Moore v. Comm'r

T.C. Memo. 2007-134

UNITED STATES TAX COURT

BARRY E. MOORE AND DEBORAH E. MOORE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 11002-03. Filed May 30, 2007.

In 1988, Ps, Georgia residents, purchased a second
home (vacation home 1), also in Georgia, which the
family used on weekends from mid-April to Labor Day for
recreational purposes. After Ps changed their
principal residence in 1995 or 1996, the lengthened
commute to vacation home 1 made its continued use
impractical, and, in 1999, they agreed to purchase
another vacation home (vacation home 2) closer to their
principal residence. In 2000, Ps disposed of vacation
home 1 and acquired vacation home 2 pursuant to a
series of transactions intended to qualify as a tax-
free, like-kind exchange of those properties under sec.
1031, I.R.C. Prompted by the need for liquidity
incident to their then-pending divorce, Ps were holding
vacation home 2 for sale at the time of trial. Ps and
their children used both vacation homes exclusively for
recreational purposes, and Ps never rented or offered
to rent either vacation home to third parties. One of
Ps’ motives in acquiring and holding each vacation home
 - 2 -

was the prospect of appreciation resulting in profit on
the eventual sale of each property.

P wife (PW) acquired a 2-percent membership
interest in a medical LLC (the LLC) upon formation of
the LLC in April 1995. In July 2000, incident to the
July 28, 2000, sale of all membership interests in the
LLC to a third party, the three LLC members executed a
written agreement describing transfers by Dr. J, who
held an 88-percent membership interest in the LLC as of
Dec. 31, 1995, of 10-percent membership interests to
each of the other two LLC members, PW and Dr. M (who
previously held a 10-percent LLC membership interest).
The agreement stated that it was “effective as of” Jan.
1, 1997. In 1998, 1999, and 2000, the LLC made
distributions to the three members consistent with a
68-20-12-percent apportionment of the LLC profits among
Dr. J, Dr. M, and PW, respectively. Ps argue that Dr.
J’s transfers of 10-percent membership interests to Dr.
M and PW did not occur until July 2000. R argues that
the July 2000 written agreement formalized a prior
oral agreement and that the effective date of those
transfers was Jan. 1, 1997.

PW received both a lump-sum cash payment and a
promissory note in consideration of the July 28, 2000,
sale of her 12-percent LLC membership interest. On
their 2000 return, Ps reported, as long-term capital
gain under the installment method of accounting, the
lump-sum cash payment and the sum of the first five
monthly payments due under the terms of the promissory
note. R argues that Ps elected out of the installment
method with respect to the gain on the sale and that Ps
are required to report the full amount of that gain in
2000.

1. Held: Neither vacation home 1 nor vacation
home 2 was held for investment. Therefore, Ps are not
entitled to treat the disposal of the former and
acquisition of the latter in 2000 as a tax-free like-
kind exchange under sec. 1031, I.R.C.

2. Held, further, PW owned a 12-percent
membership interest in the LLC during the years in
issue, 1999 and 2000.

3. Held, further, Ps did not elect out of the
installment method of accounting in connection with
 - 3 -

PW’s 2000 sale of her 12-percent LLC membership
interest.

Vivian D. Hoard and Patti M. Richards, for petitioners.

Michael L. Scheier and Jennifer J. Morales, for affected

person United Surgical Partners International, Inc.

Brenda M. Fitzgerald, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

HALPERN, Judge: By notice of deficiency dated April 10,

2003 (the notice), respondent determined deficiencies in

petitioners’ Federal income tax as follows:

Year Deficiency

1999 $96,925
2000 78,578

By the petition, petitioners assign error to respondent’s

deficiency determination. The parties have resolved certain

issues.1 The remaining issues for decision are whether (1)

petitioners’ purported exchange of vacation properties qualifies

as a tax-free “like-kind” exchange of properties under section

1
Those issues are (1) issues settled or conceded pursuant
to the parties’ stipulation of settled issues executed on May 19,
2004, and (2) issues that petitioners failed to pursue on brief,
which we treat as having been abandoned. See Nicklaus v.
Commissioner, 117 T.C. 117, 120 n.4 (2001). The issues that
petitioners failed to pursue are (1) whether petitioners are
required to include in income for 1999 $1,701 of interest and (2)
whether petitioner Barry E. Moore is entitled to relief from tax
liability for either 1999 or 2000 as an innocent spouse.
 - 4 -

10312 (the section 1031 issue), (2) petitioner Deborah E. Moore

(Ms. Moore) increased her membership interest in The Surgery

Center of Georgia, LLC (the LLC) before the years in issue (1999

and 2000), as alleged by respondent, or in July 2000, as alleged

by petitioners (the membership interest acquisition issue), and

(3) petitioners are entitled to report Ms. Moore’s gain on the

sale of her membership interest in the LLC under the installment

method, in accordance with section 453 (the installment method

reporting issue).3

The notice contains certain other adjustments that are

purely computational. Their resolution solely depends upon our

resolution of the issues remaining in dispute.

2
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
3
The parties also disagree regarding the application of
sec. 7491(a) to this case. If applicable to a factual issue,
sec. 7491(a) would cause the burden of proof on that issue to
shift from petitioners to respondent. See Rule 142(a). We need
not decide whether sec. 7491(a) applies herein because we resolve
all factual issues upon a preponderance of the evidence.
Therefore, resolution of the issues in this case does not depend
upon which party bears the burden of proof. See Estate of
Bongard v. Commissioner, 124 T.C. 95, 111 (2005); see also
Blodgett v. Commissioner, 394 F.3d 1030, 1039 (8th Cir. 2005),
affg. T.C. Memo. 2003-212; FRGC Inv., LLC v. Commissioner, 89
Fed. Appx. 656 (9th Cir. 2004), affg. T.C. Memo. 2002-276;
Brookfield Wire Co. v. Commissioner, 667 F.2d 551, 553 n.2 (1st
Cir. 1981), affg. T.C. Memo. 1980-321.
 - 5 -

Petitioners’ Challenge to Respondent’s Briefs

On the basis of Rule 151(b), Time for Filing Briefs,

petitioners argue that we must disregard respondent’s opening

brief because respondent filed that brief 1 day late and did not

move before the due date for an extension of time to file.

