                        T.C. Memo. 1996-419



                      UNITED STATES TAX COURT


       LOREN F. PAULLUS AND DONNA PAULLUS, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

              RIDGEMARK CORPORATION, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket Nos. 6105-93, 6106-93.    Filed September 17, 1996.



     Clarence J. Ferrari, Jr., George P. Mulcaire, J. Timothy

Maximoff, and C. David Spence, for petitioners.

     Christopher J. Faiferlick and Barbara M. Leonard, for

respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   Respondent determined a deficiency in

petitioners Loren F. Paullus and Donna Paullus’ 1989 Federal

income tax in the amount of $124,324 and a penalty under section
                               - 2 -


6662(a)1 in the amount of $10,690.     Respondent also determined a

deficiency in petitioner Ridgemark Corp.’s 1989 Federal income

tax in the amount of $2,488,051 and a penalty under section

6662(a) in the amount of $497,610.

     After concessions, the issues remaining for our

consideration are:   (1) Whether real property held and exchanged

in 1989 by petitioner Ridgemark Corp. qualifies for income tax

deferral pursuant to section 1031; and (2) whether petitioners

Ridgemark Corp. or Loren F. and Donna Paullus are separately

liable for penalties under section 6662(a).

                         FINDINGS OF FACT2

     Petitioner Ridgemark Corp. (Ridgemark) is incorporated, and

its principal place of business at the time its petition was

filed was Hollister, California.     Petitioners Loren F. and Donna

Paullus (petitioners), at the time their petition in this case

was filed, resided in Paicines, California.     Loren F. Paullus

(Paullus) was president of Ridgemark from 1971 until March 1992.

He also served on Ridgemark’s board of directors.

     Paullus owned and operated a 110-acre turkey ranch in

Hollister, California, which he considered developing into a golf

     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable year under
consideration, and all Rule references are to this Court’s Rules
of Practice and Procedure.
     2
       The parties’ stipulation of facts and exhibits are
incorporated in this opinion by this reference.
                               - 3 -


course as early as 1960.   Paullus decided to proceed after

determining that his ranch possessed a substantial water supply

that could support the proposed golf course operation.

     Ridgemark was incorporated by Paullus and other investors on

or about November 4, 1971.   The Pre-Incorporation Subscription

Agreement provides that Ridgemark will be able to

     transact and carry on the business of acquiring, owning
     and improving land for recreational and residential
     purposes, selling memberships in and playing privileges
     in a golf course, and subdividing and selling improved
     or unimproved lots for residential purposes * * *

Ridgemark’s articles of incorporation also provide that the

corporation's business purposes are “To engage primarily in the

specific business of acquiring, developing, owning and selling

real property."

     Paullus contributed the 110-acre turkey farm to the

corporation in exchange for stock.     The other investors

contributed cash and real property in exchange for stock in

Ridgemark.   At the time of incorporation, Paullus acquired 59.3

percent of Ridgemark’s outstanding stock.

     On or about November 12, 1971, Ridgemark was authorized by

its board of directors to purchase golf course irrigation

equipment from Western Rain Bird Sales.     Ridgemark also purchased

102-acre and 70-acre parcels for the golf course project.

     On June 22, 1972, Ridgemark filed a Declaration of Covenants

and Restrictions with San Benito County, California, for
                               - 4 -


Ridgemark Estates, a planned development.    An unincorporated

association, Ridgemark Homes Association, was formed for the

purpose of enforcing and administering covenants and

restrictions, as well as approval for home construction and lot

improvements.   Lot owners were eligible to be members of

Ridgemark Homes Association.   Ridgemark Estates was located

adjacent to the golf course.

     Ridgemark constructed the golf course and related

recreational facility.   Upon completion of the Ridgemark Golf and

Country Club, Ridgemark sold golf club memberships.    Memberships

consisted of annual, renewable licenses to use the facilities

with no proprietary rights or privileges.    Golf memberships were

sold by Ridgemark, in part, to fund the construction, operation,

and expansion of the golf course facility.

     For a few years, Ridgemark sold unimproved and unsubdivided

lots.   These sales also provided golf course funding to

Ridgemark.   Ridgemark generally followed the practice of selling

improved residential lots to purchasers for cash for the

construction by such purchasers of single family houses.

     Ridgemark acquired a real estate brokerage license.

Paullus’ daughter ran the sales department.    On or about April

1977, however, Ridgemark’s board of directors terminated its

practice of selling improved residential lots.    The board decided

that it was desirable to limit Ridgemark’s activities to the sale
                                - 5 -


of unimproved and improved land, the operation of Ridgemark Golf

and Country Club, and the conduct of the real estate brokerage

business.    The board desired to protect the corporation from

liabilities that might arise from the construction and financing

business.    Consequently, on May 3, 1977, Ridgemark Construction

Corp. (Construction) and Ridgemark Financial Corp. (Financial)

were formed to segregate the residential lot activity.

     Construction was to engage in construction, subdivision,

development, and sale of residential units and townhomes.

Financial was to engage in financing, development, improvement,

and sale of single family lots.    Ridgemark’s board of directors

resolved to sell improved lots to Construction and Financial at

prices equivalent to cost plus no less than 25-percent profit.

Before Financial and Construction were formed, Ridgemark had sold

approximately 200 lots.    After that, Ridgemark was not involved

in the improvement and sale of lots.

     As of April 1977, Ridgemark owned the following real

property:

     1.     Lot 82, Unit #2
     2.     Several lots in Unit #3
     3.     Golf course land
     4.     Clubhouse land
     5.     Miscellaneous parcels of land near the water tower
     6.     27.9 acres at the end of George’s Drive
     7.     8 acres near Ray’s Circle
     8.     5.95 acres below Ridgemark Village
     9.     7.3-acre parcel
                          - 6 -


10.   37.34 acres at the northeast corner of Airline
      Highway and Fairview Road
                                - 7 -


     11.   47.2 acres where the maintenance barn, the guest
           cottage site, and the old Paullus residence are
           located
     12.   35.08-acre parcel
     13.   7-acre parcel

     On October 18, 1977, Ridgemark conveyed improved and

unsubdivided land to Construction for $175,000.    The final

subdivision public report was issued to Construction on

February 1, 1979.

