                        T.C. Memo. 1998-167



                      UNITED STATES TAX COURT



ESTATE OF PAULINE WELCH, DECEASED, NEWTON G. WELCH, JR. AND LOIS
           WELCH MCGOWAN, CO-EXECUTORS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 27513-96.                       Filed May 6, 1998.



     James David Leckrone, for petitioner.

     William W. Kiessling, for respondent.


                        MEMORANDUM OPINION

     LARO, Judge:   The Estate of Pauline Welch (the estate)

petitioned the Court to redetermine respondent's determination of

a deficiency in the amount of $59,987 in its Federal estate tax.

Following concessions by both parties, the remaining issue is

whether the estate is entitled to discount the value of stock for

built-in capital gains tax liability.   Unless otherwise stated,
                              - 2 -


section references are to the Internal Revenue Code in effect as

of the date of the decedent's death.    Rule references are to the

Tax Court Rules of Practice and Procedure.    The term

"coexecutors" refers to the estate's coexecutors, Newton G.

Welch, Jr. (Newton) and Lois Welch McGowan.

                           Background

     This case was submitted fully stipulated under Rule 122.

The stipulation of facts and the exhibits submitted therewith are

incorporated herein by this reference.   When the petition was

filed, the coexecutors resided in Nashville, Tennessee.

     Pauline Welch (decedent) died on March 18, 1993.    At the

time of her death, decedent was a minority shareholder in two

closely held corporations, Electric Services, Inc. (ESI) and

Industrial Sales Co., Inc. (ISC).   On the date of decedent's

death, ESI had 570 shares issued and outstanding (110 voting

common shares/460 nonvoting common shares) of which decedent

owned 259 nonvoting common shares; ISC had 836 shares issued and

outstanding (150 voting common shares/686 nonvoting common

shares) of which decedent owned 259 nonvoting common shares.      The

coexecutors, decedent's son and daughter, equally inherited

decedent's property, including the common nonvoting shares of ESI

and ISC.

     The remaining shares of both corporations, voting and

nonvoting common, were held in a trust established under the will
                               - 3 -


of Newton G. Welch, decedent's deceased husband.     Pursuant to his

will, upon decedent's death, the coexecutors each received one

half of ESI's and ISC's voting common shares held in trust (i.e.,

one-half of 110 and 150 shares, respectively), and one-half of

ESI's and ISC's nonvoting common shares held in trust (i.e., one-

half of 197 and 423, respectively).1

     The estate tax valuation was done on a net asset valuation

method.   Employed by the estate, Mercer Capital Management, Inc.

(Mercer) valued ESI and ISC at $670,000 and $1,809,000,

respectively, as of the date of decedent's death.2    In arriving

at these values, Mercer did not include the following real

property owned by each corporation:    ESI owned real property

located at 213-215 5th Avenue South and 301-307 5th Avenue South,

Nashville, Tennessee; and ISC owned real property located at 305

5th Avenue South and 302 6th Avenue South, Nashville, Tennessee.

Mercer excluded these properties from its calculations because it

believed that the properties had been targeted for potential sale

to the City of Nashville.   Further, Mercer did not apply a

     1
        The record does not disclose the reason for the disparity
between the amount of shares issued and outstanding by each
corporation and the total identified shares (ESI having 570
shares issued and outstanding, 566 owned by decedent and held in
trust; ISC having 836 shares issued and outstanding, 832 owned by
decedent and held in trust).
     2
        Mercer did not consider either ESI or ISC to be in
liquidation in valuing their respective stock. Neither ESI nor
ISC was liquidated, and both corporations remain in existence and
continue to operate to date.
                                   - 4 -


discount to reflect the corporations' built-in capital gains tax

liability.

     In determining the value of decedent's shares of ESI and ISC

on the estate tax return, the estate combined the Mercer

valuation of the corporations' value with estimates of the value

of the real property owned by both corporations, and then applied

a 34-percent discount for built-in capital gains on the real

property and a 50-percent discount for decedent's minority

interest.3   The estate's computation is as follows:

                             ESI                 ISC

Mercer value               $670,000           $1,809,000
Real estate value           750,000              500,000
     total value          1,420,000            2,309,000

Less: discount for
  capital gains on real
  estate (34%)              255,000              170,000

Less: 50% discount for
  minority interest         582,500            1,069,500

     discounted value      582,500             1,069,500

Number of shares
  outstanding                   570                    836

Per share value               1,020.84             1,276.02

Number of shares owned

     3
        As for the capital gains discount, the estate did not
deduct the adjusted basis of the properties owned by ESI or ISC.
The capital gain rate of 34 percent was applied to the estimated
real estate values of the respective properties. The parties
agree that the estate should have deducted the adjusted basis
from the estimated real estate values. Our holding makes this
computational adjustment unnecessary.
                                - 5 -


  by decedent                 x 259                 x 259


Value of decedent's
  shares per estate tax
  return (Form 706)       264,398                330,491

On December 22, 1993, the coexecutors filed a Form 706, United

States Estate (and Generation-Skipping Transfer) Tax Return,

electing the date of death as the valuation date.   The reported

value of the ESI and ISC stock is $264,398 and $330,491,

respectively, for a per share value of $1,020.84 and $1,276.03,

respectively.