Petitioners also argue that, because respondent “failed to file”

an opening brief and did not seek leave of the Court to file a

reply brief, he is not permitted to file a reply brief. See Rule

151(b).

Petitioners argue that respondent should have filed his

opening brief no later than August 15, 2005, the last day of the

60-day period allotted by the Court for such filings at the

conclusion of the trial on June 15, 2005, even though the trial

transcript furnished to the parties records both the trial clerk

and the Court as stating that due date to be August 16, 2005, the

date upon which respondent’s opening brief was actually filed.

Because the Court identified a due date one day after the

close of the 60-day period allocated by the Court for the filing

of opening briefs, the Court must accept some responsibility for

the tardiness, if any, in respondent’s filing of his opening

brief. Moreover, 1 day is negligible, and we do not believe that

it prejudiced petitioners in preparing their answering brief. In

fact, petitioners do not allege that they were so prejudiced;

they allege only that we “must strike and disregard” respondent’s
 - 6 -

brief pursuant to Rule 151. Under the circumstances, we find it

inappropriate to disregard or strike respondent’s opening (or

reply) brief, and we decline to do so.

FINDINGS OF FACT

Some facts have been stipulated and are so found. The

stipulation of facts, with attached exhibits, is incorporated

herein by this reference.

At the time the petition was filed, petitioner Barry E.

Moore (Mr. Moore) resided in Elberton, Georgia, and Ms. Moore

resided in Marietta, Georgia.

The Section 1031 Issue

Background

On April 15, 1988, petitioners purchased two contiguous

parcels of lakefront real property, along with a mobile home

located on one of those parcels, on Clark Hill Lake in Lincoln

County, Georgia (the Clark Hill property). On December 3, 1999,

petitioners entered into a purchase and sale agreement wherein

they agreed to purchase improved lakefront property in Forsyth

County, Georgia (the Lake Lanier property). Thereafter, during

2000, petitioners were involved in a series of transactions

whereby they purported to (1) assign a 25-percent interest in the

purchase and sale agreement to an escrow agent, (2) join with the

escrow agent in purchasing the Lake Lanier property (75 percent

acquired by petitioners, 25 percent by the escrow agent), and (3)
 - 7 -

after buyers for the Clark Hill property had been found, through

an intermediary, exchange the Clark Hill property for the escrow

agent’s 25-percent interest in the Lake Lanier property in a

transaction intended to qualify as a deferred like-kind exchange

satisfying the requirements of section 1031(a)(3) and section

1.1031(k)-1, Income Tax Regs. Respondent denies the authenticity

of much of petitioners’ supporting documentation and alleges that

(1) the escrow agent was, in substance, acting as petitioners’

agent in acquiring a 25-percent interest in the Lake Lanier

property so that petitioners already owned that property before

the purported like-kind exchange; i.e., there was no “exchange”

of like-kind properties, and (2) petitioners otherwise failed to

satisfy the requirements of section 1031(a)(3) and the

regulations thereunder for a deferred like-kind exchange.

In order for petitioners to prevail on the section 1031

issue, the evidence must show that (1) the Clark Hill and Lake

Lanier properties were of like kind (a matter not in dispute),

(2) petitioners held both properties for investment,4 and (3)

they disposed of the former and acquired the latter in a manner

that satisfied the requirements of section 1031(a)(3) and the

regulations thereunder for a deferred like-kind exchange.

4
Petitioners do not claim that either property satisfied
the alternative definition of qualified like-kind property:
“property held for productive use in a trade or business”. Sec.
1031(a)(1).
 - 8 -

Because we find that petitioners held neither property for

investment, we make no findings of fact relating to the

sufficiency of petitioners’ attempt to satisfy the other

requirements for a deferred like-kind exchange.5

Petitioners’ Purchase and Use of the Properties

The Clark Hill Property

Petitioners’ decision to purchase the Clark Hill property

was motivated, in part, by their familiarity with the area, both

having grown up in the vicinity of Clark Hill Lake. In addition,

both their families owned property on or near Clark Hill, and Mr.

Moore’s father advised them that property on Clark Hill Lake had

appreciated and would continue to appreciate. Petitioners’

decision to invest in real estate rather than in intangibles,

such as stocks or bonds, was influenced by a prior bad experience

with a financial adviser who had stolen their money.

When in 1988 they purchased the Clark Hill property,

petitioners’ primary residence was in Norcross, Georgia, an

approximately 3-hour drive from the Clark Hill property. In 1995

or 1996, petitioners changed their primary residence to Marietta,

Georgia. The drive from the Marietta residence to the Clark Hill

property normally took between 5 and 6 hours.

5
As a result, we need not rule on respondent’s objections
to various documents petitioners offered.
 - 9 -

Beginning in late March of each year during which they owned

the Clark Hill property, Mr. Moore would spend a couple of

weekends there getting it ready for the summer months. Then,

beginning in mid to late April, petitioners’ family would visit

the property two and, sometimes, three weekends a month until

Labor Day, when Mr. Moore closed the property for the winter.

Between Labor Day and the following March, Mr. Moore would

occasionally visit the property to rake leaves and perform other

caretaker functions.

The mobile home located on the property was a double-wide

mobile home. During their tenure, petitioners built a deck

around it, built a screened-in porch on top of a portion of the

deck, and installed a satellite television receiver, a new

television, and a VHS recorder. They also replaced the roof and

repainted the home two or three times. They installed a new

washer and dryer and replaced some of the furniture (bedroom

seats and beds) that had come with the home. They kept a pontoon

boat on Clark Hill Lake and improved the dock they had in the

lake to conform to the U.S. Army Corps of Engineers electrical

requirements. During their summer stays at the Clark Hill

property, petitioners and their children used the property for

various recreational purposes, including relaxing on the dock,

boating, and fishing.
 - 10 -

Until they decided to acquire the Lake Lanier property in

late 1999, petitioners had never advertised the Clark Hill

property for sale although they had been offered money for it.

Also, petitioners never rented or attempted to rent the property

to others.

On their 1996-99 Federal income tax returns, petitioners

listed deductions for “home mortgage interest”. They did not

list on those returns any deduction for investment interest, nor

did they deduct any maintenance or other expenses associated with

the Clark Hill property.