     During 1980, Ridgemark expanded the golf course because the

existing facilities were becoming overcrowded.    A $1 million

expansion increased the clubhouse facility from 6,600 to 22,600

square feet.   Ridgemark also promoted a joint venture with

private investors to build 32 guest cottages for rental purposes

in order to increase its attraction and use as a destination golf

resort.    The expansion had a positive effect on Ridgemark’s golf

and recreation business.   Ultimately, Ridgemark acquired

ownership of the guest cottages.

     As of April 1987, Ridgemark owned the following assets:

     1.    Lot 82, Unit #2
     2.    Several lots in Unit 3
     3.    Approximately 150 acres of golf course land
     4.    Approximately 5 acres of clubhouse land
     5.    Approximately 20 acres of land near a water tower
           (Perry Hill)
     6.    27.9 acres at the end of George’s Drive
     7.    8 acres near Ray’s Circle
     8.    5.95 acres below Ridgemark Village
     9.    7.3-acre parcel near entrance to Ridgemark Village
                          - 8 -


10.   37.34 acres at the northeast corner of Airline Highway
      and Fairview Road
                               - 9 -


     11.   47.2 acres where the maintenance barn, guest cottage
           site, and the old Paullus residence were located
     12.   35.08 acres composed of three parcels located at
           George’s Drive, Ray’s Circle, and the end of Ridgemark
           Drive
     13.   7-acre parcel located off Ridgemark Drive

     Ridgemark acquired only two properties after April 1977:

(1) March 27, 1984, 1.89 acres at the corner of a major highway;

and (2) February 1985, 269 acres from Bushmont Properties

(Bushmont property).   Ridgemark paid $1,825,379.90 for the

Bushmont property.

     Ridgemark built a second 18-hole golf course, a tennis

center, and a new clubhouse facility on approximately 130 acres

of the Bushmont property.   The new 18-hole golf course located on

the Bushmont property had a cost of about $1,600,000.   The value

of the Bushmont property, after improvements, was estimated to be

$3 million.   A lighted 10-court tennis facility and a new 5,000-

square-foot clubhouse located on the Bushmont property cost

approximately $492,000.   Ridgemark also added 175 parking spaces.

     The vast majority of Ridgemark’s real property holdings had

been acquired as of 1977.   Between April 1977 and 1989, Ridgemark

sold the following properties to either Financial or

Construction:
                                  - 10 -


                                   Acquisition    Improvement    Sale
 Property Sold       Sale Price       Cost            Cost       Date

35 acres, Unit #4     $350,880     $153,732.00   $77,550.00
12/31/77
7 acres, Unit #5       175,000       58,670.00    80,901.72
10/18/77
7.3 acres, Unit #6     300,000       32,802.22    49,496.61
3/31/81
41 acres, Unit #7    2,460,000      369,583.00   249,550.00
4/12/85
13.43 acres,
  Unit # 8,
  phase one          1,347,000      121,060.00   137,123.96
11/18/85
10.53 acres,
  Unit #8,
  phase two          1,053,000       94,919.74     5,718.20
8/24/87
16.23 acres,
  Unit # 9           1,054,950      146,300.79    63,122.23
6/30/87


     On March 15, 1985, Ridgemark agreed to sell the units 7 and

8 properties to Financial and Construction, respectively.       By

that time, Ridgemark had acquired tentative maps for units 7 and

8.   The agreements provided that, concurrently with the recording

of the final maps for units 7 and 8, Ridgemark would sell the

properties to Financial and Construction.        On April 12, 1985, and

November 18, 1985, the final maps for units 7 and 8,

respectively, were granted and the transactions concluded.

     On February 24, 1987, Ridgemark agreed to sell the unit 9

property to Financial.     By that time, Ridgemark had obtained

approval for a tentative map.      The agreement contains a clause

providing that within 90 days of the recording of the final map

for unit 9, Ridgemark would sell the property to Financial.        The
                              - 11 -


final map for unit 9 was recorded on May 19, 1987.   Ridgemark’s

May 26, 1987, corporate minutes reflect that it intended to sell

the unit 9 property to Financial within 1 month.   The property

was sold on June 30, 1987, and deeded July 10, 1987.

     When Ridgemark sold the units 4 through 9 properties to

Financial and Construction, Robert A. Prior (Prior), Ridgemark’s

attorney, did the preliminary filing of the applications with the

State of California Department of Real Estate (DRE).    These lots

were developed and sold by Construction or Financial, although

the preliminary approval for subdividing was obtained in

Ridgemark’s name.   The final report, however, was issued in the

name of the subdivider, either Financial or Construction.    The

lots herein were zoned for the highest possible use (residential)

in order to maximize possible loans by third parties.

     On February 24, 1987, in an effort to “increase the

marketability of lots and townhomes”, Ridgemark’s board of

directors voted to restrict the sales of new golf memberships to

people who owned property in and resided in Ridgemark Estates.

On May 26, 1987, Ridgemark’s board of directors met to discuss

Ridgemark’s financial status, and the board reversed its decision

of February 24, 1987:

     [Ridgemark] will market a golf subscription to persons
     who are not owners of a lot or a unit and a resident of
     Ridgemark Estates. The subscription price will be
     $4,000.00. The subscription will have a term of five
     years, and will not be transferable and will have no
     golf cart use privileges, and can be converted to a
                              - 12 -


     class A golf, tennis and social membership or class A
     golf and social membership if the subscriber becomes
     the owner of a lot or unit and a resident of Ridgemark
     Estates within the five year term and pays the excess
     of the membership initiation fee over the $4,000.00
     subscription price.

