive. Nonetheless,

petitioners repeatedly assert that the allocation represents a bargained-for-agreement

and that many of the facts respondent cites in his argument do not reflect nor

adequately account for the tumultuous period in the real estate market during which

the salient events of this case took place; we agree with petitioners.

      In determining the fair market value of a property, we endeavor to ascertain

the price that a willing buyer would pay a willing seller, both persons having

reasonable knowledge of all relevant facts and neither person being under a

compulsion to buy or to sell. See United States v. Cartwright, 411 U.S. 546, 551

(1973) (applying the standard set forth in section 20.2031-1(b), Estate Tax Regs.).

The standard is objective, using a hypothetical willing buyer and seller who are
                                        - 32 -

[*32] presumed to be dedicated to achieving maximum economic advantage in any

transaction involving the property. See Estate of Newhouse v. Commissioner, 94

T.C. 193, 218 (1990). The objective willing buyer-willing seller standard must

be achieved in the context of market and economic conditions on the valuation date.

Id.

      As noted supra, we believe the agreed-upon allocations by the adverse

parties in this case serve as the most compelling evidence of the properties’ fair

market values entered into the record. Mr. Maynard, as a knowledgeable

businessman, undoubtedly pursued his best interests in the transaction. Although

at one point at trial Mr. Maynard testified that he would not have allocated the

purchase price in the manner represented in the purchase agreement, he also

testified that he was ultimately responsible for and provided petitioners with the

purchase agreement and admitted that it was possible that he received “guidance”

from them on the allocations. We do not believe, as respondent submits, that Mr.

Maynard would cavalierly dismiss the allocations without assessing their effect

upon him. Indeed, Mr. Maynard initialed the page of the purchase agreement

upon which the allocations are displayed prominently. When viewed in its entirety,

Mr. Maynard’s testimony reflects that he does not recall, with any degree of

specificity, critical aspects of the transaction at issue. The purchase agreement,
                                         - 33 -

[*33] therefore, best represents the willing sellers’ and willing buyer’s

contemporaneous views of the fair market values of the properties exchanged.

      Concerning the general economic conditions at the point of exchange, even a

casual observer of the real estate market during that period would undoubtedly

recognize its tumult.20 Petitioners aver that the exchange of the Lakeview property

with Mr. Maynard occurred at the zenith of the real estate market in Wilmington,

North Carolina, and, conversely, Mr. Maynard’s sale of the property nine months

later occurred at its nadir. Respondent has not addressed this point but has tacitly

recognized its validity by submitting the fair market value of the property as

$350,000 rather than $310,000, which Mr. Maynard received on his subsequent sale

of the property.

      In our effort to analyze the fair market value of the exchanged properties

through the prism of the relevant market at the point of transfer, we believe

that the allocations in the purchase agreement serve as the most reliable evidence in

the record before us.




      20
         We draw no negative inference from the fact that no bids were submitted for
the Lakeview property during the two months it remained on the market at a listing
price of $419,000. The lack of bids in such a short period is not reflective of a
universal lack of interest.
                                         - 34 -

[*34] C. Conclusion

       Real estate valuation is a question of fact to be resolved on the basis of the

entire record. See Ahmanson Found. v. United States, 674 F.2d 761, 769 (9th Cir.

1981); Estate of Fawcett v. Commissioner, 64 T.C. 889, 898 (1975). In accord with

our prior discussion, we find that respondent has failed to satisfy his burden of proof

in this matter.

V. Penalties

       The Commissioner bears the burden of production on the applicability of an

accuracy-related penalty and must come forward with sufficient evidence indicating

that it is proper to impose the penalty. See sec. 7491(c); see also Higbee v.

Commissioner, 116 T.C. 438, 446 (2001). Once the Commissioner has satisfied his

burden of production, the taxpayer has the burden of persuading the Court that the

Commissioner’s determination is incorrect. See Rule 142(a); Higbee v.