The Lake Lanier Property

Reasons for Purchase

After petitioners changed their principal residence from

Norcross to Marietta, Georgia, the length of the drive to the

Clark Hill property coupled with their children’s increased

weekend activities (in particular, their son’s participation in

weekend sports) made it inconvenient for the family to spend

weekends at the property. As a result, they used that property

less frequently and, during the 2 years before their disposition

of it, they may have visited the property a total of three times.

During that period, it became a chore for Mr. Moore just to

maintain the property, with the result that it became rundown and

had to be either renovated or disposed of.
 - 11 -

Beginning in late 1997 or early 1998, the foregoing problems

associated with the Clark Hill property caused petitioners to

investigate properties on Lake Lanier, which is much closer to

what was at the time petitioners’ Marietta, Georgia, residence.

Petitioners felt that a house on Lake Lanier would be of more use

to them than the Clark Hill property. Petitioners also believed

that property on Lake Lanier would appreciate more rapidly than

the Clark Hill property because it was closer to the metropolitan

Atlanta area. Petitioners acquired the Lake Lanier property in

January 2000.

Use of the Property

The Lake Lanier property consisted of a greater than 1.2-

acre tract of land, the largest double slip dock allowable on the

lake (complete with two lifts), and a house that had five

screened-in porches overlooking the lake, a full party deck, a

covered veranda, a great room with a stone fireplace, five

bedrooms, and 4-1/2 bathrooms. At the time of purchase, the

house was partially furnished, and, after purchase, petitioners

completed the furnishing themselves. They installed a satellite

TV system and a VHS recorder, and, before their second summer at

the property, they purchased a motorboat with room for six to

eight passengers.

Petitioners and their children engaged in essentially the

same activities at the Lake Lanier property as they had at the
 - 12 -

Clark Hill property. They visited the property two weekends per

month beginning in mid-March (depending on the weather) and

ending around Labor Day. In addition, the family might visit the

property once or twice each winter, and Mr. Moore and his son

would fish off the dock one Saturday night each month during the

fall. During the summer months, petitioners occasionally

entertained visitors at the house. Mr. Moore’s maintenance

activities at the Lake Lanier property were similar to, but less

frequent than, his maintenance activities at the Clark Hill

property.

The mortgage lender in connection with petitioners’ purchase

of the Lake Lanier property was SouthTrust Bank, N.A. (SouthTrust

Bank).6 On their 2000-02 Federal income tax returns, petitioners

claimed deductions for home mortgage and investment interest paid

to SouthTrust Bank as follows:

Year Home Mortgage Interest Investment Interest

2000 $36,219 $5,647
2001 42,437 1,994
2002 45,766 --

As in the case of the Clark Hill property, petitioners did

not list on their 2000-02 returns any deductions for maintenance

or other expenses associated with the Lake Lanier property.

6
In its “Credit Offering Report” assessing the risk of
various loans to Ms. Moore, including the loan to purchase the
Lake Lanier property, that property, which was to serve as
security for those loans, is consistently referred to as a
“second residence”.
 - 13 -

Also, as in the case of the Clark Hill property, petitioners

never rented or attempted to rent the Lake Lanier property, and

they never offered it for sale until forced to do so by the need

for liquidity in connection with the division of their assets

incident to their divorce. Both the sale and the divorce were

still pending at the time of the trial.

The Membership Interest Acquisition Issue

The LLC Operating Agreement

The LLC was organized in the State of Georgia on April 19,

1995, and, as of that date, the “Operating Agreement of The

Surgery Center of Georgia” (the LLC operating agreement or the

agreement) became effective. Pursuant to the agreement, the

initial members of the LLC and their initial membership interests

were as follows:

Member Percent Interest

Laser Centers of America, Inc. 45
Stephen N. Joffe, M.D. 35
Barry McKernan, M.D. 10
Hugh McLeod, M.D. 8
Deborah Moore 2

At that time, Dr. Joffe was the CEO and sole shareholder of Laser

Centers of America, Inc., which was designated the manager of the

LLC.7

7
On a day-to-day operational basis, however, Ms. Moore
managed the LLC.
 - 14 -

Article 8 of the LLC operating agreement governs

“Allocations and Distributions”. Section 8.5, entitled “Interim

Distributions”, provides in pertinent part as follows:

To the extent * * * [cash in excess of current and
anticipated needs] exists, the Members * * * may make
Distributions to the Members in accordance with their
Membership Interests. Such distributions shall be in
cash or Property (which need not be distributed
proportionately) or partly in both, as determined by
the Manager.

Article 10 of the agreement is entitled “Disposition of

Membership Interests”. Section 10.1 provides: “No Membership

Interest of the * * * [LLC] shall be Disposed, except as

hereinafter provided in this Article 10.” Section 10.2.1,

governing voluntary dispositions of membership interests,

provides in pertinent part: “Any Member who desires voluntarily

to Dispose of the Membership Interest * * * owned by him in the

* * * [LLC] shall give the Manager * * * written notice of his

intent and the terms of such proposed Disposition.” Section 10.3

gives the LLC an overall 90-day right of first refusal to

purchase or to designate a purchaser for the selling member’s

interest at a designated purchase price. Section 10.5 provides

that the closing of a sale of a membership interest must occur no

later [earlier?] than 90 days after the giving of written notice

of the sale required in section 10.2. Section 10.7 states: “Any

attempted Disposition of a Membership Interest, or any part
 - 15 -

thereof, not in compliance with * * * [article 10] is null and

void ab initio.”

Dr. Joffe’s 1995 Purchases of Additional Interests in the
LLC

On September 28, 1995, Laser Centers of America, Inc., sold

its 45-percent membership interest in the LLC to Dr. Joffe, and,

on December 31, 1995, Dr. McLeod sold his 8-percent membership

interest in the LLC to him. As a result, as of December 31,

1995, Dr. Joffe owned 88 percent, Dr. McKernan owned 10 percent,

and Ms. Moore owned 2 percent of the LLC.

The Moore Letter; the Joffe Memorandum

In a handwritten letter dated July 1, 1997, to James P.

