Goudas v. Commissioner

T.C. Memo. 1996-555

UNITED STATES TAX COURT

CARL GOUDAS AND MARILYN GOUDAS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 1448-94. Filed December 23, 1996.

Frederick N. Widen and Benjamin J. Ockner, for petitioners.

Terry W. Vincent, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

BEGHE, Judge: Respondent determined a deficiency of

$230,158 in petitioners' 1988 Federal income tax, and additions

to tax of $11,508 and $57,540, respectively, under sections
 - 2 -

6653(a) and 6661.1 The deficiency arose from respondent’s

determination that petitioner2 had a distributive share of

$827,968 in the partnership gain on the sale of a shopping mall

by Pecaris Enterprises (Pecaris), a partnership in which

petitioner has a 25-percent interest, to Coastal Investments Co.

(Coastal), a partnership in which he has a 90-percent interest.

We hold that petitioner's distributive share of partnership

gain that Pecaris realized on the sale of the Mall is $827,968,

the amount determined by respondent, although we arrive at that

destination by a somewhat different route than respondent would

have had us follow. We reject respondent's determination of the

additions to tax.

FINDINGS OF FACT

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

The stipulation of facts and attached exhibits are incorporated

herein. When petitioners filed their petition, they resided in

Ohio.

1
Unless otherwise identified, section references are to the
Internal Revenue Code in effect for 1988, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
2
Marilyn Goudas has an interest in this case solely by
virtue of having filed a joint 1988 Federal income tax return
with her husband. Accordingly, all references to petitioner in
the singular are to Carl Goudas.
 - 3 -

Petitioner was born in Greece and came to the United States

at age 12. He attended grammar school in the United States, with

his last grade level attended being the fifth grade at age 15.

Petitioner has been a commercial real estate broker for

several years, acting primarily as a broker of strip shopping

centers.

Petitioner has limited knowledge of Federal income taxes,

and relied on professional advisers for tax advice and the

preparation of his tax returns. Martin Sugarman, a certified

public accountant, prepared petitioners' 1988 Federal income tax

return in accordance with the instructions of Ken McPhaill, a tax

manager of a national accounting firm, who died prior to the

trial of this case. Mr. McPhaill orally advised Coastal on the

overall Federal income tax treatment of the transaction at issue,

and his firm prepared Coastal's 1988 return of partnership

income.

Pecaris Partnership

In 1975, petitioner, with Christ Spillas and Peter Boyas,

formed Pecaris, an Ohio general partnership. Pecaris was formed

to acquire commercial real estate, and acquired and held various

properties.

Mr. Boyas provided the initial financing for Pecaris, but

has had no role in its day-to-day affairs. Mr. Spillas collected

and posted rents and paid payables, kept the books of the
 - 4 -

partnership, acted as the tax matters partner, and provided

information to the accounting firm that prepared the partnership

returns of income. Petitioner acted as managing partner, with

the primary responsibility of identifying and proposing

properties for purchase by Pecaris and acting on its behalf in

the purchase and sale of properties.

In 1976, Pecaris purchased a strip shopping center known as

the North Shore Mall (the Mall), located in Willowick, Ohio, at a

cost of $2.8 million.

In April 1978, the terms of the Pecaris partnership were

memorialized in a written partnership agreement. Under the terms

of the Pecaris partnership agreement, petitioner and Mr. Spillas

each has a 25-percent interest in profits and losses, and

Mr. Boyas has a 50-percent interest. The Pecaris partnership

agreement contains no express provision regarding how it can be

amended. However, in January 1985, petitioner and Messrs. Boyas

and Spillas executed a written amendment to the Pecaris

partnership agreement that replaced its original provisions

concerning disposition of interests in the partnership on

retirement or death of a partner.

Coastal Partnership

At monthend November 1987, petitioner and Vincent Giorgi

formed Coastal, an Ohio general partnership, for the purpose of

acquiring, owning, leasing, and operating commercial real estate.
 - 5 -

Coastal was specifically formed for the purpose of acquiring the

Mall.

From inception, the terms of the Coastal partnership were

memorialized in a written partnership agreement, which provides

that it can be amended only by written agreement of the partners.

Under the terms of the Coastal partnership agreement, petitioner

has a 90-percent partnership interest and Mr. Giorgi has a 10-

percent partnership interest, and their interests in cash-flow,

profits, losses, and tax credits follow their partnership

interests. The Coastal partnership agreement obligates the

partners to contribute to the partnership, as initial capital, in

proportion to their interests in the partnership, the amounts

needed to acquire the Mall and provide initial working capital.

The Coastal partnership agreement designates Mr. Giorgi, who

is a certified public accountant, as the tax matters partner.

Mr. Giorgi is the financial manager of Coastal, and he consulted

Mr. McPhaill in connection with the preparation of Coastal's

initial book entries and 1988 return of partnership income.

Disposition and Acquisition of the Mall

On December 17, 1987, Pecaris and Coastal entered a written

agreement under which Coastal agreed to purchase the Mall from

Pecaris for $4.8 million, which Coastal agreed to pay upon the

following terms: $100,000 in "Cash or check herewith as earnest

money to be held in escrow by" HGM Hilltop Realty (HGM), a realty
 - 6 -

company for which petitioner worked as a broker;3 $600,000 to be

deposited in escrow; and $4.1 million, to be paid from the

proceeds of a first mortgage nonrecourse loan to be obtained by

Coastal from Canada Life Assurance Co. (Canada Life). The $4.1

million amount of the mortgage loan was the maximum that Canada

Life was willing to lend on the security of the Mall, based on

Canada Life's valuation of the Mall at approximately $5.5 million

and use of a 75-percent maximum loan-to-value ratio.

Also on December 17, 1987, petitioner, using a preprinted

HGM commission agreement form, wrote a commission agreement

between Pecaris and HGM for payment by Pecaris of $100,000 to HGM

for effecting the sale of the Mall from Pecaris to Coastal. The

commission agreement authorized "ESCROW AGENT * * * by

irrevocable assignment, to disburse to HGM HILLTOP, REALTORS a

check in the amount of $100,000.00". Petitioner signed this

agreement as a partner of Pecaris; the HGM signature line was

left blank.

Petitioner, as partner in both Coastal and Pecaris, was on

both sides of the negotiation of the purchase agreement and the

fixing of the purchase price. Messrs. Boyas and Spillas and

petitioner signed the purchase agreement on behalf of Pecaris,

3
There is no evidence in the record that the earnest money
was ever placed in escrow or any indication of the nature or
extent of the ownership or employment relationship between
petitioner and HGM.
 - 7 -

and Mr. Giorgi signed the purchase agreement on behalf of

Coastal. Petitioner acted on behalf of both Pecaris and Coastal

in consummating the transaction.

On the basis of Canada Life's valuation, the Mall had some

value in excess of the stated purchase price of $4.8 million.

