T.C. Memo. 1997-10
UNITED STATES TAX COURT
MARSHALL I. GORDON, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4489-94. Filed January 7, 1997.
Nathan M. Sutton, Janice S. Martin, Lyle D. Pishny, for
petitioner.
Charles M. Berlau, for respondent.
MEMORANDUM OPINION
RAUM, Judge: The Commissioner determined a $243,216
deficiency in petitioner's 1988 Federal income tax and a $60,804
section 6661(a) addition to tax for substantial understatement.
The issues are: (1) Whether petitioner (petitioner or Marshall)
realized capital gain on the transfer of a 22.5-percent interest
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in Blackbob, a Kansas property, and (2) whether he is liable for
a section 6661(a) addition to tax. The facts have been
stipulated. Unless otherwise indicated, all section references
are to the Internal Revenue Code in effect for the year in issue,
and all Rule references are to the Tax Court Rules of Practice
and Procedure.
Marshall I. Gordon, petitioner, resided in Overland Park,
Kansas, when the petition in this case was filed. Petitioner and
his sister, Suzanne Aron (Suzanne), were in dispute over the
estate of their late father, Milton Gordon, and assets owned by
Gordon Realty Company, Inc. (Gordon Realty). They agreed to
submit all of their differences to binding arbitration.
Gordon Realty owned an undivided 5/6 interest (83.333%) in
Blackbob, a plot of land located at 135th and Blackbob, Johnson
County, Kansas (Blackbob). Of the 900 shares of common stock
outstanding in Gordon Realty, petitioner owned 486 shares,
Suzanne owned 269 shares, and their respective children owned the
remaining shares. Pursuant to a plan of liquidation under which
it was required to distribute all of its property and assets,
Gordon Realty conveyed to petitioner, Suzanne, and their
respective children undivided proportionate ownership interests
in real estate (including Blackbob) of 45.001 percent, 24.907
percent, and 13.425 percent, respectively. The remaining 1/6
interest (16.667%) in Blackbob was owned by Milton Gordon,
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deceased. On December 29, 1987, pursuant to a Journal Entry of
Final Settlement, 60 percent of that 1/6 interest was conveyed to
petitioner personally or for his benefit, and 40 percent to
Suzanne personally or for her benefit.
In December 1986, petitioner's wife, Elaine Gordon (Elaine),
filed for divorce. In a Memorandum Decision of March 13, 1987,
the divorce court ruled that Elaine and her husband, Marshall,
were "deemed to own 45% of [Blackbob]", one-half of which (22.5
percent) was allocated to Elaine. The court ordered Marshall "to
obtain a deed from Gordon Realty to Mrs. Gordon, conveying to her
a 22.5% interest in the tract." When he failed to deliver the
deed, Elaine filed a "Motion to Compel Defendant, Gordon Realty
Company, Inc., and Defendant, Gordon Financial Corporation, to
Transfer Real and Personal Property".
On October 9, 1987, petitioner and Elaine met before the
district court judge and announced that they had reached a
compromise. Elaine would receive $800,000 for her share of
Blackbob, "conditioned upon the * * * execution of the agreement
between Marshall Gordon and Suzanne Aron as set forth in the
arbitor's [sic] award." The parties agreed to "formally prepare
a separation agreement and submit it to the Court for its
approval at a later date."
In February 1988, the arbitration between petitioner and
Suzanne formally ended. An award was entered requiring that the
ownership of all assets of the Estate of Milton Gordon and Gordon
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Realty be adjusted. Petitioner would be the owner of all the
interests held by the Estate of Milton Gordon and all interests
distributed by Gordon Realty in all of the property except
Blackbob, and Suzanne would be the sole owner of Blackbob. As
part thereof, she was to pay petitioner the sum of $1,386,002.30.
In July 1988, petitioner, Suzanne, and Elaine entered into
an "Exchange Agreement", under which they would transfer Blackbob
and other properties. This agreement provided:
At closing each of the parties shall deliver their
respective deeds, conveyances or releases and any funds
payable hereunder to Company [title company] with
instructions to record the documents in accordance with the
terms and provisions above set forth at such time as Company
is in position to record same and has funds available to it
for distribution to those parties entitled to payment
hereunder, it being understood that the payment to Third
Party [Elaine] shall be made out of the funds payable
hereunder by Second Party [Suzanne] to First Party
[Marshall], and that such payment shall be deemed as a
payment made by First Party to Third Party.