Kelly (Mr. Kelly), counsel to the LLC during 1996-98, Ms. Moore

listed percentage distributions, including an 8-percent share for

herself, “should * * * [the LLC] be sold or distributions be

made.” In that letter (the Moore letter), Ms. Moore further

noted: “Deborah Moore has 2% originally already. Also, the

agreement for the above percentages in no way interferes with the

original LLC percentages.”8

8
In substantial part, the Moore letter states:

July 1, 1997

James P. Kelly
200 Galleria Pkwy
Suite 1510
Atlanta, Ga 30339

(continued...)
 - 16 -

Sometime between July 1 and late December 1997, Dr. Joffe

executed a handwritten, undated memorandum (the Joffe memorandum)

to Ms. Moore, in which he states: “This is to confirm that

Debbie Moore will receive 10% (Ten Percent) of the net proceeds

of the sale of * * * [the LLC].”

The Kelly Correspondence

During 1997, Mr. Kelly sent three letters (the Kelly

correspondence) to Ms. Moore in her capacity as the de facto

manager of the LLC.

In the first letter, dated October 17, 1997, Mr. Kelly

advised Ms. Moore that the LLC could “lawfully issue 6% of its

stock to you under the safe harbor for reasonable compensation to

8
(...continued)
Jim:

I spoke with Dr. Joffe and here are the % distributions for
the Surgery Center of Georgia, LLC should the center be sold or
distributions be made. These are % of net profit.

J. Barry McKernan -- 10%
J.K. Champion -- 3%
Robert S. Cowles -- 3%
Deborah Moore -- 8%
Ronald Van Tuyl -- 1%
William S. Armstrong -- 2%
Rick Hawkins -- 1%

J. Barry McKernan has originally 10% already in the Surgery
Center of Ga and Deborah Moore has 2% originally already. Also
the agreement for the above percentages in no way interferes with
the original LLC percentages. Call for questions.

Thanks,
Deborah Moore
 - 17 -

employees.” The letter also describes the formal requirements

needed to effect such an issuance of shares.

The other two letters, both dated October 28, 1997, concern

the potential application of Medicare Antikickback laws to

proposed physician acquisitions of stock in the LLC. In one of

those letters, Mr. Kelly states his understanding that the LLC

“currently is owned by Dr. Joffe (88%) * * * Dr. McKernan (10%)

and * * * [Ms. Moore] (2%)”.

The SouthTrust Bank Credit Offering Report and the $50,000
Revolving Note

In connection with a $50,000 loan to the LLC, evidenced by a

$50,000 “revolving note” dated March 29, 1999, SouthTrust Bank

prepared a “Credit Offering Report” (the SouthTrust Bank credit

report), which states: “The [LLC] was started, according to the

tax return, on 5/1/95. During 1995, two members of the LLC sold

their interests to Dr. Joffe who now owns 88%.” That portion of

the SouthTrust Bank credit report is date-stamped “Dec-01-98”.

In another portion of the SouthTrust Bank credit report, entitled

“Collateral”, the word “Unsecured” appears. The word “Unsecured”

is also typed on the revolving note in the section of the

printed form dealing with security agreements.

The LLC Returns

The initial short year return, Form 1065, U.S. Partnership

Return of Income, filed by the LLC for 1995 reflects the 1995

sales by Laser Centers of America, Inc., of its 45-percent
 - 18 -

ownership interest and by Dr. McLeod of his 8-percent ownership

interest in the LLC to Dr. Joffe. The sales are reflected in

footnotes to the Schedules K-1, Partner’s Share of Income

Credits, Deductions, etc., prepared for Drs. Joffe and McLeod and

for Laser Centers of America, Inc.

The returns filed by the LLC for 1996-99 include Schedules

K-1 for Drs. Joffe and McKernan and for Ms. Moore (collectively,

the LLC members), which reflect percentage profit and loss

sharing and capital ownership interests for them of 88, 10, and 2

percent, respectively. The LLC’s final return for its short year

ending July 31, 2000, reflects those same percentage interests

for the LLC members at the beginning of the year, and a zero-

percent interest for each at yearend.9

The LLC’s 1996 and 1997 returns reflect no distributions to

the LLC members. The 1998-2000 LLC returns reflect distributions

to the LLC members in the following amounts and percentages of

total distributions:
1998 1999 2000
Member Amount % of Total Amount % of Total Amount % of Total

Dr. Joffe $40,538 67.86 $268,510 63.91 $978,466 68
Dr. McKernan 12,000 20.08 96,979 23.08 287,785 20
Ms. Moore 7,200 12.05 54,642 13.01 172,671 12

Sale of the LLC Membership Interests

On or about November 30, 1999, the LLC, the LLC members, and

Surgicoe Corp. (Surgicoe) entered into a “Membership Interest

9
As discussed infra, the LLC members sold their interests
in the LLC effective July 28, 2000.
 - 19 -

Purchase Agreement” (the Surgicoe purchase agreement) pursuant to

which the LLC members agreed to sell their membership interests

in the LLC to Surgicoe for a total of $9,988,352, subject to

certain adjustments at closing. After those adjustments, the

total purchase price was reduced to $9,490,051. The Surgicoe

purchase agreement provides that “[t]he Purchase Price shall be

allocated as set forth in Schedule 2.2.4.” The record contains

two such schedules. The first, presumably attached to the

agreement, provides: “Consideration to be allocated among

Sellers as provided in a closing statement to be executed by

Sellers at Closing.” The second, presumably executed sometime

between the dates of the Surgicoe purchase agreement and the

closing, allocates the total purchase price among the LLC members

on the following percentage basis: 68 percent to Dr. Joffe, 20

percent to Dr. McKernan, and 12 percent to Ms. Moore. The

distribution of the final, adjusted purchase price was as

follows:

Member Amount % of Total

Dr. Joffe $6,453,234.68 68
Dr. McKernan 1,898,010.20 20
Ms. Moore 1,138,806.12 12

Surgicoe’s purchase of Ms. Moore’s interest in the LLC

consisted of Ms. Moore’s receipt from Surgicoe of $661,774.01 in

cash, LLC debt relief apportioned to Ms. Moore of $316,206.24,

and a promissory note dated July 28, 2000, in the sum of
 - 20 -

$160,825.87. Also, on that date, Ms. Moore executed (1) a

“Certificate of Limited Liability Company Interest in the Surgery

Center of Georgia, LLC”, in which she certifies to her ownership

of a “12% limited liability company interest * * * in [the LLC],”

and (2) an “Irrevocable Member Interest Power” pursuant to which

she states that she “does hereby sell * * * to [Surgicoe] a 12%

interest as a member in [the LLC]” and appoints a named attorney

to transfer that interest on the LLC’s books.