     On March 4, 1994, Newton acquired all of the voting and

nonvoting shares of both ESI and ISC which he did not already own

from Lanny B. McGowan, his brother-in-law, and Lois Welch McGowan

(collectively the McGowans) for $2,100,000.   At the time of the

transaction, Newton and the McGowans each owned 50 percent of

ESI's and ISC's voting and nonvoting shares. The purchase price

for the nonvoting shares of ESI and ISC was $1,021 and $1,276 per

share, respectively, the approximate per share value identified

on the estate's tax return.   The remainder of the purchase price

was allocated equally between ESI's and ISC's voting stock.

Newton, as the buyer in the stock purchase agreement, covenanted

that ESI and ISC would purchase real property to relocate the

businesses of ESI and ISC once possession of their respective

properties was lost to the Metropolitan Government of Nashville
                               - 6 -


and Davidson County due to condemnation proceedings.     The

provision in the aforementioned agreement reads as follows:

          13.01 Replacement Property. Buyer, [ISC and ESI]
     represent[s] and warrant[s] to Sellers that one or more
     of said entities plan to purchase real property to
     relocate the business of [ISC and ESI] once possession
     of said property is lost to the Metropolitan Government
     of Nashville and Davidson County, Tennessee due to
     condemnation proceedings. Buyer, [ISC and ESI]
     acknowledges that Sellers are relying upon the purchase
     of said replacement property in order to secure the
     [$350,000] Promissory Note constituting part of the
     deferred payment to Sellers.

     On May 31, 1994, ESI and the Metropolitan Development and

Housing Authority (Housing Authority) entered into a contract of

sale of real estate for the properties located at 213-215 5th

Avenue South and 301-307 5th Avenue South for $775,000.     Also on

May 31, 1994, ISC and the Housing Authority entered into a

similar contract for the sale of properties located at 305 5th

Avenue South and 302 6th Avenue South for $550,000.

     ESI and ISC each made elections on their 1994 U.S.

Corporation Income Tax Return, Form 1120, not to recognize gain

realized from the compulsory or involuntary conversion of

property under section 1033(a)(2).     On its 1994 return, ESI

elected not to recognize $701,161 in realized gain resulting from

a June 20, 1994, condemnation of its building and land.     On its

1994 return, ISC also elected not to recognize $465,250 in

realized gain resulting from a June 20, 1994, condemnation of its

building and land.   In doing so, both corporations stated that
                               - 7 -


they were planning to purchase replacement property within the

replacement period.

     ESI's 1994 tax return shows a net operating loss (NOL)

carryover generated for 1993 in the amount of $120,990: $87,443

of the carryover was utilized in 19904; leaving $33,547 available

for carryover to 1994.   The $33,547 NOL was used in 1994 to

offset taxable income of $19,465.   ESI's 1995 tax return shows an

available NOL carryover of $14,217, used to offset taxable income

of $21,587.   After application of the NOL, ESI's 1994 and 1995

taxable income was zero and $7,370, respectively.   ISC's 1994 and

1995 tax returns show no NOL carryover, $195,462 and $21,182 in

taxable income, respectively, and $59,480 and $3,177 in total tax

due, respectively.

     On September 27, 1996, respondent issued a notice of

deficiency which determined, among other things, that the fair

market value of decedent's shares in ESI and ISC was $328,294 and

$365,419, respectively, rather than the $264,398 and $330,491

shown on the estate tax return.   The primary difference between

respondent's determined value and the estate's returned value

stems from respondent's disallowance of the built-in capital

gains discount.5

     4
        This data indicates that ESI either had losses or broke
even in 1992 and 1993.
     5
         Respondent's determined value also reflects an increase
                                                    (continued...)
                                 - 8 -


                            Discussion

     For Federal estate tax purposes, property includable in the

gross estate is generally included at its fair market value on

the date of decedent's death.    Secs. 2031(a) and 2032(a); sec.

20.2031-1(b), Estate Tax Regs.    Fair market value is defined as

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.