The property exchange took place on September 7, 1988.
Elaine executed a quitclaim deed transferring her interest in the
Blackbob property to petitioner. The deed was entered into the
transfer record on September 8, 1988. Petitioner's children
delivered their deeds to their interests in Blackbob to
petitioner. Petitioner conveyed by deed to Suzanne his interest
in Blackbob, the interest formerly allocated to Elaine, and the
interests held by his children. Suzanne delivered $1,386,002.30
to the title company. The title company disbursed $800,000 as
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"Payment to Elaine Gordon for Release of Judgment", $99,847.39 to
petitioner's children, and $484,658.91 to petitioner.
On September 8, 1988, Elaine filed a "Release and
Satisfaction of Judgment" with the district court. Bearing a
face date of September 7, 1988, this document provided:
1. The petitioner [Elaine] and respondent [Marshall]
entered into a Separation Agreement and under the terms
thereof * * * petitioner shall receive $800,000 in cash
secured by an equitable interest in the real property
located at 135th Blackbob, Johnson County, Kansas; and
2. Respondent has paid to the petitioner the sum of
$800,000; and,
3. The judgment herein entered for the petitioner in
the amount of $800,000 against the respondent should be
released and fully satisfied and the petitioner's interest
in the real property located at 135th and Blackbob, Johnson
County, Kansas, should be released.
On September 28, 1988, 3 weeks after the exchange took
place, petitioner and Elaine filed the Separation Agreement.
Under the terms of the agreement, Elaine was given, as her
personal property, "$800,000 in cash or other good negotiable
instrument, secured by equitable interest on the real property
located at 135th and Blackbob, Johnson County, Kansas." This
provision was initialed by petitioner on July 22, 1988, and by
Elaine on September 2, 1988. The first page states that the
agreement was made and entered into on October 9, 1987. However,
the certification by the clerk of the district court attests that
the original document was filed on September 28, 1988. The
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Journal Entry approving the Property Settlement Agreement was
filed on September 7, 1988.
On his 1988 income tax return, petitioner, as stipulated by
the parties, reported long-term capital gain of $486,002 (rounded
to the nearest dollar) with respect to the Blackbob exchange. In
the statutory notice of deficiency, the Commissioner determined
that petitioner received unreported long-term capital gain of
$900,000 (the difference between the $1,386,002.30 cash paid by
Suzanne and the $486,002.30 reported by petitioner). Upon
petitioner's showing that he paid $100,000 for his children's
ownership interests in Blackbob,1 which he transferred to
Suzanne, respondent has since conceded $100,000 of the $900,000
long-term capital gain ascribed to petitioner.2
The Commissioner and petitioner agree that an exchange of
interests occurred between petitioner, Suzanne, and Elaine. They
both agree that Elaine conveyed by deed her interest in Blackbob
to petitioner, which he subsequently transferred to his sister.
They agree that Suzanne provided $800,000, which was deemed a
1
Actually, the title company paid only $99,847.39 instead
of $100,000 on petitioner's behalf to his children, but nothing
here appears to turn upon the comparatively minor difference.
Perhaps it represents part of the title company's fee for its
participation as escrow agent.
2
The parties have stipulated with respect to a number of
issues not in controversy now, and the Commissioner has conceded
that petitioner is not liable for the section 6661(a) addition to
tax with respect to the items involved in the foregoing settled
issues.
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payment by petitioner to Elaine. However, they place different
interpretations upon these events. The Government contends that
petitioner was the owner of the disputed 22.5 percent interest in
Blackbob and, as such, should be taxed on the $800,000 portion of
the cash supplied by Suzanne that was allocable to him.
Petitioner argues that, at the time of the exchange, although he
acted as a conduit between Suzanne and Elaine, Elaine was the
owner of 22.5 percent of Blackbob and, as the seller of that
22.5-percent interest to Suzanne, should bear whatever the
applicable tax burden might be.
After the estate of his father was settled, petitioner
received 45 percent of Blackbob from Gordon Realty. The divorce
court allocated 22.5 percent of Blackbob, half of that 45-percent
interest, to Elaine. At the same time, petitioner and Suzanne
were having their interests in their father's estate and Gordon
Realty arbitrated. The arbitration resulted in Suzanne's getting
all of Blackbob in exchange for $1,386,002.30.