The corporate minutes reflect that the board of directors

considered the further expansion of the golf facility and other

related activities, such as the purchase of 10 gasoline-powered

golf carts.   The board also explored the possibility of future

development of all the remaining land south of Airline Highway.

Ridgemark’s engineer estimated that approximately 300 lots would

be produced at an average net sale price of $60,000, which would

produce gross profits of $18 million.   An additional $9 million

could be produced by selling the lots improved with houses.

     In the same meeting, the board of directors also authorized

Paullus to have preliminary discussions with representatives of

potential purchasers regarding the sale of Ridgemark.   By that

time, certain Ridgemark shareholders sought to dispose of their

shares.   Paullus desired to be relieved of the responsibilities

involved in the management of Ridgemark Golf and Country Club.

He also sought to liquidate Ridgemark’s assets in order to expand

into a new venture, the proposed Paicines project.

     On February 23, 1988, the corporate minutes reflected the

fact that the tentative map for the unit 10 property, comprising

164 lots, had been filed with the San Benito County Planning
                               - 13 -


Department.   The tentative map for the unit 10 property was

approved on April 6, 1988.

     On May 5, 1988, the board investigated the advantages

inherent in having Ridgemark perform as the subdivider of unit 10

as compared with selling the property to Construction and having

it act as the subdivider.    The board determined that the

development of unit 10 by Construction would be preferable.

     On August 2, 1988, Joseph Drosihn (Drosihn), a

representative of Y.L. Shen (Shen), contacted Ridgemark regarding

the purchase of all the developable land owned by Ridgemark.

Drosihn and Paullus agreed that land that had been formerly

conveyed to Financial would be reconveyed to Ridgemark and

included within its assets upon sale.

     On August 8, 1988, Ridgemark represented that it intended to

subdivide land that was covered under prior agreements with the

local water utility.   Consequently, the unit 10 property needed

sewer and water service installed.      Ridgemark was referred to as

“Subdivider” in the agreement and agreed to pay $290,465 for

installation of water facilities and $282,559 for the

installation of sewerage facilities.

     On August 12, 1988, Ridgemark’s board of directors met to

discuss the offer by Shen.    The minutes of the meeting state:

     The President [Paullus] advised the meeting that his
     legal and tax advisors are developing a transaction
     structure to include a tax free exchange in the sale of
     the Corporation and the purchase of the Paicines Ranch,
                              - 14 -


     for the benefit of him and his associates in the
     Paicines Ranch project and, in order to implement such
     structure, he and his associates are willing to
     purchase the shares of the capital stock of the
     Corporation from the other shareholders at the same
     price per share as that paid by the purchaser, less a
     prorata [sic] share of the brokers’ commission, and
     with an interest rate of 10% per year on the deferred
     portion of the purchase price and providing each
     selling shareholder the security given by the
     purchaser.

On August 23, 1988, the board further discussed the Drosihn

proposal.   Paullus reported that he had reached an agreement with

Drosihn that once approval of the final map for unit 10 was

obtained, the sales of lots in unit 10 would commence.   The

minutes contain the notation that there were 97 people interested

in purchasing lots in unit 10.

     In an August 27, 1988, letter, Shen’s representative was

informed that Ridgemark’s board had authorized its corporate

officers to engage in negotiations to sell Ridgemark.    The letter

provides that neither the assets nor the stock of Construction or

Financial were involved in any proposed sale.   Initially,

negotiations contemplated a straightforward sale of all of

Ridgemark’s stock to Shen.

     An agreement with San Benito County recorded on

September 22, 1988, reflects that Ridgemark was “in the process

of developing or improving” the unit 10 property.   Ridgemark was

required to make improvements, including the necessary paving,

curbs, gutters, catch basins, pipes, culverts, water mains, storm
                              - 15 -


drainage systems, and sanitary sewers.   Ridgemark and San Benito

County agreed that Ridgemark would be contractually liable to

complete the enumerated improvements after the issuance of the

final map.   On September 23, 1988, Ridgemark notified DRE that as

subdivider of unit 10, it would grant nonexclusive easements to

certain streets to the owners of the lots in unit 10.

     On September 26, 1988, Ridgemark entered into a Subdivision

Services Agreement with Bill Vierra & Associates, Inc. (Vierra).

In this agreement, Ridgemark agreed to be represented by Vierra

in filing the Preliminary and Final Public Report applications

with DRE in connection with “Ridgemark Estates No. 10".

     On the same date, Vierra filed an application for a Final

Public Report for Ridgemark Estates, unit 10.   Ridgemark is

reflected as the subdivider, with Paullus as its representative.

The Notice of Intention for unit 10 reflects that it would be

used solely for single family residential homes.   However, the

lots in unit 10 would be sold as vacant lots.   The ultimate

purchaser would be responsible for special fees charged to the

lot, such as school impact fees, fire and police department

impact fees, and traffic mitigation impact fees, either when the

purchaser obtained a building permit or prior to occupancy.

Finally, it was indicated that membership in Ridgemark Golf and

Country Club would be utilized as an inducement for the unit 10

lots.   On November 14, 1988, Ridgemark’s board of directors
                              - 16 -


determined that Shen’s proposal was unacceptable, and Paullus was

authorized to terminate negotiations and “proceed with the sales

of lots in the Unit 10 subdivision.”     On December 6, 1988, Shen’s

representative, Drosihn, and Paullus, however, signed a letter of

intent delineating the terms and conditions for Shen’s purchase

of Ridgemark’s outstanding shares.     Ridgemark reserved the right

to structure a tax-free or tax-deferred exchange without any

added cost or risk to the buyer.