However, there is no other evidence in the record that bears on

the fair market value of the Mall or of petitioner's 25-percent

partnership interest in Pecaris, either in gross or with respect

to his partnership interest in Pecaris attributable to its

ownership of the Mall. Petitioner's proportionate interest in

the Mall was subject to liabilities and closing costs of

$504,314, giving him a net equity interest in the Mall of

$695,686, if its value should be deemed to be the agreed purchase

price of $4.8 million.4

4
The liabilities and closing costs to which the Mall and a
25-percent interest therein were subject were as follows:

Stated purchase price of Mall . . . . . . . . . . . . $4,800,000
Capco Enterprises mortgage $1,765,344
Security deposits 35,445
Real property taxes 23,380
Prepaid rents 19,532
Adjustment for real estate commission 100,000
Closing costs 73,553 2,017,254
Pecaris equity in Mall, valued
at $4.8 million . . . . . . . . . . . . . . . . . 2,782,746
25 percent of stated purchase price of Mall . . . . 1,200,000
25-percent share of costs and
liabilities . . . . . . . . . . . . . . . . . . . 504,314
Petitioner's 25-percent equity in
Mall, if it should be valued at
$4.8 million stated purchase price . . . . . . . . 695,686
 - 8 -

Petitioner hired Continental Title Co. (Continental) to

provide escrow services and title insurance for the transaction.

The conveyance, assignment, and transfer by Pecaris to Coastal of

the Mall real property, leases, and tangible personal property

all occurred in February 1988. The purchase agreement as written

contemplated a straight sale of the Mall to Coastal for $4.8

million cash, and the fee paid to Continental was determined on

the basis of that stated purchase price.5 However, petitioner

and Mr. Giorgi lacked the personal resources that would have

enabled Coastal to pay the additional $700,000 in cash required

to consummate the transaction for the stated purchase price of

$4.8 million. The escrow and financing statements show that only

$4.1 million of mortgage loan proceeds were deposited in the

escrow account, and that the $700,000 shortfall was made up of

credits in that amount.

The $700,000 of credits was attributable to two items:

First, petitioner informed Continental, in writing, that HGM had

"received a note from Coastal * * * in the amount of $100,000

* * * in payment in full from Pecaris" to HGM of the commission

due from Pecaris for petitioner's handling of the sale of the

Mall. The record contains no evidence that the $100,000 deposit

called for by the purchase agreement was ever made, or that any

5
In addition, the real property transfer tax of $4,800
represented a $1 payment per $1,000 paid as consideration for the
transfer.
 - 9 -

such note was issued by Pecaris or Coastal (see supra note 3,

infra note 10), or that the commission was otherwise paid.

Second, petitioner informed and instructed Continental, in

writing, that he had "already collected as down payment $600,000

so give Pecaris credit for the $600,000 and deduct same from Carl

Goudas share of distribution" (sic) from the escrow account.

In accordance with petitioner's instructions to Continental,

the credits were shown by entries in the escrow account.

Continental's escrow statement to Coastal showed a credit from

Pecaris to petitioner in the amount of $700,000. Continental's

escrow statement to Pecaris, in addition to showing the cash

balances due petitioner and Messrs. Boyas and Spillas from the

escrow account, showed a credit to petitioner of $600,000, and

recited that the real estate commission had been paid to HGM by

promissory note in the amount of $100,000.

Soon after the conveyance of the Mall by Pecaris, Coastal

recorded, in its general journal, a contribution to capital by

petitioner in the amount of $700,000. Pursuant to the Coastal

partnership agreement, petitioner intended, and was expected by

Mr. Giorgi, to contribute or cause to be transferred to Coastal

an interest in the Mall in lieu of a cash contribution.

Petitioner made no other contribution to the capital of Coastal

during 1988. Mr. Giorgi initially contributed $70,100 to the

capital of Coastal, and an additional $6,151 later during the

year. During 1988, petitioner and Mr. Giorgi received cash
 - 10 -

distributions from Coastal that exceeded their reported

distributive shares of partnership income for the year.

Messrs. Boyas and Spillas received direct cash payments by

Continental from the escrow account in proportion to their

partnership interests, in the amounts of $1,391,566 and $695,783,

respectively. Petitioner received a direct cash payment from the

escrow account in the amount of $95,783, based on petitioner’s

$695,783 net interest in the Mall (equivalent to the interest of

Mr. Spillas) minus the above-mentioned $600,000 credit.6 These

cash payments to the Pecaris partners represented the bulk of the

proceeds from the $4.1 million Canada Life mortgage loan that

remained after the pay-off of the liabilities and closing costs

to which the Pecaris partnership's interest in the Mall had been

subject. According to the escrow statement prepared by

Continental for Coastal, $78,063 of the mortgage loan proceeds

was paid to Coastal as "excess loan proceeds".

Petitioner also received another cash payment from the

escrow account in the amount of $30,000. This payment was a

6
The difference between these amounts and the calculation
supra in note 4, is attributable to a small amount of interest
received on the overnight investment of the mortgage loan
proceeds by or on behalf of Coastal:
100 percent 25 percent
Pecaris equity in Mall, valued at $4.8 million . . . $2,782,746 $695,686

Interest on investment of
mortgage loan proceeds . . . . . . . . . . . . . . 388 97
2,783,134 695,783
 - 11 -

commission from Capco Enterprises, the mortgagee under the

preexisting mortgage on the Mall that was satisfied as a result

of the consummation of the transaction. See supra note 4. The

record does not show whether petitioner included the amount of

this commission in the income reported on the Schedule C of

petitioners' 1988 Federal income tax return.

Upon conveyance of the Mall from Pecaris to Coastal,

petitioner’s partnership interest in the Mall, by virtue of the

difference between his interests in Pecaris and Coastal,

increased from 25 percent to 90 percent, without any outlay of

funds by him. As a result, petitioner’s share of mortgage

liabilities associated with the Mall increased from $441,336

(25 percent of the Capco Enterprises mortgage to which the Mall

was subject in the hands of Pecaris) to $3,690,000 (90 percent of

the Canada Life mortgage loan of $4.1 million to which the Mall

became subject in the hands of Coastal at the time of the

conveyance.7

Messrs. Boyas and Spillas did not become aware of

petitioner’s partnership interest in Coastal, and of his

participation on both sides of the transaction, until after the

7
Canada Life viewed the transaction as both a refinancing of
the Mall, and as a “buying out” by petitioner of the interests of
the other Pecaris partners. In addition, the loan agreement
stated that “The purpose of the loan is to provide permanent
financing for the Real Property and to discharge all existing
financing."
 - 12 -

sale of the Mall had been consummated.8 Upon being informed of

petitioner's participation in Coastal, they did not voice any

objection or take any action against petitioner. The Pecaris

partnership continues, with petitioner and Messrs. Boyas and

Spillas retaining their respective partnership interests in the

remaining assets and liabilities of the partnership.

Tax Reporting of the Transaction

Pecaris reported the transaction on its Form 1065 U.S.

Partnership Return of Income as a sale of the Mall for $4.8

million with a realized and recognized gain of $3,311,873.9

Pecaris used the $100,000 commission as an offset to reduce the

gain reported on its 1988 return of partnership income as

distributable to petitioner and Messrs. Boyas and Spillas.