The results of the divorce decree and the arbitration award
were mutually inconsistent, with 22.5 percent of Blackbob awarded
to Elaine by the divorce court, and, about a year later, 100
percent to Suzanne in the entirely separate arbitration
proceedings. Petitioner, Elaine, and Suzanne resolved the
inconsistency by having Elaine yield her 22.5-percent interest in
Blackbob and accept $800,000, instead. Elaine consented to this
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in a 3-way agreement, and the parties exchanged their interests
using a title company as an escrow.
Suzanne placed $1,386,002.30 in the escrow account.
Petitioner purchased the interests of his children in Blackbob
for $100,000. The children transferred their interest to him,
and he, in turn, transferred that interest over to Suzanne. The
$100,000 payable by petitioner to his children was paid to them
on his behalf by the title company out of the $1,386,002.30
supplied by Suzanne.3 As indicated above, the Government has
acknowledged petitioner's acquisition of his children's ownership
interest in Blackbob and conceded that $100,000 of the
adjustment.
As we view this case, the controversy should be decided on
the basis of the substance of the matters affecting petitioner,
Elaine, and Suzanne. In substance, Elaine was the true owner of
22.5 percent of Blackbob, and she in effect sold that interest to
Suzanne, using petitioner as a conduit to enable him to transfer
it to Suzanne along with his own 22.5 percent plus that which he
acquired from his children, thus enabling Suzanne to become the
sole owner of Blackbob.4
To summarize:
3
See supra note 1.
4
To be sure, some portion of Blackbob was owned by
Suzanne's children, but no question has been raised with respect
thereto, presumably because Suzanne acquired her children's
interest or was otherwise content to treat it as her own.
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1. Petitioner's children transferred their interest in
Blackbob for $100,000.
2. Petitioner acquired Elaine's 22.5-percent interest as a
conduit to complete the sale to Suzanne.
3. Petitioner transferred to Suzanne his children's
interest, his own 22.5-percent interest, and the 22.5-
percent interest which he had simultaneously reacquired for
that purpose from Elaine.
4. Petitioner did not in substance sell anything to Elaine,
and did not realize any gain on the transaction with Elaine.
Contrary to the Government's argument, we find that Elaine,
not petitioner, was the owner of the disputed 22.5-percent
interest in Blackbob immediately prior to the tripartite
exchange. The Government relies on the Separation Agreement,
which changed Elaine's interest from the right to ownership of
22.5 percent of Blackbob to "$800,000 in cash or other good
negotiable instrument, secured by equitable interest on
[Blackbob]." The Government states in its reply brief that the
"Separation Agreement was made and entered into, and executed by
petitioner and Elaine Gordon on October 9, 1987." Based on the
execution of the Separation Agreement on October 9, 1987, the
Government contends that at the time the exchange occurred,
Elaine no longer had an ownership interest in Blackbob; she held
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only an equitable interest. See Hill v. Hill, 185 Kan. 389, 345
P.2d 1015, 1023 (1959).
The flaw in that argument is the contention that the
Separation Agreement was executed on October 9, 1987. On that
date, petitioner and Elaine merely announced that they had
reached a potential compromise; they did not file anything with
the court. In fact, petitioner and Elaine initialed the
Separation Agreement in the sections describing the equitable
interest as late as July 22, 1988, and September 2, 1988. The
exchange actually occurred thereafter, on September 7, 1988.
Finally, the Separation Agreement was not filed until September
28, 1988, a fact to which the Government has stipulated. At the
time immediately prior to the exchange, Elaine still held an
ownership interest.
The Government makes an extended argument based upon Kansas
law and differences between warranty deeds and quitclaim deeds.
Of course, Kansas law is controlling as to the technicalities of
title relating to the property. But such niceties in local law
(cf. Helvering v. Hallock, 309 U.S. 106, 114 (1940)) do not
detract from the substance of the transaction as we view this
record.
We hold that petitioner did not realize any $800,000 capital
gain with respect to the transaction before us. Since there is
no deficiency with respect to this $800,000, petitioner is not
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liable for any section 6661(a) substantial understatement
addition in connection with this item.
Decision will be entered
under Rule 155.