     On December 7, 1988, Shen rejected the proposed stock sale

because of “an adverse unresolved tax problem”.     Drosihn,

however, advised Paullus that Shen was still interested in

purchasing Ridgemark and sought a meeting of tax specialists to

structure the transaction in a mutually acceptable manner to

resolve the tax problem.   It became evident that Shen was not

interested in purchasing the Ridgemark Golf and Country Club

unless Paullus agreed to manage the operation for a period of 10

years.   Paullus was unwilling to continue the management of the

golf course and resort facilities.     On December 13, 1988,

Ridgemark’s board of directors met to discuss Shen’s new offer to

purchase the 120 lots in the unit 10 subdivision.3    The tax

consequences of the proposed purchase were discussed in the

minutes.

     3
       The minutes for Aug. 23, 1988, reflect that due to a
boundary dispute, Ridgemark decided to exclude the disputed strip
of land and reduced the land in question from 164 to 120 lots.
                              - 17 -


     Paullus counteroffered in a December 15, 1988, letter, which

proposed a restructured transaction under which Shen would

acquire Ridgemark’s assets except the land, facilities, and

equipment of Ridgemark Golf and Country Club.   Specifically,

Ridgemark offered to sell the unit 10 property for a price of $10

million, with Shen assuming the responsibility of completing the

improvements related to the subdivision of the property into

buildable lots.   An alternative offer for $11,500,000 was made

under which Ridgemark would complete the improvements.   The

letter offered the unit 10 property for sale upon the terms and

conditions specified, which included Ridgemark’s tax-free

exchange requirement.   The schematics associated with the offer

included the statement that the proposed transaction appeared to

qualify for a section 1031 exchange.   On December 21, 1988,

Paullus sent a completed draft of the letter and schematic of the

proposed transaction.   Ridgemark obtained the approval of the

final subdivision map and constructed certain offsite

improvements for the unit 10 property because Shen, through

assignees, wanted to be able to build houses and sell lots as

soon as possible after closing.

     On January 9, 1989, Ridgemark’s board of directors removed

the restriction that preferred4 memberships in Ridgemark Golf and


     4
       The preferred memberships (class A) entitled those members
to full privileges of the recreational facility.
                                - 18 -


Country Club be sold only to owners of lots who resided in

Ridgemark Estates.   At the same time, Paullus offered to purchase

the shares of Ridgemark’s shareholders who did not wish to

participate in the development of the Paicines area properties.

On January 23, 1989, the Loan, Option and Purchase Agreement

(Purchase Agreement) was approved by the board of directors.      The

Purchase Agreement provided that Ridgemark, as the seller, would

diligently complete, at its expense, all offsite improvements for

unit 10.   Ridgemark completed the offsite improvements after the

Purchase Agreement execution at a cost of about $1,600,000.    The

Purchase Agreement provided that Ridgemark had the right to

structure a tax-deferred exchange, and Shen was required to

cooperate to effectuate such an exchange.    Moreover, Ridgemark

agreed to make golf and country club memberships available to

purchasers of homes in the unit 10 property on the same terms and

conditions as to the preferred members.

     The Purchase Agreement also provided that Shen had two

options to purchase, in increments, any remaining developable

land owned by Ridgemark.    The first option was exercisable in

1991, and the second in 1993.    Each option was worth

approximately $7 million.    Neither option was exercised.

Ultimately, the optioned land reverted to Ridgemark.

     Shen was expected to complete the purchase of the unit 10

lots by March 27, 1989.    If Shen did not complete the purchase of
                              - 19 -


the unit 10 lots, Paullus outlined a plan to the board for a

joint venture with outside investors.    Ridgemark would contribute

the unit 10 lots that would be utilized for the venture.    The

purchase and transfer of the unit 10 property was completed on

March 27, 1989, for a final gross selling price of $11,250,000.

     On April 7, 1989, Paullus exercised his option to purchase

the outstanding shares of his fellow shareholders in Ridgemark.

After the transaction, petitioners personally owned 36.32 percent

of Ridgemark's outstanding shares.     Paullus, along with his wife,

were also the trustees of the Loren and Donna Paullus Family

Trust, which owned 35.02 percent of Ridgemark’s outstanding

shares.   In 1990, Ridgemark sold its golf courses, clubhouses,

and recreational facilities for $12 million to the members of

Ridgemark Golf and Country Club.

     The property acquired by Ridgemark as an exchange consisted

of approximately 2,261 acres (the Paicines property).    The

Paicines property was acquired with the intention of developing a

new and expanded golf course and resort facility.    Approximately

1,000 acres were contemplated for five or six golf courses,

clubhouses, and appurtenant buildings.    To obtain a better

financing note, the Paicines property was zoned for residential

purposes.

     From 1980 to 1993, Ridgemark filed statements with the State

of California, and in the space for the “type of business”, the

following was reflected:
                                - 20 -


           Year           Business

           1980           Golf and Country   Club
           1981           Golf and Country   Club
           1982           Golf and Country   Club
           1983           No record
           1984           Golf and Country   Club
           1985           Left blank
           1986           Left blank
           1987           Left blank
           1989           Golf and Country   Club
           1990           Ranch Properties
           1991           Left blank
           1992           Left blank
           1993           Left blank

     At the time the petition was filed in this case, Ridgemark

owned the following property:

     1.   Approximately 20 acres of land near a water tower (Perry
          Hill)
     2.   27.9 acres at the end of George’s Drive
     3.   8 acres near Ray’s Circle
     4.   5.95 acres below Ridgemark Village
     5.   37.34 acres at the northeast corner of Airline Highway
          and Fairview Road
     6.   47.2 acres where the maintenance barn, the guest cottage
          site, and the old Paullus residence were located