8
Mr. Spillas testified that he did not know the identity of
the principal parties of Coastal at the time of the transaction,
but became aware of petitioner’s interest in Coastal prior to the
filing of the Pecaris 1988 partnership return, which Mr. Spillas
signed on behalf of Pecaris. Mr. Boyas testified that he did not
recall when petitioner's identity as a partner in Coastal was
revealed to him, but that the reason for his inability to recall
was that he regarded petitioner's role on the other side of the
transaction as unimportant.
9
On its 1988 Form 1065 and Form 4797, Pecaris reported and
computed the gain on the sale of the Mall as follows:

Gross sales price . . . . . . . . . . . . $4,800,000
Cost or other basis plus
expenses of sale . . . . . $3,022,670
Depreciation allowed . . . . 1,534,543
Adjusted basis . . . . . . . 1,488,127
Total gain . . . . . . . . . . . . . . . 3,311,873
 - 13 -

Pecaris allocated the gain to its three partners in accordance

with their interests in profits, as specified in the Pecaris

partnership agreement. Accordingly, Pecaris reported

petitioner’s distributive 25-percent share of the gain from the

sale, $827,968, on its Schedule K-1, and that is the amount of

the adjusting increase in petitioner's gain as determined in

respondent's statutory notice to petitioner.

Coastal and petitioner reported the transactions affecting

petitioner’s interest in the Mall as nontaxable transactions on

their respective returns for 1988. The yearend tax balance

sheet, Schedule L of Coastal's 1988 Form 1065, disregarded

petitioner's capital contribution of $700,000 as having any

effect for tax purposes on petitioner's capital account or on

Coastal's basis in the Mall, and showed Coastal as having a cost

basis in the Mall substantially less than $4.8 million, on the

order of what would have been approximately $4.1 million as of

the time of the conveyance of the Mall by Pecaris to Coastal.10

10
The Coastal 1988 yearend Schedule L Tax Balance Sheet and
schedules thereto do not disclose or show any note or other
obligation of Coastal to HGM in respect of the $100,000
commission. The Coastal balance sheet and Schedule M
Reconciliation of Partners' Capital Accounts show the following:

Schedule L - Balance Sheet
Assets

Cash $74,886 Current liabilities $102,026

Trade accounts and
receivables 78,159 Mortgages, etc. 4,071,244
(continued...)
 - 14 -

Petitioners reported no distributive share of gain to petitioner

from Pecaris in respect of the Mall transaction on their 1988

Form 1040. Petitioners attached Form 8082 (Notice of

Inconsistent Treatment or Amended Return) to their 1988 Form

1040, disclosing that petitioner was taking a position

inconsistent with the Schedule K-1 filed by Pecaris.

Petitioners' Form 8082 showed a reduction to zero in the amount

of the Pecaris reported section 1231 gain of $827,968 attributed

to petitioner and provided the following explanation: "Traded up

Real Estate Interests in Like-Kind Exchange." Petitioners' Form

8082 did not disclose that the $100,000 real estate brokerage

commission used by Pecaris as an offset in computing its gain on

10
(...continued)
Buildings and other
depreciable assets $3,459,502 Partners' capital (182,469)
Minus depreciation 113,936 3,345,566

Land 458,845

Other assets 33,345 _________
Total liabilities
Total assets 3,990,801 and capital 3,990,801

Schedule M - Reconciliation of Partners' Capital Accounts

Capital
beginning of Capital Capital
year contributed Income Withdrawals end of year

Petitioner - 0 - - 0 - $7,450 $258,399 ($250,949)

Giorgi - 0 - $76,251 329 8,100 68,480

Total - 0 - 76,251 7,779 266,499 (182,469)
 - 15 -

the sale of the Mall had not been included by petitioner in his

gross income.

OPINION

We address one procedural or evidentiary issue and two sets

of substantive tax issues: First, whether we are permitted to

look beyond the terms of the purchase agreement and the Pecaris

partnership agreement to determine the gain realized by Pecaris

on the sale of the Mall; and second, the amount of the Pecaris

gain for tax purposes and the amount thereof to be allocated to

petitioner, and the correlative questions of the tax treatment of

the credits or their equivalents received by Pecaris and

petitioner and contributed by petitioner to the capital of

Coastal. We then consider the additions to tax.

I. Whether Danielson Requires Agreement With Respondent's
Determination

Respondent determined and continues to argue that Pecaris

agreed to sell and did sell the entire Mall to Coastal for $4.8

million, and that petitioner’s recognized gain on his

distributive 25-percent share of partnership gain from the sale

of the Mall is $827,968. Petitioners argue that the transaction

should be treated as a sale by Pecaris of a 75-percent undivided

interest in the Mall for $3.6 million, no part of the gain on

which is allocable to him, and a distribution by Pecaris--

nontaxable to him under section 731--of a 25-percent undivided

interest in the Mall, followed by his contribution--nontaxable to
 - 16 -

him under section 721--to Coastal of that interest,11 with the

remaining $500,000 of mortgage loan proceeds being used to

discharge the portion of the transaction expenses and preexisting

liabilities attributable to his 25-percent undivided interest

received from Pecaris and contributed to Coastal.

Under petitioners' view, Pecaris was entitled to use 75

percent of its adjusted basis in the Mall in computing its gain

on the receipt of the reduced purchase price of $3.6 million for

the 75-percent undivided interest that it sold and the

distributive shares of such gain to Messrs. Boyas and Spillas.

Applying petitioners' view, those shares of gain would remain the

same as reported by Pecaris and Messrs. Boyas and Spillas on

their returns, and no part of the Pecaris gain would be allocable

to petitioner. Also, under petitioners' view, the remaining 25

percent of the Pecaris adjusted basis in the Mall is attributable

to the undivided 25-percent interest therein that petitioner

claims was distributed to him by Pecaris and contributed by him

to the capital of Coastal.

11
The rationale of allowing nonrecognition treatment to
petitioner under secs. 721 and 731 of the continuation and
expansion of his residual partnership interest in the Mall would
be that he did not liquidate his investment in the Mall but
rather continued it in another form, with a greater proportionate
interest, subject to nonrecourse liabilities that were
substantially increased both proportionately and absolutely.
See sec. 1.1002-1(c), Income Tax Regs.
 - 17 -