Sec. 20.2031-1(b), Estate Tax Regs.; see also United States v.

Cartwright, 411 U.S. 546, 551 (1973); Mandelbaum v. Commissioner,

T.C. Memo. 1995-255, affd. without published opinion 91 F.3d 124

(3d Cir. 1996).   The willing buyer and the willing seller are

hypothetical persons, instead of specific individuals and

entities, and the characteristics of these imaginary persons are

not necessarily the same as the personal characteristics of the

actual seller or a particular buyer.     Estate of Bright v. United

States, 658 F.2d 999, 1005-1006 (5th Cir. 1981).

     In determining the value of unlisted stocks, actual arm's-

length sales of such stock in the normal course of business

within a reasonable time before or after the valuation date are

ordinarily the best criteria of market value.    In the absence of


     5
      (...continued)
in the value of ESI's and ISC's real property from the estate's
reported value of $750,000 and $500,000, respectively, to
$775,000 and $550,000, respectively.
                                - 9 -


arm's-length sales, the value of closely held stock must be

determined indirectly by weighing the corporation's net worth,

prospective earning power, dividend-paying capacity, and other

relevant factors.   Sec. 2031(b); Estate of Andrews v.

Commissioner, 79 T.C. 938, 940 (1982).    Fair market value is a

factual determination for which the trier of fact must weigh all

relevant evidence and draw appropriate inferences and

conclusions.   Commissioner v. Scottish Am. Inv. Co., 323 U.S.

119, 123-125 (1944).

     The parties agree that the fair market value of decedent's

interest in ESI and ISC as of the applicable valuation date,

absent a discount for built-in capital gains, is $328,294 and

$365,419, respectively.6   The estate argues that a willing seller

and a willing buyer of the corporate stock would have discounted

the value of ESI's and ISC's stock to reflect the income tax

liability due upon sale of the condemned properties.     In support

thereof, the estate contends:    At the time of decedent's death,

the real property owned by ESI and ISC was under threat of

condemnation by the Housing Authority; that the real property was

in fact sold to the Housing Authority; and that a portion of the

nonvoting common stock owned by the decedent at her death was

     6
        These figures reflect   respondent's allowance of the 50
percent minority discount and   the parties' agreement that the
fair market value of the real   property formerly owned by ESI and
ISC, absent any discount, was   $775,000 and $550,000,
respectively.
                              - 10 -


sold on March 4, 1994, at a per share price equal to the per

share price shown on the estate's Federal estate tax return.     As

to the March 4, 1994, stock sale, the estate is, in essence,

arguing that the sale is indicative of what a willing buyer would

have paid for the stock on the valuation date given the income

tax liability inherent in the aforementioned property.

     Respondent makes several arguments for disallowing a built-

in capital gains discount.   First, respondent argues that the

estate has not established that a liquidation of the corporations

or the sale of the corporations' assets was likely to occur.

Among other things, respondent contends that the estate has

failed to show that the condemnation of the subject properties

was foreseeable on the valuation date, and that the evidence

establishes that legislative action to condemn the property was

not taken until August 12, 1993, more than 5 months after the

valuation date.   Second, respondent argues that the discount is

not warranted where only the real estate, and not the

corporations, was subject to condemnation.   Third, respondent

argues that the discount is not warranted where both corporations

could avoid, and did indeed avoid, the recognition of gain under

section 1033.

     As previously stated, ordinarily a sale within a reasonable

time before or after the valuation date is the best criteria of
                              - 11 -


market value.   See Estate of Scanlan v. Commissioner, T.C. Memo.

1996-331, affd. without published opinion

116 F.3d 1476 (5th Cir. 1997).   However, in this case, we do not

assign any weight to the March 4, 1994, stock sale which included

the sale of nonvoting common shares in ESI and ISC.   The sale was

between related parties, the coexecutors (decedent's son and

daughter).7   Moreover, the coexecutors appear to have determined

the sales price of the stock solely by referencing its fair

market value as reported on decedent's Federal estate tax return,

even though the sale occurred approximately 12 months after

decedent's death.   We therefore focus our attention on the issue

of whether the value of decedent's interest in ESI and ISC

includes a discount for built-in capital gains tax liability.