     Ridgemark’s operating revenue, costs of sales, and gross

income for its golf operations were:
                              - 21 -


                   Golf          Golf
     Fiscal      Operating     Operating        Golf
     Yearend      Revenue    Cost of Sales   Gross Income

      1977        $433,052      $460,242      ($27,190)
      1978         465,827       404,665        61,162
      1979         461,287       500,717       (39,430)
      1980         758,853       708,625        50,228
      1981       1,263,595     1,101,881       161,714
      1982       1,386,201     1,154,674       231,527
      1983       1,813,201     1,446,022       367,179
      1984       2,189,645     2,133,112        56,533
      1985       2,419,178     2,279,223       139,955
      1986       2,520,139     2,253,109       267,030
      1987       3,131,939     2,535,181       596,758
      1988       3,239,153     2,737,566       501,587
      1989       3,149,241     2,885,885       263,356

       Total   23,231,311    20,600,902      2,630,409


Ridgemark’s operating revenue, costs of sales, and gross income

for its real estate operations were:

               Real Estate
    Fiscal      Operating     Real Estate    Real Estate
    Yearend      Revenue     Cost of Sales   Gross Income

     1977       $1,015,183     $493,010         $522,173
     1978          344,291      220,121          124,170
     1979          257,506      169,666           87,840
     1980            -0-          -0-              -0-
     1981            -0-          -0-              -0-
     1982          305,409       21,656          283,753
     1983          363,350      107,592          255,758
     1984           16,504       14,187            2,317
     1985        1,043,797      273,270          770,527
     1986        1,747,094      386,014        1,361,080
     1987        2,194,609      432,086        1,762,523
     1988        1,743,924      319,629        1,424,295
     1989        1,502,664      307,855        1,194,809

       Total   10,534,331    2,745,086         7,789,245

     Ridgemark’s total gross operating revenue, cost of sales,

and gross income were $33,765,642, $23,345,988, and $10,419,654,

respectively, for the years between 1977 and 1989.
                               - 22 -


     The membership fees for Ridgemark Golf and Country Club

increased from $700 in 1971, when Ridgemark was formed, to

approximately $14,000 in 1990, when it was sold to the members.

     Petitioners deducted $292,773 for depreciation on Schedule F

of their 1989 Federal income tax return with respect to certain

farm property.    Respondent determined that the depreciation

deduction claimed by petitioners exceeded the allowable amount by

$191,637.   The parties agreed that the proposed adjusted capital

gain of $213,993 would be reduced to $174,030.      Petitioners have

conceded the remaining adjustments.

                               OPINION

     The parties agree that Ridgemark “exchanged” the unit 10

property for the Paicines property.      The disagreement concerns

whether the unit 10 property was held primarily for sale in the

ordinary course of Ridgemark’s business.     Respondent contends

that Ridgemark was a real property dealer and that the exchange

of the unit 10 property was merely a continuation of established

subdivision activities.   Ridgemark contends that the unit 10

property was sold to liquidate its assets, and that the offsite

improvements were merely a condition of the sale.     Petitioners

bear the burden of establishing that respondent’s determination

is erroneous.    Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933).

     Generally, section 1001(c) requires that gain or loss on the

sale or exchange of property shall be recognized.      Section
                                - 23 -


1031(a) provides for the nonrecognition or deferral of gain or

loss when “property held for productive use in a trade or

business or for investment * * * is exchanged solely for property

of like kind which is to be held either for productive use in a

trade or business or for investment.”

     Section 1031(a) treatment, however, does not apply to any

exchange of “property held primarily for sale”.    See sec.

1031(a)(2).   Section 1221(1) provides that a capital asset does

not include by definition “property held by the taxpayer

primarily for sale to customers in the ordinary course of his

trade or business”.

     In Malat v. Riddell, 383 U.S. 569, 572 (1966) (quoting Corn

Prods. Refining Co. v. Commissioner, 350 U.S. 46, 52 (1955), and

Commissioner v. Gillette Motor Transp., Inc., 364 U.S. 130, 134

(1960)), the Supreme Court explained the function of the section

1221(1) definition as differentiating “between the ‘profits and

losses arising from the everyday operation of a business’ * * *

and ‘the realization of appreciation in value accrued over a

substantial period of time’”.    The Court also defined

“primarily”, as utilized in section 1221(1), as “‘of first

importance’” or “‘principally.’”    Whether property is held by a

taxpayer primarily for sale to customers in the ordinary course

of a trade or business is essentially a factual question.

Guardian Indus. Corp. v. Commissioner, 97 T.C. 308, 316 (1991).
                                - 24 -


     Other cases have developed a framework for determining

whether sales of land are considered sales of a capital asset or

sales of property held primarily for sale to customers in the

ordinary course of a taxpayer’s trade or business.     See Major

Realty Corp. & Subs. v. Commissioner, 749 F.2d 1483 (11th Cir.

1985), affg. in part and revg. in part T.C. Memo. 1981-361; Byram

v. United States, 705 F.2d 1418 (5th Cir. 1983); Suburban Realty

Co. v. United States, 615 F.2d 171 (5th Cir. 1980); Parkside,

Inc. v. Commissioner, 571 F.2d 1092, 1096 (9th Cir. 1977), revg.

T.C. Memo. 1975-14; Biedenharn Realty Co. v. United States, 526

F.2d 409 (5th Cir. 1976); United States v. Winthrop, 417 F.2d 905

(5th Cir. 1969); Estate of Freeland      v. Commissioner, 393 F.2d

573 (9th Cir. 1968), affg. T.C. Memo. 1966-283; Los Angeles

Extension Co. v. United States, 315 F.2d 1 (9th Cir. 1963).