At the calendar call of the session of the Court at which

this case was tried, respondent filed a motion in limine to

"exclude all evidence pertaining to an alleged oral modification

made to the written sale agreement * * * as inadmissible pursuant

to the principles espoused by the Tax Court in Estate of Durkin

v. Commissioner, 99 T.C. 561 (1992)"12 and by the Court of

Appeals for the Third Circuit in Commissioner v. Danielson, 378

F.2d 771 (3d Cir. 1967), vacating and remanding 44 T.C. 549

(1965). These cases stand, in respondent's view, for the

12
In Estate of Durkin v. Commissioner, 99 T.C. 561 (1992),
the taxpayer decedent had not disclosed on his income tax return
his bargain purchase of assets from a closely held corporation,
and his bargain sale of his shares to the other shareholder, so
as not to report any gain. The Court rejected the argument of
his personal representative and surviving spouse that the
transactions were in substance a redemption or sale of his stock
at a capital gain, the Commissioner having discovered the bargain
purchase on audit and determined it to be a constructive
dividend. We found that decedent had not exhibited "an honest
and consistent respect for the substance of * * * [the]
transaction", Id. at 574 (quoting Estate of Weinert v.
Commissioner, 294 F.2d 750, 755 (5th Cir. 1961), revg. and
remanding 31 T.C. 918 (1959)). Decedent had reported the
transactions on his tax return consistently with the form in
which they were cast, and the effort of his successors in
interest to restructure the transaction to track its alleged
substance was a litigation strategy developed years later in
response to our previous opinion in Estate of Durkin v.
Commissioner, T.C. Memo. 1992-325, upholding the Commissioner's
determination that the value of the purchased assets
substantially exceeded the price paid by decedent. Moreover, the
Commissioner's challenge to the price paid by decedent to the
corporation did not open the door for the successors in interest
to disavow the form of the transactions: "To hold otherwise
would at a minimum be an untoward invitation to the kind of
mispricing and concealment that petitioners attempted here".
Estate of Durkin v. Commissioner, 99 T.C. at 575.
 - 18 -

proposition that taxpayers may disavow the form of their

transactions to challenge the tax consequences flowing therefrom

"only by adducing proof which in an action between the parties to

the agreement would be admissible to alter that construction or

to show its unenforceability because of mistake, undue influence,

fraud, duress, etc.” Id. at 775.

Respondent argued that, under Danielson and Estate of

Durkin, petitioner was bound by the terms of the purchase

agreement, which characterized the transfer of the Mall, and the

subsequent tax reporting of the transaction by Pecaris and

petitioner's partners in accordance with the terms of the Pecaris

partnership agreement, as a straight cash sale of the Mall for

$4.8 million with 25 percent of the distributive share of the

Pecaris partnership gain therefrom allocable to petitioner.

Insofar as Estate of Durkin v. Commissioner, supra, is

concerned, we observe that petitioner did not conceal or

otherwise fail to report the transaction on his income tax

return. Petitioners' income tax return disclosed that petitioner

was taking a return position inconsistent with that of Pecaris

and his fellow partners, Messrs. Boyas and Spillas. Petitioner's

concealment was in failing to disclose to Messrs. Boyas and

Spillas his position on the other side of the Mall transaction as

the dominant partner of Coastal, and in failing to carry through

with them to request and obtain amendments of the purchase
 - 19 -

agreement and the Pecaris partnership agreement to provide for a

part sale of the Mall to Coastal and a special allocation that

would have been consistent with the position he took on his own

income tax return and that he now takes in this case.

We denied respondent's motion at the calendar call, "without

prejudice to renew in the brief after we've had a trial".

Respondent's brief in answer, after observing that "At this

juncture, the motion in limine to preclude the introduction of

evidence is moot", went on, without disavowing respondent's

position on the motion, in effect to broaden her position to

encompass the Pecaris partnership agreement:

After further reflection, and as noted by the
Court (Motion Hearing Tr. 9) during the oral
presentation of respondent's motion, it may well be
that respondent imprecisely placed the focus of her
motion on the wrong agreement.

The record is clear that the purchase/sale
Agreement, bolstered by the additional written
instruments memorializing and consummating the sale
of the Mall are entirely consistent with the manner in
which Pecaris reported the transaction. Additionally,
this consistency continues through the allocation of
the gain from the transaction per the written Pecaris
partnership agreement.14 (Ex. D (par. 4.)) As
suggested by the Court, this partnership agreement
may be the critical "agreement" which petitioner is
attempting to modify.
14
Per the written partnership agreement,
petitioner was entitled to share in one-fourth (25%)
of the profits and losses of the Pecaris partnership
enterprise.

The Court of Appeals for the Sixth Circuit has adopted the

Danielson rule, North Am. Rayon Corp. v. Commissioner, 12 F.3d
 - 20 -

583, 587-589 (6th Cir. 1993), affg. T.C. Memo. 1992-610, and does

not confine it to cases of allocation of payments to covenants

not to compete, Schatten v. United States, 746 F.2d 319, 321-322

(6th Cir. 1984). Although this Court generally applies the

"strong proof" rule originally enunciated in Ullman v.

Commissioner, 29 T.C. 129 (1957), affd. 264 F.2d 305 (2d Cir.

1959), we are bound to apply the Danielson rule if we are

satisfied that the Court of Appeals to which the case is

appealable would do so, Golsen v. Commissioner, 54 T.C. 742

(1970), affd. 445 F.2d 985 (10th Cir. 1971); Lardas v.

Commissioner, 99 T.C. 490 (1992); Lang v. Commissioner, T.C.

Memo. 1993-474.

In arguing that we should look beyond the express terms of

the purchase agreement, petitioners don't contend that the

agreement was entered into under any mistake, undue influence,

fraud, duress, or the like. Instead, petitioners dispute the

substance of the transaction, asserting that the purchase

agreement alone doesn't express the reality of the transaction as

actually consummated by the parties.

We're satisfied that the Danielson rule doesn't confine

petitioner's tax treatment to the terms of the purchase

agreement. We so hold because the purchase agreement alone

didn't reflect the entirety of the subsequently consummated

transaction that actually occurred. We have not only looked at
 - 21 -

the purchase agreement, but also to the other operative

documents, including the mortgage loan agreement and escrow

documents, as well as the instruments of conveyance, assignment,

and transfer used to accomplish the property transfers, and the

Pecaris and Coastal partnership agreements, to determine the

integrated, overall agreement between the parties that was

actually consummated. In re Steen, 509 F.2d 1398, 1403 (9th Cir.

1975); 3 Corbin on Contracts, secs. 581-582 (West 1960 & Supp.

1994).13 Furthermore, as the Court of Appeals for the Ninth

Circuit said in In re Steen, supra at 1403 n.5, parol and

extrinsic evidence are admissible to show that the true

consideration paid and received was different from that stated in

the agreement (quoting Haverty Realty & Inv. Co. v. Commissioner,

3 T.C. 161, 167 (1944)):

Turning now to the question of consideration: "* * *
the recitals of a written instrument as to the
consideration received are not conclusive, and it is
always competent to inquire into the consideration and
show by parol or other extrinsic evidence what the
real consideration was." Deutser v. Marlboro Shirt Co.

13
The Danielson rule encompasses and mirrors the parol
evidence rule, Commissioner v. Danielson, 378 F.2d 771, 779 (3d
Cir. 1967), vacating. and remanding 44 T.C. 549 (1965); Schmitz
v. Commissioner, 51 T.C. 306, 317 (1968), affd. sub nom.
Throndson v. Commissioner, 457 F.2d 1022 (9th Cir. 1972).
Because the parol evidence rule does not exclude evidence where
there is a series of transactional documents that must be read
together before the agreement is treated as wholly integrated, 3
Corbin on Contracts, secs. 581-582 (West 1960 & Supp. 1994), the
Danielson rule applies only after all those documents have been
aggregated to form the overall agreement.
 - 22 -

(C.C.A., 4th Cir.), 81 Fed. (2d) 139, 142, citing many
authorities. * * *

The foregoing analysis satisfies us that the entire record

is available for our review to help us determine the gain

realized by and recognized to Pecaris on the sale of the Mall.