Commissioner, 116 T.C. at 447. A taxpayer can meet this burden by proving that

he or she acted with reasonable cause and in good faith. Sec. 6664(c)(1); see also

Viralam v. Commissioner, 136 T.C. 151, 173 (2011).

       Respondent, in the statutory notice of deficiency, determined that petitioners

are liable for an accuracy-related penalty because of a substantial understatement of

income tax or, alternatively, for negligence or disregard of rules or regulations.
                                        - 35 -

[*35] See sec. 6662(a) and (b)(1) and (2). In posttrial briefs, however, respondent

focused solely on petitioners’ alleged substantial understatement of income tax.

Accordingly, we conclude that respondent has abandoned his alternative argument

relating to petitioners’ alleged negligence or disregard of rules or regulations. See

Mendes v. Commissioner, 121 T.C. 308, 312-313 (2003) (“If an argument is not

pursued on brief, we may conclude that it has been abandoned.”).

      A substantial understatement of income tax exists if the understatement

exceeds the greater of 10% of the tax required to be shown on the return or $5,000.

Sec. 6662(d)(1)(A). Petitioners conceded various adjustments to income before

trial, and our findings supra may require some adjustments to petitioners’ 2006 tax

liability. As the effect of such computational adjustments remains unclear, we

cannot presently determine whether petitioners’ underpayment was due to a

“substantial understatement” of income tax for their 2006 taxable year. This issue,

however, will be resolved following a Rule 155 computation.

      Notwithstanding that for the moment we leave unresolved whether petitioners

reported a substantial understatement of income tax for their taxable year 2006, for

purposes of judicial economy we turn to whether petitioners had reasonable cause

and acted in good faith as to any underpayment of their income tax liability.
                                         - 36 -

[*36] “Reasonable cause requires that the taxpayer have exercised ordinary

business care and prudence as to the disputed item.” Neonatology Assocs., P.A. v.

Commissioner, 115 T.C. 43, 98 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002). A

taxpayer may demonstrate reasonable cause through good-faith reliance on

the advice of an independent professional, such as a tax adviser, a lawyer, or an

accountant, as to the item’s tax treatment. United States v. Boyle, 469 U.S. 241,

251 (1985); Canal Corp. & Subs. v. Commissioner, 135 T.C. 199, 218 (2010); sec.

1.6664-4(b), Income Tax Regs. To prevail in this effort, the taxpayer must show

that he or she: (1) selected a competent adviser with sufficient expertise to justify

reliance; (2) supplied the adviser with necessary and accurate information; and (3)

actually relied in good faith on the adviser’s judgment. Neonatology Assocs., P.A.

v. Commissioner, 115 T.C. at 99; see Sanford v. Commissioner, T.C. Memo. 2008-

158, 2008 Tax Ct. Memo LEXIS 159, at *17.

      Petitioners submit that they relied on their accountant in preparing their

taxable year 2006 return; however, at trial they offered no testimony or evidence

concerning the expertise of their accountant, the information they allegedly provided

to their accountant, or their actual reliance in good faith on their accountant’s

advice. Accordingly, we find that petitioners have failed to demonstrate their

reasonable cause and good faith in this case.
                                          - 37 -

[*37] VI. Conclusion

      Recapitulating our prior discussions, we hold that (1) petitioners failed to

demonstrate that they held the Memorial Avenue property for investment or

business purposes; (2) respondent failed to satisfy his burden of proof in his attempt

to demonstrate that petitioners improperly allocated fair market values to

real properties in their like-kind exchange; and (3) subject to a Rule 155

computation, petitioners are liable for a section 6662(a) accuracy-related penalty.

      In reaching our holdings herein, we have considered all arguments made,

and, to the extent not mentioned above, we conclude they are moot, irrelevant,

groundless, or otherwise without merit.

      To reflect the foregoing,


                                                         Decision will be entered

                                                   under Rule 155.