The estate must prove error in respondent's determination of

value as set forth in respondent's notice of deficiency.   Rule

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

     This Court has repeatedly rejected reductions in value of

closely held stock to reflect built-in capital gains tax

liability where the evidence fails to establish that a

liquidation of the corporation or sale of the corporation's

assets is likely to occur.   See Ward v. Commissioner, 87 T.C. 78,

103-104 (1986); Estate of Andrews v. Commissioner, supra at 942;


     7
        We also note that Lanny B. McGowan, Lois Welch McGowan's
husband, was and remains an officer of ISC.
                              - 12 -


Estate of Cruikshank v. Commissioner, 9 T.C. 162, 165 (1947);

Estate of Thalheimer v. Commissioner, T.C. Memo. 1974-203, affd.

on this issue and remanded without published opinion 532 F.2d 751

(4th Cir. 1976).   Recently, in Eisenberg v. Commissioner, T.C.

Memo. 1997-483, the Court stated:

     taxpayers may not obtain a valuation discount for
     estate and gift tax purposes based on an event that may
     not transpire. Hence, "When liquidation is only
     speculative, the valuation of assets should not take
     these costs into account because it is unlikely they
     will ever be incurred." [Estate of Andrews v.
     Commissioner, supra at 942; emphasis added.]


          In sum, the primary reason for disallowing a
     discount for capital gain taxes in this situation is
     that the tax liability itself is deemed to be
     speculative. [In prior cases] * * * there was a
     failure to show the requisite likelihood that the
     beneficiaries would liquidate the corporation or sell
     the underlying assets and incur the tax and other
     expenses. Further, there was no showing that a
     hypothetical willing buyer would desire to purchase the
     stock with the view toward liquidating the corporation
     or selling the assets, such that the potential tax
     liability would be of material and significant concern.

     We find that in this case the potential for capital gains

tax recognition was too speculative to warrant application of the

capital gains discount.   As suggested in Eisenberg v.

Commissioner, supra, and other cases cited above, the estate must

show the requisite likelihood that the corporation would sell the

assets and incur the tax.   Assuming that the condemnation of the
                              - 13 -


subject properties was foreseeable as of the valuation date8, see

Ithaca Trust Co. v. United States, 279 U.S. 151 (1929)(subsequent

events are not considered in determining fair market value,

except to the extent that they were reasonably foreseeable at the

date of valuation); Estate of Scanlan v. Commissioner, supra, and

consequently there was the requisite likelihood that the

corporations would sell the properties, the estate has failed to

show that it was likely that either of the corporations would pay

built-in capital gains tax upon sale.

     As a general rule, gain realized from the sale or other

disposition of property must be recognized.   See sec. 1001(c).

Section 1033 provides an exception to this general rule by

allowing gain realized from certain involuntary conversions to be

deferred.   Realized gain can be deferred in its entirety under

section 1033 if: (1) nonrecognition treatment is elected; (2)

qualified replacement property is purchased within the time

limits specified; and (3) the cost of the qualified replacement

property equals or exceeds the amount realized on the conversion.

Sec. 1033(a)(2)(A).   Among other things, an involuntary


     8
        The only evidence submitted which tends to show that the
estate was aware of potential condemnation of the real property
on the valuation date, and not thereafter, is a magazine article
entitled Nashville Neighborhoods Downtown Turning Renderings into
Reality, published in the Aug. 1992 issue of Nashville Business
and Lifestyles. The article discusses revitalization of the
downtown Nashville area, and the proposal appears to encompass
properties owned by ESI and ISC.
                               - 14 -


conversion results when property is condemned by the government.

Sec. 1033(a).   The aforementioned exception to the general rule

that gain is recognized casts doubt on whether or when a taxpayer

would have to recognize gain as a result of an involuntary

conversion.9

     A section 1033 election was available to the estate on the

applicable valuation date.   The estate presented no evidence that

on or near the valuation date either corporation considered

recognizing the built-in capital gain and foregoing the election

under section 1033.   Additionally, ESI and ISC manifested their

intent to find replacement properties by filing the section 1033

elections with each corporation's 1994 Federal income tax

returns.   The principal shareholder, and now sole shareholder,

Newton covenanted to find replacement property when he acquired

the shares of the other shareholders.   Given these facts, no

reduction in value should be allowed for the corporations' built-

in capital gains, and we therefore uphold respondent's

determination on this issue.




     9
        We also note that a corporation's recognition of built-in
capital gains is far from certain, even in the absence of special
nonrecognition provisions such as sec. 1033. A corporation's NOL
carrybacks and carryovers can limit or extinguish any potential
recognition of built-in capital gain for up to 19 years. See
sec. 172. For example, in 1994, ESI could have offset its
$701,162 capital gain by the $33,547 NOL carryover (if the gain
had been recognized).
                             - 15 -


     We have considered all other arguments made by the parties

and found them to be either irrelevant or without merit.

     To reflect the foregoing,

                                        Decision will be entered

                                   under Rule 155.