Assignment and Assumption Agreement

In 2000, in connection with, and sometime before, the July

28, 2000, closing of the sale of the LLC membership interests to

Surgicoe, Drs. Joffe and McKernan and Ms. Moore executed an

“Assignment and Assumption Agreement * * * made and entered into

and effective as of the 1st day of January, 1997” (the assignment

and assumption agreement or, sometimes, just the agreement),

whereby Dr. Joffe, “in consideration of the continued services of

* * * [Dr. McKernan and Ms. Moore] and other good and valuable

consideration”, transferred a 10-percent membership interest in

the LLC to Dr. McKernan and a 10-percent membership interest in

the LLC to Ms. Moore. The last sentence of the agreement, just

before the signatures of Drs. Joffe and McKernan and Ms. Moore,

reads: “IN WITNESS WHEREOF, the parties have executed this

Agreement under seal to be effective as of the date [January 1,

1997] first above written.” The agreement states that it is “a
 - 21 -

Georgia contract and shall be governed by and construed in

accordance with Georgia law.”

Dr. Joffe, on behalf of himself as manager of the LLC and on

behalf of the LLC, executed a “Waiver of Notice and Right to

Purchase” (which is attached to the assignment and assumption

agreement) whereby he specifically waived (1) the right to

receive notice pursuant to section 10.2.1 of the LLC operating

agreement of his membership interest dispositions and (2) the

LLC’s rights, pursuant to section 10.3 of the LLC operating

agreement, either to purchase Dr. Joffe’s 10-percent membership

interests transferred to Dr. McKernan and Ms. Moore or to

identify another purchaser thereof.

The Installment Method Reporting Issue

As noted supra, part of the consideration Ms. Moore received

for the sale of a 12-percent interest in the LLC to Surgicoe

consisted of a promissory note in the sum of $160,825.87. That

note provided for 60 consecutive monthly payments of combined

principal and interest of $3,358.03, beginning September 1, 2000,

and ending August 1, 2005. On their 2000 return, Schedule D,

Capital Gains and Losses, petitioners reported as long-term

capital gain $631,590 from the July 28, 2000, sale of

“partnership interest” and “note payments” in the sum of $16,790.
 - 22 -

OPINION

I. The Section 1031 Issue

A. Analysis

As noted supra, the issue before us is whether petitioners

held the Clark Hill and Lake Lanier properties “for investment”.

That depends on their intent or purpose in holding the

properties, determined as of the time of the exchange. E.g.,

Bolker v. Commissioner, 81 T.C. 782, 804 (1983), affd. 760 F.2d

1039 (9th Cir. 1985).

Petitioners point to their interest in the appreciation

potential of the Clark Hill and Lake Lanier properties, both

before and after acquisition, and argue: “If investment intent

is one motive for holding * * * property, it is held for

investment for purposes of Section 1031.” Petitioners’ argument,

if carried to its logical extreme, is that the existence of any

investment motive in holding a personal residence, no matter how

minor a factor in the overall decision to acquire and hold (or

simply to hold) the property before its inclusion in an exchange

of properties, will render it “property * * * held for

investment” with any gain on the exchange eligible for

nonrecognition treatment under section 1031. Petitioners are

mistaken. It is a taxpayer’s primary purpose in holding the

properties that counts. Montgomery v. Commissioner, T.C. Memo.

1997-279 (“section 1031 requires that both the property
 - 23 -

transferred and the property received in a like-kind exchange be

held primarily for productive use in a trade or business, or for

investment.”), affd. in part and revd. in part on another issue

without published opinion 300 F.3d 866 (10th Cir. 1999). Indeed,

in Starker v. United States, 602 F.2d 1341, 1350-1351 (9th Cir.

1979), the U.S. Court of Appeals for the Ninth Circuit recognized

the longstanding rule that the exclusive use of property by the

owner as his residence contradicts any claim by him that the

property is held for investment. The court applied the rule

specifically to section 1031 exchanges. The court said:

It has long been the rule that use of property solely
as a personal residence is antithetical to its being
held for investment. Losses on the sale or exchange of
such property cannot be deducted for this reason,
despite the general rule that losses from transactions
involving * * * investment properties are deductible.
A similar rule must obtain in construing the term “held
for investment” in section 1031. * * * [Id.;
citations omitted.]

This and other courts have reached the same conclusion in

the context of deciding whether expenses incurred with respect to

a personal residence are deductible under section 212(2) as

“expenses paid or incurred * * * for the management,

conservation, or maintenance of property held for the production

of income”. Property held for investment is property held for

the production of income within the meaning of section 212. See

Newcombe v. Commissioner, 54 T.C. 1298, 1302 (1970) (an expense

deduction is justified under section 212(2) only if the property
 - 24 -

to which it relates “is ‘held for investment,’ i.e., for the

production of income”); sec. 1.212-1(b), Income Tax Regs. Thus,

both section 1031 and section 212(2) involve the same factual

inquiry whether the property in question was held for investment.

As a preliminary matter, we accept as a fact that

petitioners hoped that both the Clark Hill and Lake Lanier

properties would appreciate. However, the mere hope or

expectation that property may be sold at a gain cannot establish

an investment intent if the taxpayer uses the property as a

residence. See Jasionowski v. Commissioner, 66 T.C. 312, 323

(1976) (“if the anticipation of eventually selling the house at a

profit were in itself sufficient to establish that the property

was held with a profit-making intent, rare indeed would be the

homeowner who purchased a home several years ago who could not

make the same claim”). Moreover, a taxpayer cannot escape the

residential status of property merely by moving out. In Newcombe

v. Commissioner, supra, the taxpayers listed their former

residence for sale on or about the day they moved out, December

1, 1965. They sold the property at a loss on February 1, 1967.