The record makes abundantly clear that the cash consideration

paid by or on behalf of Coastal was substantially less than the

stated purchase price of $4.8 million, thereby providing a

toehold for petitioner's argument that we should not impute

realized gain to Pecaris by reference to any more than the cash

consideration actually paid and received. Cf. Don E. Williams

Co. v. Commissioner, 429 U.S. 569, 579-580 (1977) (quoting

Commissioner v. National Alfalfa Dehydrating & Milling Co., 417

U.S. 134, 148-149 (1974)); Bartels v. Birmingham, 332 U.S. 126,

130-132 (1947). But that's not the end of the matter; we must

consider whether the $700,000 of credits is includable in the

amount realized by Pecaris for the purpose of computing its gain

on the sale of the Mall.

II. Tax Treatment of Pecaris on Its Sale to Coastal

The parties have not shown us what the capital accounts of

Pecaris actually looked like on its books before and after the

Mall transaction. It seems likely, from the way Pecaris reported

the transaction on its partnership return and accompanying

schedules, that Pecaris accounted for the credits as if they had

been received from Coastal as cash equivalents or receipts that
 - 23 -

were included in the reported amount realized of $4.8 million,

and then distributed to petitioner. On the Coastal side of the

transaction, there's a disparity in the book and tax treatments

of petitioner's participation in Coastal: Coastal recorded on

its books a contribution to capital by petitioner in the amount

of $700,000; on Coastal's tax balance sheet reconciliation of

partners' capital accounts, petitioner is shown as having made no

capital contribution. This disparity is reflected in Coastal's

book and tax accounting for the receipt of the Mall, which was

booked at a value that exceeds its tax basis by approximately the

same amount as the equivalent amounts of the credits and

petitioner's capital contribution.

It's the tax treatment of the credits, at both the Pecaris

partnership and partner levels, over which the parties part

company.

A. Amount of Pecaris Gain

1(a) Amount Realized

Having opened up the transaction for review, we must first

determine the amount of the Pecaris gain on its sale of the Mall

to Coastal. Under section 1001(a) "The gain from the sale or

other disposition of property shall be the excess of the amount

realized therefrom over the adjusted basis" of the property.

Under section 1001(b), "The amount realized * * * shall be the
 - 24 -

sum of any money received plus the fair market of the property

(other than money) received."

Since the amount of money received by Pecaris did not exceed

$4.1 million, we must address whether the $700,000 credit is

properly includable in the amount realized by Pecaris. In this

connection, Mr. Berardinelli, the president of Continental, the

escrow agent, testified that it's common practice in escrowed

real estate transactions for the escrow agent to make offsetting

or netting entries in the escrow account to reflect offsetting

obligations and to pay the net amount due to the party entitled

thereto. The additional consideration given by Coastal was the

$700,000 credit to petitioner's capital account in Coastal. The

way in which the capital account credit served as a substitute

for a $700,000 cash payment from Coastal to Pecaris can be seen

by analyzing the network of obligations arising from the sale of

the Mall. Coastal was obligated to pay Pecaris $700,000 over and

above the proceeds of the new mortgage financing. Through a

combination of petitioner's actions and the profit-sharing

provisions of the Pecaris partnership agreement, Pecaris was

obligated to pay to petitioner or at his direction a total of

$795,783, consisting of $695,783, the 25-percent distributive

share of the net proceeds of the sale, plus the $100,000

brokerage commission. Petitioner was paid $95,783 from escrow,

leaving an unpaid balance of $700,000 that was satisfied by the
 - 25 -

credits. Under the Coastal partnership agreement, petitioner was

obligated to make a capital contribution of $700,000 to Coastal.

Petitioner satisfied that obligation to Coastal by causing

Pecaris to transfer to Coastal all right, title, and interest in

the Mall, and Coastal credited $700,000 to petitioner's capital

account; as a result, petitioner became the dominant partner in

Coastal, with a 90-percent interest in capital and profits.

There was thus a circle of obligations in the amount of $700,000,

which were netted against one another and discharged without the

need for settlement in cash. In sum, Coastal discharged its

obligation to Pecaris by satisfying the Pecaris obligation to

petitioner by crediting him with a $700,000 capital contribution,

and petitioner's obligation to Coastal was satisfied by his

causing Pecaris to transfer to Coastal all right, title, and

interest in the Mall for a cash consideration that was $700,000

less than Coastal was obligated to pay under the terms of the

purchase agreement.

There is one other problematic element in the computation of

the amount realized by Pecaris. The Coastal escrow statement

discloses that there was a distribution to Coastal of $78,063 of

excess mortgage loan proceeds. As a result, it appears that the

cash proceeds of the sale of $4.1 million should be reduced by

$78,063, because Pecaris did not receive that amount in cash.

However, it also appears that the amount of the mortgage proceeds
 - 26 -

distributed to Coastal from the escrow account is approximately

equal to Mall-associated liabilities of Pecaris for security

deposits, real property taxes, and prepaid rents (see infra note

14) that were assumed or taken subject to by Coastal. The relief

of Pecaris of responsibility for those obligations was part of

the consideration received by Pecaris on the sale of the Mall.

The amount realized by Pecaris on the sale of the Mall stands at

$4.8 million.

(b) Pecaris Adjusted Basis

Respondent, in computing the larger gain that she determined

using an amount realized of $4.8 million, of course allowed the

entire adjusted basis of the Mall to be used in computing the

resulting gain. It's only petitioners, in their effort to leave

the tax position of petitioner's Pecaris partners unaffected, but

treat petitioner as having no share of the Pecaris partnership

gain, who came up with the notion that what Pecaris sold was a

75-percent undivided interest in the Mall for $3.6 million. This

led to petitioners' correlative argument that the Pecaris

partnership was entitled to use only 75 percent of its basis in

computing the gain on that sale.

Petitioners' argument suffers from a fatal flaw.

Petitioner's recharacterization of the transaction as a sale by

Pecaris of a 75-percent undivided interest in the Mall and a

Pecaris distribution to petitioner, followed by a contribution by
 - 27 -

him to Coastal of a 25-percent undivided interest in the Mall, is

contradicted by the express terms of the warranty deed. That

deed conveyed to Coastal the entire fee interest of Pecaris in

the Mall. Under Ohio law, a partnership is an entity for the

purpose of owning, conveying and acquiring property, Ohio Rev.

Code Ann. sec. 1775.07(C) (Baldwin 1993), and the terms of the

deed, assignment, and bill of sale indicate that Pecaris conveyed

directly to Coastal the entire fee interest in the Mall and the

associated leases and tangible personal property. This leaves no

room for petitioners' argument that petitioner received a

distribution of a 25-percent undivided interest in the Mall,

which he then contributed to Coastal in exchange for his

partnership interest in Coastal.