     In Suburban Realty Co. v. United States, supra at 178, the

Court of Appeals stated that the definition of “capital asset”

gave rise to three questions:

     1)   was taxpayer engaged in a trade or business, and,
          if so, what business?
     2)   was taxpayer holding the property primarily for
          sale in that business?
     3)   were the sales contemplated by taxpayer “ordinary”
          in the course of that business?

     In United States v. Winthrop, supra, and Biedenharn Realty

Co. v. United States, supra, various factors were considered in

answering the three questions:

     (1) the nature and purpose of the acquisition of the
     property and the duration of the ownership; (2) the
     extent and nature of the taxpayer’s efforts to sell the
                               - 25 -


       property; (3) the number, extent, continuity and
       substantiality of the sales; (4) the extent of
       subdividing, developing and advertising to increase
       sales; (5) the use of a business office for the sale of
       the property; (6) the character and degree of
       supervision or control exercised by the taxpayer over
       any representative selling the property; and (7) the
       time and effort the taxpayer habitually devoted to the
       sales. [United States v. Winthrop, supra at 910;
       citation omitted.]

See English v. Commissioner, T.C. Memo. 1993-111; Dunwoody v.

Commissioner, T.C. Memo. 1992-721; see also Parkside, Inc. v.

Commissioner, supra at 1096; Estate of Freeland v. Commissioner,

supra at 582; Los Angeles Extension Co. v. United States, supra

at 3.

       The frequency and substantiality of sales over an extended

period of time are integral indicia to be considered.    The

juxtaposition of the two aforementioned factors, therefore,

“‘will usually conclude the capital gains issue against [the]

taxpayer.’”    Suburban Realty Co. v. United States, supra at 176-

178 (quoting Biedenharn Realty Co. v. United States, supra at

418).

       At the same time, the courts have held that these factors

are not exclusive.    United States v. Winthrop, supra at 911.

Rather, each case must be decided on its own peculiar facts.

Specific factors, or a combination thereof, are not necessarily

controlling.    Biedenharn Realty Co. v. United States, supra at

415.

       Respondent contends that Ridgemark was a dealer in real

property, and intended to sell the unit 10 property in the
                               - 26 -


ordinary course of its business.    Essentially, respondent asserts

that the unit 10 property was inventory, and did not qualify for

the nonrecognition provision of section 1031.    Ridgemark argues

that it held the unit 10 property for investment purposes.

     Consequently, the issue is clearly drawn, and we focus on

the characterization of the unit 10 property held by Ridgemark.

1. Nature and Purpose of the Acquisition of the Property and the
Duration of Ownership

     Ridgemark segregated its business of operating Ridgemark

Golf and Country Club from the development and sales of lots.

Development and sales were placed in separate corporate entities.

After the creation of the new corporations, Ridgemark had seven

sales of property, excluding the unit 10 property.    The sales

were made over a 12-year period exclusively to Financial or

Construction, the new corporate entities, which developed and

sold real property.

     The one significant acquisition (the Bushmont property) was

used to expand Ridgemark Golf and Country Club.    Ridgemark also

found it necessary to sell some of its real property holdings to

finance a new 18-hole golf course and other facilities on the

Bushmont property.    Ridgemark’s primary activity was the

development and operation of golf courses.    To that end, it was

successful, thereby increasing the value of the facility,

including the adjacent real property.    Specifically, demand for

the lots and residences in Ridgemark Estates was increased by

coupling them to the golf and country club memberships.
                               - 27 -


     Ridgemark’s success can be seen in the price increases for

golf and country club membership from $700 in 1971 to

approximately $14,000 in 1990, when the golf and country club was

sold to its members.   As significant, Ridgemark did not intend to

sell the unit 10 property on an individual basis.   In early 1987,

a number of Ridgemark’s shareholders decided to disassociate

themselves from the business of owning and operating Ridgemark

Golf and Country Club.   This was to be accomplished by selling

all of Ridgemark’s assets, including the real property holdings.

Originally, it was to be accomplished by a cash sale of

Ridgemark’s outstanding shares.   Shen was the ostensible

purchaser until the adverse tax consequences deterred him.    Shen

then became interested in the business of Ridgemark Golf and

Country Club until Paullus advised him that he would not manage

the facility after its sale.   Shen thereafter developed an

interest in the developable real property held by Ridgemark,

including the unit 10 property.

     Throughout the period, 1980 through 1989, Ridgemark

consistently reported its business activity as the operator of a

golf and country club.   We find this to be probative evidence of

Ridgemark’s primary involvement in the golf and country club

business.   See Malinowski v. Commissioner, 71 T.C. 1120, 1125

(1979).

     Appreciation in value of the unit 10 property stems from its

proximity to the facilities extant in the Ridgemark Golf and
                               - 28 -


Country Club, as well as the existing residential developments

that Construction and Financial developed and sold.   By itself,

property sold as undeveloped land, with development to be done

under contract for the purchasers, does not automatically reflect

that the land is held for sale to customers in the ordinary

course of a taxpayer’s trade or business.    Reithmeyer v.

Commissioner, 26 T.C. 804, 813 (1956).

     Finally, we note that Ridgemark held the unit 10 property

for approximately 4 years prior to the transaction in question.

This relatively long holding period also tends to support the

conclusion that Ridgemark held the property for investment

purposes.    Ridgemark held a relatively significant amount of real

estate from 1977 and 1987 with only limited sales to related

companies.   This is more indicative of an investment motive in

Ridgemark.

     We note that a sale of a large tract in a single transaction

does not necessarily mean that the property was not held for sale

in the ordinary course of a taxpayer’s trade or business.    See

Major Realty Corp. v. Commissioner, 749 F.2d 1483, 1489 (11th

Cir. 1985), affg. in part and revg. in part on another issue T.C.

Memo. 1981-361; Williams v. United States, 329 F.2d 430 (5th Cir.

1964); Lawrie v. Commissioner, 36 T.C. 1117, 1121 (1961).