The issue in Newcombe relevant to this case was whether, during

1966, the property was held for the production of income (i.e.,

for investment) so as to entitle the taxpayers to deductions for

maintenance expenses under section 212(2). In denying those

deductions we stated:
 - 25 -

The taxpayer must * * * be seeking to realize a
profit representing postconversion appreciation in the
market value of the property. Clearly, where the
profit represents only the appreciation which took
place during the period of occupancy as a personal
residence, it cannot be said that the property was
“held for the production of income.” * * * [Id. at
1302.]

We added: “The placing of the property on the market for

immediate sale, at or shortly after * * * its abandonment as a

residence, will ordinarily be strong evidence that a taxpayer is

not holding the property for postconversion appreciation in

value.” Id.10

This Court has frequently applied the reasoning of one or

both of Jasionowski and Newcombe in rejecting taxpayer arguments

that because a second or vacation home was held for appreciation

(i.e., investment) the taxpayer was entitled to a deduction,

under section 212(2), for expenses incurred to maintain or

improve the property. See, e.g., Ray v. Commissioner, T.C. Memo.

1989-628; Houle v. Commissioner, T.C. Memo. 1985-389; Gettler v.

Commissioner, T.C. Memo. 1975-87. In both Ray and Houle we

denied the deductions on the ground that the taxpayers treated

10
In a concurring opinion, Judge Forrester observed:

The time when the conversion occurred is obviously
the key, and any appreciation prior thereto would not
have grown while the property was being “held for
investment” * * * but while the property was being held
as taxpayers’ personal residence. [Newcombe v.
Commissioner, 54 T.C. 1298, 1304 (1970) (Forrester, J.,
concurring).]
 - 26 -

the houses as a “second home” (Ray) or “second residence”

(Houle). In Gettler, we denied the deductions, concluding that

“the primary purpose in both acquiring the house and holding on

to it was to use it as a vacation home.” The cited cases stand

for the proposition that the holding of a primary or secondary

(e.g., vacation) residence motivated in part by an expectation

that the property will appreciate in value is insufficient to

justify the classification of that property as property “held for

investment” under section 212(2) and, by analogy, section 1031.

Moreover, putting aside petitioners’ expectations that both

the Clark Hill and Lake Lanier properties would appreciate in

value, there is no convincing evidence that the properties were

held for the production of income, and there is convincing

evidence that petitioners and their families used the properties

as vacation retreats. Petitioners made neither the Clark Hill

nor Lake Lanier property available for rent. Nor is there any

evidence that petitioners held either property primarily for sale

at a profit. They did not offer the Clark Hill property for sale

until late 1999 when they decided to acquire the more accessible

Lake Lanier property. Thereafter, the Clark Hill property was

held for immediate sale, not for investment. See Newcombe v.

Commissioner, supra at 1302. They did not offer the Lake Lanier

property for sale until required to do so by the need for

liquidity incident to their divorce. While it is true that Mr.
 - 27 -

Moore spent considerable time fixing up and maintaining both

properties and petitioners made substantial improvements at the

Clark Hill property, those actions are consistent with enjoying

the properties as vacation homes. Petitioners did not hold the

Clark Hill property out for rent or sale, yet they added a deck

and screened-in porch, installed a satellite television receiver,

and purchased a television, a VHS recorder, and a new washer and

dryer for their use at the property. They replaced furniture and

kept a boat on the lake, which they used for boating and fishing.

Petitioners added similar electronic equipment to the Lake Lanier

house. That house was of some substance, containing five

bedrooms and having, among other amenities, five screened-in

porches overlooking the lake, a double slip dock, a great room

with a stone fireplace, and a full party deck. Surely, that

house represented a substantial portion of the purchase price of

the Lake Lanier property, yet petitioners made no effort to

recover any portion of that investment by renting the house out;

indeed, they did not even offer it for rent. Petitioners would

have us believe that they used the house only as a caretaker’s

cottage while awaiting the expected appreciation in the value of

the property as a whole. While awaiting that event, however,

they purchased a 6- to 8-passenger motorboat to pass the time on

the lake. Also inconsistent with their claim that they held the

two properties for investment is their failure to claim any tax
 - 28 -

deductions for maintenance expenses or depreciation connected

with the properties. Also, on their tax returns, they treated

all of their interest deductions for 1996–99 and most of those

deductions for 2000–02 as home mortgage interest rather than as

investment interest.

In short, the evidence overwhelmingly demonstrates that

petitioners’ primary purpose in acquiring and holding both the

Clark Hill and Lake Lanier properties was to enjoy the use of

those properties as vacation homes; i.e., as secondary, personal

residences. That conclusion is buttressed by Mr. Moore’s

testimony that, after petitioners’ regular weekend use of the

Clark Hill property ceased during the last 2 years of their

ownership, they allowed it to become “run down” so that it

“needed to be looked after or * * * [disposed of].” That lack of

upkeep is inconsistent with a professed intention to protect

their investment in and maximize their profit on the sale of the

property but consistent with an attitude that continued upkeep

and maintenance were warranted only in connection with

petitioners’ regular, personal use of the property.

The caselaw upon which petitioners principally rely is

inapposite. In Vandeyacht v. Commissioner, T.C. Memo. 1994-148,

we sustained the taxpayers’ deductions for expenses associated

with two oceanfront recreational properties. In that case,

however, the taxpayers never occupied the properties, a
 - 29 -

condominium and a house, nor used them for personal purposes;

and, although the taxpayers’ children and friends stayed in both

properties, they paid fair market rent to the taxpayers.

In Hambleton v. Commissioner, T.C. Memo. 1982-234, we denied

deductions for expenses relating to farming activities on a 110-

acre tract of farmland because we found that the taxpayers lacked

the requisite profit motive under section 183. We found,

however: “Although * * * [the taxpayers] used approximately one

acre surrounding the house for personal use, * * * [the

taxpayers’] principal motivation in purchasing the 110 acre farm

was to realize a profit through appreciation in the value of the

land.” We denied the deductions only because the taxpayers were

unable to explain how any of the expenses were “ordinary and

necessary to the holding of the property as an investment.” The

taxpayers’ circumstances in Hambleton are readily distinguishable

from petitioners’ circumstances wherein the properties in

question are not obviously divisible into residential and

nonresidential portions and, as far as we can tell, were used

entirely and exclusively as weekend vacation retreats.