We therefore reject petitioners' correlative argument. We

see no reason why the Pecaris partnership should not be entitled

to use its entire adjusted basis in the Mall in computing its

gain on the sale. That gain is $3,311,873, as computed by

Pecaris and respondent. See supra note 9.

2. Amount Recognized to Pecaris

Section 1001(c) provides:

Except as otherwise provided in this subtitle, the
entire amount of the gain or loss, determined under
this section, on the sale or exchange of property shall
be recognized.

The question is whether any nonrecognition provisions of the

Internal Revenue Code apply to the Mall transaction to reduce the
 - 28 -

gain recognized to Pecaris to any amount less than the gain

realized that we have already determined. Having rejected

petitioner's argument that Pecaris distributed to petitioner a

25-percent undivided interest in the Mall, which he then

contributed to Coastal in exchange for his partnership interest,

we nevertheless observe that the creation of the partnership

interest issued by Coastal to petitioner appears to have been an

element of the consideration given and received by Pecaris.

Petitioner so structured the transfer of the Mall to Coastal that

the shortfall in the cash consideration was ultimately satisfied

by his receipt of a 90-percent partnership interest in Coastal.

We therefore ask whether section 721, providing for

nonrecognition of gain or loss on a contribution of appreciated

property to a partnership, causes any portion of the gain

realized by Pecaris to be entitled to nonrecognition. In

particular, did the Mall transaction amount to a transfer of the

Mall by Pecaris to Coastal in exchange for cash and a partnership

interest in Coastal having a value of $700,000, which Pecaris

then distributed to petitioner, plus $95,683 in cash, with

disproportionately greater amounts of cash being distributed to

petitioner's partners in Pecaris?

It seems that a transfer of appreciated property to a

partnership in exchange for a partnership interest and cash can

be treated in at least three different ways: (a) Part-sale part-
 - 29 -

contribution; (b) contribution followed by distribution of cash;

or (c) contribution with a receipt of boot. See Hesch, Tax

Management Portfolio 710, Partnerships; Overview, Conceptual

Aspects and Formation A-98 to A-100 (1996). However, there also

appears to be no authority that clearly governs the choice to be

made.

None of these possibilities was raised or argued by the

parties. We resist the temptation to tease out their varying tax

consequences because there is nothing more in the documentation

of the transaction that would allow it to be characterized more

appropriately in any of these three ways than the part-sale to

Coastal part-distribution by Pecaris to petitioner that we have

already rejected. The overwhelmingly dominant aspect of the Mall

transaction, supported both by its documentation and by the

relative cash consideration paid and received, was a sale for

cash. See sec. 707(a)(2)(B), enacted by the Deficit Reduction

Act of 1984, Pub. L. 98-369, sec. 73(a), 98 Stat. 591 (DEFRA),

and DEFRA sec. 73(b), 98 Stat. 592; sec. 1.707-9(a), Income Tax

Regs.; H. Rept. 98-861, at 862 (1984), 1984-3 C.B. (Vol. 2) 1,

116; see also secs. 1.721-1(a), 1.731-1(c)(3), Income Tax Regs.

The Mall transaction therefore stands as a sale that was a

recognition transaction to Pecaris in its entirety. We do not

regard Pecaris as having made a nontaxable capital contribution

to Coastal entitled to nonrecognition under section 721, but as
 - 30 -

having received a credit, which was included in the amount

realized by Pecaris (but was not itself the receipt by Pecaris of

a partnership interest in Coastal in consideration of a

contribution of property by Pecaris to Coastal), that enabled and

entitled petitioner to receive a 90-percent partnership interest

in Coastal.

B. Petitioner's Share of Pecaris Gain

We now consider petitioner's share of the Pecaris gain

as computed above. Under the Pecaris partnership agreement,

petitioner has a 25-percent interest in profits and losses.

Petitioner did not disclose to Messrs. Boyas and Spillas,

prior to consummation of the Mall transaction between Pecaris and

Coastal, that he was on the Coastal side of the transaction as

its dominant partner.14 Although petitioner testified that he

participated in the negotiations on both sides of the

transaction, along with Mr. Spillas and Mr. Giorgi, Mr. Spillas

testified that the three Pecaris partners agreed on the purchase

price. We don't believe that there were actual arm's-length

negotiations between Pecaris and Coastal to fix the purchase

price. If petitioner had made Messrs. Spillas and Boyas aware

14
Petitioner's nondisclosures to Messrs. Boyas and Spillas
may well have violated his fiduciary duty to them as his
partners, but that's another story. See Meinhard v. Salmon, 164
N.E. 545 (N.Y. 1928), cited with approval by In re Binder's
Estate, 27 N.E. 2d 939, 949 (Ohio 1940), and Restatement (First)
of Restitution, sec. 190-191, 781-789 (App. 1988); see also infra
text at 37.
 - 31 -

that he intended to take less cash by reason of the credits, they

might well have agreed to recast the deal and provide for a

special partnership allocation, which would have reflected

petitioner's receipt of a nontaxable distribution as his only

interest in the Mall, so that petitioner would not have been

allocated any gain from the sale of the Mall. Or, if they had

been made aware of the possibly higher value of the Mall, they

might have required petitioner to find an additional investor in

Coastal willing to pay additional cash consideration to obtain an

interest in the Mall, so as to increase the overall purchase

price and the cash distributions that they would have ultimately

received.

Petitioner, who had his own tax advisers, neither

apprised his partners of the possible excess value of the Mall

nor asked them to amend the partnership agreement (which could

have been effective for allocation purposes at any time before

filing the Pecaris partnership return, sec. 761(c)), to provide a

special allocation that would have relieved petitioner from

recognizing his distributive share of Pecaris gain from the sale

of the Mall. Petitioner's partners allowed him to handle the

Mall sale, and petitioner organized the buying group without

telling them until after the deal was done that he had a 90-

percent interest in that group. The Pecaris partnership

agreement was not amended to provide a special allocation of the
 - 32 -

gain from the Mall sale. As a result, petitioner is in a bind of

his own making, bound by the general partnership profit

allocation provisions of the Pecaris partnership agreement.15

Petitioners maintain that the general partnership allocation

rules of section 704 do not apply to tax petitioner on a share of

gain determined by reference to his stated percentage interest in

the profits of Pecaris. Petitioners maintain that the

distribution to petitioner of an undivided interest in the Mall

contemporaneously with the cash distributions to Messrs. Boyas

and Spillas, and their lack of any objection, amounted to a de

facto amendment of the Pecaris partnership agreement. However,

we have rejected that characterization, holding that petitioner

did not receive a distribution from Pecaris of an interest in the

Mall.

Section 761(c) requires that all partners agree to an

amendment to the partnership agreement. At the time the

transaction closed, petitioner's Pecaris partners were not aware

of his interest as a Coastal partner in the other side of the

transaction. Although Messrs. Boyas and Spillas may have become

aware of petitioner's participation in Coastal prior to the

15
In this connection, respondent's brief appropriately
quoted:

For of all the sad words of tongue or pen,
The saddest are these: "It might have been!"