However, Ridgemark does not have a history of continuously and

regularly purchasing raw land that was later sold for

development.
                                - 29 -


     The relative paucity of purchases and sales, coupled with

the other factors discussed herewith, suggests that the real

property was peripheral to the business of operating Ridgemark

Golf and Country Club.     Pritchett v. Commissioner, 63 T.C. 149,

164 (1974).

     Accordingly, unit 10 was held for a relatively long period

of time and was acquired for investment purposes.

2. The Extent and Nature of the Taxpayer’s Efforts To Sell the
Property

     Ridgemark and Paullus sought to sell assets in order to

concentrate on developing a golf resort in Paicines.    The

question is whether there were any acts of sales promotion on the

part of Ridgemark or its agents.    For example, improving and

developing the land is a possible avenue to promote sales.    See

Reithmeyer v. Commissioner, supra at 813 ("The obvious reason for

the platting and subdividing was to attract buyers.").     The Fifth

Circuit Court of Appeals in Estate of Barrios v. Commissioner,

265 F.2d 517 (5th Cir. 1959), revg. 29 T.C. 378, 383 (1957),

while reversing the Tax Court for other reasons, agreed with the

general principle that improvement and development of land was an

avenue to promote sales.    The Court of Appeals stated:

          The idea of selling a large tract of land in lots
     embraces necessarily the construction of streets for
     access to them, the provision of drainage and the
     furnishing of access to such a necessity as water. It
     is hardly conceivable that taxpayer could have sold a
     lot without doing these things. To contend that
     reasonable expenditures and efforts, in such necessary
     undertakings are not entitled to capital gains
     treatment is to reject entirely the established
                              - 30 -


     principle that a person holding lands under such
     circumstances may subdivide it for advantageous sale.
     [Id. at 520.]

Property sold as undeveloped land with development to be done by

the seller under contract for the purchasers does not

automatically cause the land to be held for sale to customers in

the ordinary course of the taxpayer’s trade or business.

Reithmeyer v. Commissioner, supra at 813.     In the setting of this

case, we find that selling the unit 10 property with the offsite

improvements required by Shen did not convert it into a sale in

the ordinary course of a trade or business.

     Respondent contends that Ridgemark’s property was zoned for

the highest use (residential), and that fact is dispositive of

Ridgemark’s intent.   We believe the zoning classification was

necessary to maximize possible loans by third parties.     Although

residential zoning is a necessary element for subdivision, it

does not, per se, convert property to inventory status.

     The record does not demonstrate that Ridgemark utilized an

agent or broker.   Although the August 12, 1988, minutes mention

brokers’ commissions, it appears that Ridgemark did not want an

agent to negotiate for it, but that it was willing to pay a

commission or a finder’s fee if a successful sale was finalized.

     Finally, we find it troublesome that Ridgemark maintained a

sales office and that there was a list of 97 people interested in

purchasing lots in the unit 10 property.    That is one factor that

is indicative of an intention to sell the unit 10 property in the
                               - 31 -


ordinary course of Ridgemark’s business.    Paullus’ daughter also

had names of potential purchasers of lots in unit 10.    There was

some connection between the unit 10 property and Ridgemark’s

sales office.

     Additionally, Ridgemark concedes that before the sale of the

unit 10 property to Shen, it was taking steps to develop and sell

the property in the process of liquidating its holdings.

Respondent argues that this made Ridgemark a dealer in real

property when it engaged in preparations to sell the unit 10

property prior to its final sale to Shen.   Ridgemark contends

that it should not be deprived of its investor status simply

because it prepared to sell the land to third parties.

     Overall, we believe Ridgemark’s position is supported by the

facts.   Ridgemark sought to liquidate its assets so it could

maximize the amount of cash and attention it could focus on the

proposed Paicines golf and resort facility.   It was contemplated

that, if the transaction with Shen was not consummated, Ridgemark

would follow the same pattern it had followed in the past.     In

other words, Ridgemark would sell the unit 10 property to either

Construction or Financial.

3. The Number, Extent, Continuity, and Substantiality of the
Sales

     Courts have generally viewed frequent sales that generate

substantial income as tending to show that property was held for

sale rather than investment.   Suburban Realty Co. v. United

States, 615 F.2d at 181; Biedenharn Realty Co. v. United States,
                                - 32 -


526 F.2d 409 (5th Cir. 1976).    Conversely, infrequent sales

resulting in large profits tend to show that property was held

for investment.   Bramblett v. Commissioner, 960 F.2d 526 (5th

Cir. 1992).

     The unit 10 property was sold to Shen for $11,250,000.

Previously, Ridgemark was willing to sell the unit 10 property to

Shen for $10 million, which incorporated approximately $1,500,000

of offsite improvements, with a $2,563,454 basis.      Consequently,

at the sale, Ridgemark received net proceeds of approximately $9

million.   This is evidence of long-term appreciation as opposed

to normal inventory markup.   We also recognize that Ridgemark’s

golf operating revenue is approximately twice the revenue from

real estate transactions.   This factor quantitatively reflects

that Ridgemark’s primary source of income and business operation

was the management of a golf resort facility.      The real estate

sales were, at best, peripheral.

     There was a significant difference between the unit 10

property and prior property sales.       Ridgemark incurred costs of

approximately $2 million in completing the unit 10 property,

compared to about $600,000 expended in connection with the seven

parcels that had been sold to Financial or Construction.      Of the

$2 million, approximately $1,600,000 was spent for improvements

in satisfaction of the Agreement with Shen.      We do not agree with

respondent that Ridgemark would have, in any event, made these

improvements irrespective of whether Shen completed the sale.
                                - 33 -


     Finally, Ridgemark sold eight parcels of land in a 12-year

period between 1977 and 1989.    By comparison, only one

significant purchase of property was made subsequent to

Ridgemark’s 1971 formation (Bushmont property in 1985).