Lastly, neither Holmes v. Commissioner, 184 F.3d 536 (6th

Cir. 1999), revg., vacating, and remanding T.C. Memo. 1997-401,

nor Frazier v. Commissioner, T.C. Memo. 1985-61, addresses the

issue of whether a personal residence that the taxpayers use

exclusively for recreational purposes can constitute property
 - 30 -

held for investment. Rather, the issue in both cases, decided in

the taxpayers’ favor, was whether incidental recreational or

residential use by the taxpayers or family members of property

primarily used by the taxpayers for commercial farming or fishing

(or whether the personal enjoyment they derived from those

primary usage activities) negated the taxpayers’ profit motive

for engaging in those activities.

B. Conclusion

Neither the Clark Hill nor Lake Lanier property constituted

property held for investment for purposes of section 1031(a).

Therefore, petitioners’ disposition of the former and acquisition

of the latter did not qualify as a tax-free “like-kind” exchange

of properties under section 1031.

II. The Membership Interest Acquisition Issue

A. Introduction

Our resolution of this issue will determine whether

petitioners are required to report, as Ms. Moore’s distributable

share, 2 percent of the LLC’s income for the years in issue, as

alleged by petitioners, or 12 percent of that income, as alleged

by respondent.

B. Petitioners’ Position

Petitioners acknowledge that Dr. Joffe transferred a 10-

percent membership interest in the LLC to Ms. Moore, which,

together with his transfer of another 10-percent interest to Dr.
 - 31 -

McKernan, reduced his percentage membership interest in the LLC

from 88 to 68 percent and increased Ms. Moore’s percentage

membership interest from 2 to 12 percent. Petitioners argue,

however, that those transfers occurred in July 2000 upon the

execution of the assignment and assumption agreement.

Petitioners also argue that the 1998-2000 distributions from

the LLC to its members in amounts either precisely or closely

reflecting a 68-20-12-percent profit split among Dr. Joffe, Dr.

McKernan, and Ms. Moore, respectively (referred to by

petitioners’ counsel, on brief, as “disproportionate

distributions”), did not reflect a shift in the membership

interests among those three individuals before July 2000, but,

instead, reflected an informal agreement among them that Dr.

McKernan and Ms. Moore should be compensated by those

distributions for the use of LLC profits and the pledge of LLC

assets to discharge Dr. Joffe’s debt to the creditors of his

failed surgery center in Cincinnati, Ohio. In effect,

petitioners argue that, to the extent the 1998-2000 distributions

to Ms. Moore and Dr. McKernan exceeded 2 percent and 10 percent,

respectively, of the LLC’s current and accumulated profits, they

represented a return of capital.

In support of their position, petitioners rely primarily

upon: (1) the Moore letter, which speaks of distribution

percentages and not shares of income, (2) the Joffe memorandum,
 - 32 -

confirming his agreement to give Ms. Moore “10% of the net

proceeds upon the sale of * * * [the LLC]”, but, petitioners

argue, not an additional 10-percent share of annual income, (3)

the fact that the Schedules K-1 attached to the 1997-2000 LLC

partnership returns all state that the three members share LLC

profits and losses in a ratio of 88 percent for Dr. Joffe, 10

percent for Dr. McKernan, and 2 percent for Ms. Moore, (4) the

Kelly correspondence, in which Mr. Kelly expressed his

understanding, presumably obtained from the Moore letter and,

perhaps, from other conversations or communications with Ms.

Moore, that the foregoing 88-10-2-percent LLC ownership split was

still in effect, (5) the LLC members’ failure to satisfy the

requirements of the LLC operating agreement governing

dispositions of membership interests, and (6) the SouthTrust Bank

credit report, which, petitioners allege, indicates that, as late

as December 1, 1998, SouthTrust Bank believed that Dr. Joffe

still owned 88 percent of the LLC. Petitioners state: “The

documentary evidence of the bank loan * * * confirms that * * *

[Dr. Joffe] pledged * * * [his 88 percent] membership interest to

SouthTrust Bank in March 1999, [the date of the loan] over two

years after respondent claims he transferred 10% of that interest

[to Ms. Moore].”

Petitioners view the language in the assignment and

assumption agreement creating an effective date “as of” January
 - 33 -

1, 1997, (the effective date provision) as an improper and

ineffective “backdating” of that agreement or, alternatively, as

“a draftsman’s error that can be reformed under Georgia law”;

i.e., as a mutual mistake correctable by the introduction of

parol evidence.

C. Respondent’s Position

Respondent argues that the assignment and assumption

agreement was the means of “formalizing” Dr. Joffe’s transfer of

10-percent membership interests in the LLC to Dr. McKernan and

Ms. Moore effective January 1, 1997, and that “[f]rom that time

forward” the division of ownership among the LLC members was 68

percent for Dr. Joffe, 20 percent for Dr. McKernan, and 12

percent for Ms. Moore. In support of his position, respondent

argues that the 1998-2000 cash distributions to those three

individuals “in the approximate ratio of 68/20/12 * * *

demonstrates that the LLC made its cash distributions based upon

the members’ interests, as modified in 1997.”

Respondent also seeks to refute all of petitioners’ attacks

on the effective date provision. He acknowledges the failure to

follow the procedural requirements set forth in the LLC operating

agreement for transfers of membership interests, but he points

out that those requirements were specifically waived by Dr.

Joffe, as manager of the LLC, and by the parties to the

assignment and assumption agreement by their entering into that
 - 34 -

agreement, an action that amounted to their consent to the waiver

of those requirements. He argues that the assignment and

assumption agreement was not “backdated”, i.e., it “was not a

document * * * [attempting] to change the past or * * * to

misrepresent the past”, but, rather, “was * * * created to

formalize informal transactions that had occurred in the past”.