[John Greenleaf Whittier, Maud Muller, St. 53]
 - 33 -

preparation and filing of the Pecaris partnership return, there

is no evidence that they actually agreed to an amendment to the

Pecaris partnership agreement. Petitioners' argument that there

was a de facto amendment is belied by the way that Pecaris

reported the transaction on its 1988 partnership return.16

Petitioners argue that the definitions of partnership

agreement and amendment of the partnership agreement are much

more expansive, for the purpose of determining distributive

shares of gain under section 704(b), than they are under section

761. Compare sec. 1.761-1(c), Income Tax Regs., with sec. 1.704-

1 (b)(2)(ii)(h), Income Tax Regs. The regulation under section

704(b) states:

Partnership agreement defined. For purposes of
this paragraph, the partnership agreement includes all
agreements among the partners, or between one or more
partners and the partnership, concerning affairs of the
partnership and responsibilities of partners, whether
oral or written, and whether or not embodied in a
document referred to by the partners as the partnership
agreement. * * * [Sec. 1.704-1(b)(2)(ii)(h), Income
Tax Regs.]

Be that as it may, petitioners have not persuaded us that the

construction they wish to put on the transaction was reflected in

16
Mr. Spillas testified that he learned of petitioner's
participation in Coastal before the Pecaris return was prepared,
and that he thought that petitioner had some contact with
Pecaris' accountant regarding "some modification," but did not
know for certain whether petitioner and the Pecaris return
preparer discussed modifying the Pecaris agreement. Mr. Spillas
testified that he instructed the Pecaris return preparer to do
what was necessary for the partnership to effectuate a correct
filing.
 - 34 -

any actual agreement, oral or otherwise, among the Pecaris

partners, or that the reduced distribution of cash to petitioner

from the escrow amounted to a de facto amendment of the Pecaris

partnership agreement. In the circumstances of this case, we do

not indulge in any of the constructions that petitioners have

asked us to adopt to determine that none of the Pecaris gain was

allocable to petitioner.

While the characterization of tax items is determined at the

partnership level, sec. 702(b), a partner must include his

distributive share of partnership income in gross income whether

or not he has received any distributions from the partnership,

sec. 702(c). This is true even when the partner's right to

receive distributions may be contingent or forfeitable, United

States v. Basye, 410 U.S. 441 (1973), or the partnership's income

has been concealed by another partner. Starr v. Commissioner,

267 F.2d 148 (7th Cir. 1959), affg. in part, revg. in part, and

remanding T.C. Memo. 1958-50. Because the partnership serves as

a conduit through which income is allocated to each partner in

proportion to his partnership interest, the partner takes these

amounts into income in his taxable year in which the

partnership's taxable year ends. Secs. 702(a), 706(a).

Section 704(a) provides that a partner's distributive share

of partnership income, gain, loss, or deduction is generally

determined by the partnership agreement. According to the
 - 35 -

Pecaris partnership agreement, petitioner had and continues to

have a 25-percent profits and losses interest in the partnership.

Thus, 25 percent of Pecaris' gain from its sale of its entire

interest in the Mall must be allocated to petitioner under the

partnership allocation rules, regardless of what was distributed

to him in cash. United States v. Basye, supra at 453 ("it is

axiomatic that each partner must pay taxes on his distributive

share of the partnership's income without regard to whether that

amount is actually distributed to him"); Curtis v. Commissioner,

T.C. Memo. 1995-344 (few principles of partnership taxation are

more firmly established than the notion that, no matter the

reason for nondistribution, each partner must pay taxes on his

distributive share).

Petitioners also argue that any allocation to petitioner of

gain from the sale of the Mall would not have "substantial

economic effect" under section 704(b) and the regulations

thereunder. Petitioner's argument is premised on the conclusion

we've already rejected, that the Mall transaction, insofar as

petitioner is concerned, amounted to a distribution to him by

Pecaris of an undivided interest in the Mall that he contributed

to Coastal. The inclusion of the $700,000 credit in the amount

realized by and recognized to Pecaris and distributed by Pecaris

to petitioner, supports our conclusion that the allocation of a

distributive share of the Pecaris gain to petitioner has
 - 36 -

substantial economic effect, and that there is no meaningful

discrepancy between the economic effect of and of the tax

accounting for petitioner's participation as a partner of

Pecaris.

We need not accept petitioners' invitation to engage in an

extended substantial economic effect analysis of the Pecaris

partnership agreement. We don't have here the usual situation

that section 704(b) and the regulations thereunder are designed

to deal with, in which the taxpayer is trying to justify a

special allocation provided by the partnership agreement. Here

we have a common garden variety partnership agreement with a

straightforward conventional provision for sharing profits and

losses that petitioners are asking us to disregard. The absence

of any agreement among the Pecaris partners modifying the general

profit and loss sharing provisions of the Pecaris partnership

agreement precludes any special allocation of the gain from the

sale of the Mall away from petitioner. See Deauville Operating

Corp. v. Commissioner, T.C. Memo. 1985-11.

Petitioner presses the argument that the Pecaris partners'

capital accounts were not kept in accordance with the section

704(b) regulations, sec. 1.704-1(b)(2)(ii)(b)(1), Income Tax

Regs., that liquidating distributions were not required to be

made in accordance with those regulations, sec. 1.704-

1(b)(2)(ii)(b)(2), Income Tax Regs., and that there was no
 - 37 -

deficit make-up provision in the Pecaris partnership agreement,

sec. 1.704-1(b)(2)(ii)(b)(3), Income Tax Regs. Even assuming for

the sake of argument that allocating gain from the sale of the

Mall to petitioner would lack substantial economic effect under

the section 704(b) regulations, his distributive share of income

should then be determined in accordance with his interest in the

partnership. Sec. 1.704-1(b)(3), Income Tax Regs. Absent

substantial economic effect, petitioner and the other Pecaris

partners would still be allocated gain in accordance with their

respective partnership interests under the partnership agreement.

Accordingly, we hold that petitioner's distributive share of

Pecaris partnership gain is recognized to him on the Pecaris

partnership sale of the Mall. As a 25-percent partner of

Pecaris, petitioner's distributive share of gain from the sale of

the Mall is $827,968 (Pecaris gain of $3,311,873 x .25).

____________________________

Before we address the additions to tax, we briefly advert to

three issues lurking in the record that are not in issue: The

$100,000 brokerage commission that was not the subject of an

additional adjustment by respondent; petitioner's pretrial

motion, which we denied, for leave to amend petition to take

account of any reduction in petitioner's reported taxable income

from Coastal that would result from the increased basis of the

Mall buildings and tangible personal property in the hands of
 - 38 -

Coastal attributable to taxing petitioner on a distributive share

of Pecaris gain on the sale of the Mall; and the tax treatment of

the value of the Mall in excess of $4.8 million, 90 percent of

which was arguably appropriated by petitioner without the

knowledge of his partners.