     Accordingly, Ridgemark fits the pattern of infrequent but

substantial sales of property which indicates, generally, that it

was held for investment purposes.    See Bramblett v. Commissioner,

supra.

4. The Extent of Subdividing, Developing, and Advertising To
Increase Sales

     Respondent asserts that Ridgemark routinely subdivided and

incurred substantial improvement costs before selling the land to

either Construction or Financial.    Also, respondent contends that

the fact that Ridgemark recorded final subdivision maps on

certain property before the sales were complete demonstrates that

it was involved in the business of dealing in real property.

     The seven sales of real property during the 12-year interval

between 1977 and 1989 can be divided into two categories:

(1) Three sales of large unsubdivided parcels, and (2) four sales

in which the title to the property could not be transferred

without a new map being recorded to create a separate legal

parcel.5   Ridgemark contends that the recordation of a final map

     5
       See Cal. Govt. Code sec. 66426 (West Supp. 1996), which
provides:

          A tentative and final map shall be required for
     all subdivisions creating five or more parcels, five or
                                                   (continued...)
                                - 34 -


was a condition precedent to Ridgemark’s ability to convey legal

title to the aforementioned parcels to Financial and

Construction.

      Ridgemark notes that it sold three parcels of real property

between 1977 and 1984.   Two were sold to Construction, and one

was sold to Financial.   For example, on October 18, 1977,

Ridgemark deeded 7 acres of unsubdivided land to Construction for

$175,000.

      All properties sold after 1977 were conveyed after the final

subdivision map was recorded.    In particular, when Ridgemark

agreed to sell the unit 9 property to Financial, there was a

tentative map for the property.    At the time of the sale on

June 30, 1987, the final map for unit 9 had been recorded.      A

similar pattern occurred for units 7 and 8, which were sold to

both Financial and Construction, respectively.

5.   The Use of a Business Office for the Sale of the Property

      Respondent places heavy reliance on the fact that Ridgemark

compiled a list of names of people interested in purchasing lots

in the unit 10 property.   Ridgemark points out that the list was

created several months after it had decided to proceed with a




      5
       (...continued)
      more condominiums as defined in Section 783 of the
      Civil Code, a community apartment project containing
      five or more parcels, or for the conversion of a
      dwelling to a stock cooperative containing five or more
      dwelling units * * *
                              - 35 -


sale of all its assets, and therefore the list is not relevant to

its intention regarding the unit 10 property.

     Ridgemark had explored the options available to it with the

intention of disposing of all its assets.   Given that Shen had

backed out of an earlier deal, we find it credible that Ridgemark

sought alternatives in the event the transaction might not be

consummated.   One of the options was selling to another buyer.

The possession of the names of potential buyers of the unit 10

property, by itself, is not dispositive of this issue.

     The existence of a sales office is a weakness in Ridgemark’s

position, but not a fatal one.   In this regard, the existence of

a sales office did not result in sales for Ridgemark.

6. The Time and Effort the Taxpayer Habitually Devoted to the
Sales

     After the formation of the sister corporations, Construction

and Financial, Ridgemark was substantially involved in the

development and expansion of its golfing and recreational

business.

     Ridgemark’s corporate minutes demonstrate that the board of

directors spent significant portions of its time discussing the

proposed transaction with Shen and various aspects of the golfing

business.

     There was a symbiotic relationship between the operation of

Ridgemark Golf and Country Club and the sales of land.   That

interrelationship generated the dispute concerning Ridgemark’s

trade or business.   Although Ridgemark pursued the sale of the
                               - 36 -


unit 10 property, that activity did not rise to the level of a

trade or business.    Instead, the real estate aspect was

incidental to the primary business (golf) and constituted an

investment so that the property was not part of Ridgemark’s

inventory.

     Accordingly, we hold that Ridgemark was entitled to the

nonrecognition of income from the sale of the unit 10 property

under section 1031, and thus there is no underpayment to which

section 6662(a) would be applied.

     Finally, we consider whether petitioners are liable for the

accuracy-related penalty for negligence under section 6662.

Respondent determined that they were negligent or intentionally

disregarded rules and regulations and that the section 6662(a)

20-percent penalty should apply.    Sec. 6662(b)(1).

     Negligence has been defined as the failure to make a

reasonable attempt to comply with the provisions of this title,

and the term “disregard” includes any careless, reckless, or

intentional disregard.   Sec. 6662(c).   Petitioners bear the

burden of showing that they were not negligent.    Rule 142(a);

Bixby v. Commissioner, 58 T.C. 757, 791-792 (1972).

     Respondent determined an accuracy-related penalty of $10,690

due to negligence or disregard of rules or regulations.     Sec.

6662(b)(1) and (c).   In the notice of deficiency, respondent

determined that the depreciation deduction claimed by petitioners

on their 1989 Schedule F exceeded the allowable amount by
                              - 37 -


$191,637.   Petitioners have conceded $174,030 of the proposed

adjusted capital gain of $213,993.     Petitioners have also

conceded the remaining adjustments.     However, respondent contends

that petitioners were negligent with respect to the depreciation

deductions.   Consequently, respondent asserts that the

underpayment due to negligence was $53,452, out of the total

underpayment of $124,324.6

     Petitioners contend that they reasonably relied on the

advice, expertise, and knowledge of their accountant.     However,

petitioners have not presented specific evidence that reliance on

their accountant, under the circumstances, was reasonable.     Thus,

petitioners are liable for the accuracy-related penalty pursuant

to section 6662(a).


                                      Decision will be entered under

                               Rule 155 in docket No. 6105-93.

                                      Decision will be entered for

                               petitioner in docket No. 6106-93.




     6
       The issues related to the remaining underpayments of
$70,872 have been resolved.