Petitioner received from Pecaris a cash distribution of

$95,783 and total credits of $700,000, only $600,000 of which was

attributable to his interest as a partner of Pecaris, and

equatable with the cash distribution of $695,783 received by

petitioner's equal partner in Pecaris, Mr. Spillas. The other

$100,000 of credit was attributable to the brokerage commission

in that amount that does not appear to have been paid, but which

was used by Pecaris as an offset in computing its gain realized

on the sale of the Mall. Although the record does not disclose

whether it was HGM or petitioner who was actually entitled to

receive the commission or the nature or extent of the ownership

or employment relationship between petitioner and HGM, it's

clear that petitioner received the benefit of the credit in the

computation for partnership accounting purposes of his capital

contribution to Coastal. Inasmuch as the right to receive the

commission arose not from petitioner's status as a partner of

Pecaris, see, e.g., Kobernat v. Commissioner, T.C. Memo. 1972-

132, but as a real estate broker affiliated with HGM, see

Williams v. Commissioner, 64 T.C. 1085, 1088-1089 (1975), section
 - 39 -

707(a) would appear to apply to cause the credit received in

exchange for services rendered to the partnership to be included

in petitioner's gross income as compensation. Shotts v.

Commissioner, T.C. Memo. 1990-641. Be that as it may, respondent

neither made any such adjustment in the statutory notice nor

moved to amend her answer to include it.

Petitioners filed a pretrial motion, which we denied, for

leave to amend petition to compute the reduction in petitioner's

taxable income from Coastal for 1988 that would result from the

increased basis and depreciation of the Mall buildings and

tangible personal property attributable to taxing petitioner on a

distributive share of Pecaris gain on the sale of the Mall. The

record of this case as tried lacks the facts with respect to the

relative values and amounts of purchase price allocable to land

and buildings and other depreciable property needed to make a

Rule 155 computation giving effect to the basis adjustment.

Because Canada Life valued the Mall at $5.5 million,

Coastal's purchase of the Mall for $4.8 million, including the

$700,000 credit, arguably yielded a windfall to Coastal, with 90

percent of the benefit accruing to petitioner. Any excess value

of the Mall that petitioner appropriated should also be added to

petitioner's gross income, resulting in a deficiency in excess of

the amount determined by respondent. Although the actual value

of the Mall may well have exceeded $4.8 million, based upon the
 - 40 -

amount that Canada Life was willing to lend on the security of

the Mall, it would be sheer speculation for us to pick any value

in excess of $4.8 million and use that figure to support charging

petitioner with any additional income for tax purposes.

Respondent has not moved to do so, and respondent would have had

the burden of proving any alleged excess value if we had allowed

an amendment to respondent's answer to that effect. There having

been no motion to amend the answer or argument to this effect by

respondent, see sec. 6214(a), and in view of our uncertainty as

to, and lack of evidence of, the actual amount of the excess, we

have confined our analysis to the acknowledged fact that the Mall

had a value no less than $4.8 million. Cf. Law v. Commissioner,

84 T.C. 985, 989 (1984).

III. Additions

A. Section 6653 Negligence Addition

Respondent determined that petitioners are liable for an

addition to tax for negligence under section 6653(a)(1) for 1988.

Section 6653(a)(1) provides that, if any part of any underpayment

is due to negligence or disregard of rules or regulations, there

shall be added to the tax an amount equal to 5 percent of the

underpayment.

Negligence is a lack of due care or failure to do what a

reasonable and ordinarily prudent person would do under the
 - 41 -

circumstances. Rybak v. Commissioner, 91 T.C. 524, 565 (1988);

Neely v. Commissioner, 85 T.C. 934, 947 (1985).

We find that the underpayment was not due to negligence or

disregard of rules or regulations. Petitioner has limited

knowledge concerning Federal income taxes, and relied primarily

on professional tax advisers and his partner in Coastal, who is a

certified public accountant charged with its financial

management, in preparing his 1988 tax return and disclosing the

transaction at issue. Respondent relies on Jaques v.

Commissioner, 935 F.2d 104 (6th Cir. 1991), affg. T.C. Memo.

1989-673, maintaining that petitioner failed to establish what

information was given to his accountant. In order for reliance

on professional advice to excuse a taxpayer from the negligence

additions to tax, the reliance must be reasonable, in good faith,

and based upon full disclosure. Freytag v. Commissioner, 89 T.C.

849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501

U.S. 868 (1991). We are satisfied that petitioners have met

their burden of proof on each of these factors.

Petitioners attached Form 8082 to their tax return,

disclosing petitioner's treatment of the transaction at issue as

being different from the way in which Pecaris treated the

transaction. Although we disagree with the way in which the

transaction was treated by petitioner for tax purposes,

petitioners' Form 8082 disclosure convinces us that petitioner
 - 42 -

sufficiently disclosed to his accountant his transactions with

Pecaris, and that petitioners reasonably relied on the way in

which their accountant treated the transaction on the joint

return.

The characterization of the Mall transaction and partnership

allocation rules present complex legal issues, on which there can

be reasonable differences of opinion. See Yelencsics v.

Commissioner, 74 T.C. 1513, 1533 (1980); cf. Marcello v.

Commissioner, 43 T.C. 168, 182 (1964), affd. and remanded in part

380 F.2d 499 (5th Cir. 1967). Petitioner's beliefs that the

credits should not be included in the amount realized by Pecaris

or in the computation of its taxable gain and that there was a de

facto amendment to the Pecaris partnership agreement that

relieved him from the allocation of gain that we hold him

accountable for, were not completely untenable. We reject

respondent's imposition of the addition to tax for negligence.

B. Section 6661 Substantial Understatement Addition

Respondent determined that petitioners are liable for the

addition to tax for substantial understatement of income tax in

1988. Income tax is substantially understated if the amount of

the understatement exceeds the greater of 10 percent of the tax

required to be shown on the return for the taxable year or

$5,000. Sec. 6661(b)(1)(A). Section 6661(a) provides for an

addition to tax equal to 25 percent of the amount of any
 - 43 -

underpayment attributable to such understatement. Pallottini v.

Commissioner, 90 T.C. 498 (1988). This amount may be reduced if

the taxpayer shows that there was substantial authority for his

treatment of an item, or that the relevant facts affecting the

tax treatment of the item are adequately disclosed on the return

or in a separate statement attached to the return. Sec.

6661(b)(2)(B); secs. 1.6661-3, 1.6661-4, Income Tax Regs.

Petitioners disclosed on Form 8082 that petitioner was

treating the disposition of the Mall in a manner inconsistent

with the treatment by Pecaris and his Pecaris partners. Although

petitioners' Form 8082 did not apprise respondent of the exact

nature of the controversy, petitioners' disclosure on their

return for respondent flagged their omission from their 1988

gross income of $827,968--the amount of respondent's adjustment.

See Schirmer v. Commissioner, 89 T.C. 277, 285-286 (1987) (citing

S. Rept. 97-494, at 274 (1982)). We reject respondent's

imposition of the section 6661 substantial understatement

addition.

To reflect the foregoing,

Decision will be entered

for respondent with respect to

the determined deficiency and

for petitioners with respect to

the additions to tax.