He also argues that the effective date provision is not an

example of mutual mistake that would otherwise permit petitioners

to introduce parol evidence to establish the actual effective

date of Dr. Joffe’s transfer of a 10-percent interest in the LLC

to Ms. Moore; and he argues that the LLC’s 1998-2000 increased

distributions to Dr. McKernan and Ms. Moore were not simply a

monetary quid pro quo for the use of LLC assets as collateral for

the discharge of Dr. Joffe’s bank debt related to his failed

Cincinnati Surgery Center. Rather, he argues that those

distributions corroborated a prior increase in the LLC membership

interests of those individuals.

D. Analysis

1. Introduction

Although each party can point to evidence supporting that

party’s view regarding the date upon which Ms. Moore’s membership

interest in the LLC increased from 2 percent to 12 percent, we

find that a preponderance of the evidence supports respondent’s
 - 35 -

view that Ms. Moore owned a 12-percent membership interest in the

LLC during the years in issue, 1999 and 2000.

2. The Assignment and Assumption Agreement

The assignment and assumption agreement does not set forth

an execution date. Rather, it states that it “is made and

entered into and effective as of the 1st day of January, 1997 by

and among * * * [the LLC members]”.

Petitioners argue that the execution date of the agreement

(alleged by petitioners, without dispute by respondent, to be

sometime during July 2000, when the agreement was entered into in

connection with the closing of the sale of the membership

interests in the LLC to Surgicoe) is its effective date. They

cite Georgia caselaw, which permits the introduction of parol

evidence to establish the actual date of execution, and they rely

upon both Georgia statutory law and caselaw, which permit

equitable reformation of a contract in order to conform with the

true intent of the parties where there has been a mutual mistake

in the drafting of the contract. Respondent disputes the

applicability of both lines of authority.

a. Enforceability of the Effective Date Provision

(1) Governing Principles of Georgia Law

As noted supra, the assignment and assumption agreement

specifically states that it is to be “governed by and construed

in accordance with Georgia law.” Under Georgia law, it is clear
 - 36 -

that the parties to a contract can give the contract retroactive

effect. See Am. Cyanamid Co. v. Ring, 286 S.E.2d 1, 3 (Ga.

1982). In that case, the Supreme Court of Georgia was called

upon to determine the effective date of a contract executed by

the parties sometime after July 1, 1975, the first sentence of

which read: “This contract entered into as of July 1, 1975”, and

the last sentence of which read: “In witness whereof, the

parties hereto have executed this contract as of the day and year

first above written.” On the basis of those two sentences (which

are virtually identical, both in language and in contract

placement, to the corresponding sentences in the assignment and

assumption agreement), the court held that the effective date of

the contract was July 1, 1975. In reaching that conclusion, the

court observed that “the effective date of a contract is not the

date of execution where the contract expressly states that its

terms are to take effect at an earlier date.” Id. at 674; see

also Goldstein v. Ipswich Hosiery Co., 122 S.E.2d 339, 345 (Ga.

Ct. App. 1961) (“It is elemental that contracting parties may

agree to give retroactive effect, between themselves, to their

contracts as they may see fit.”); 2 Williston on Contracts, sec.

6:60 (4th ed. 1991) (“it seems clear that, where the parties

themselves agree that a contract between them should be given

effect as of a specified date, absent the intervention of third

party rights, there is no sound reason why that agreement should
 - 37 -

not be given effect”). Williston cites both Am. Cyanamid and

Goldstein as the embodiment of Georgia precedent in support of

the quoted statement.

Petitioners attempt to discredit the effective date language

of the agreement, alleging that it is inconsistent with Dr.

Joffe’s and Ms. Moore’s actions during 1997-2000, which, they

argue, demonstrate an intent to transfer a 10-percent membership

interest in the LLC from Dr. Joffe to Ms. Moore no earlier than

July 2000. Under Georgia law, however: “Where the terms of a

written contract are clear and unambiguous, the court will look

to the contract alone to find the intention of the parties.”

Health Serv. Ctrs., Inc. v. Boddy, 359 S.E.2d 659, 661 (Ga.

1987).

(2) The Effective Date Provision Is Not a Prohibited
Backdating of the Assignment and Assumption
Agreement

We do not view the effective date provision as an attempt to

backdate the assignment and assumption agreement in order to

retroactively obtain an unwarranted tax benefit. Rather, we

consider its purpose to have been to reduce to writing a prior

oral understanding among the parties. As the cases petitioners

cite make clear, “backdating” generally involves an effort to

make it appear that the document in question was executed on a

date prior to its actual execution date; i.e., there is an effort

to mislead the reader. That is not true of the assignment and
 - 38 -

assumption agreement, where the “effective as of” phrase makes

clear that the intended effective date differs from the execution

date.

The parties to the agreement were operating at arm’s length.

A retroactive increase in Dr. McKernan’s and Ms. Moore’s share of

LLC profits would have necessarily resulted in a retroactive

decrease in Dr. Joffe’s share of those profits. Thus, aside from

possible tax rate differentials among the three individuals

(unsupported by any evidence in the record), the respondent is

indifferent as regards the respective profit shares of each. The

cases petitioners cite do not involve parties dealing at arm’s

length or IRS indifference to their actions. In Georgiou v.

Commissioner, T.C. Memo. 1995-546, we rejected taxpayer attempts

to rely upon (1) documents dated 1 to 3 years before their actual

execution dates in order to establish beneficial stock ownership,

during the preexecution years, of a corporation the losses of

which would then have been available in consolidation to offset

the taxpayer’s income in those years, and (2) corporate minutes,

a security agreement, promissory notes, and altered accounting

records, all dated before, but executed or prepared after,

certain advances by a corporation to the taxpayer shareholder, in

order to show that the advances were loans rather than

constructive dividends. Similarly, each of the other cases

petitioners cite in support of their argument that courts
 - 39 -

uniformly disregard (and may even find fraudulent) backdated

documents involves taxpayer efforts to use those documents solely

in order to achieve a tax result dependent upon timely action by

the taxpayer, where the time to act had already passed. See

e.g., United States v. Whistler, 139 Fed. Appx. 1 (9th Cir.

2005); Dobrich v. Commissioner, T.C. Memo. 1997-477, supplemented

T.C. Memo. 1998-39, affd. without published opinion 188 F.3d 512

(9th Cir. 1999); Medieval Attractions N.V. v. Commissioner, T.C.

Memo. 1996-455. The circumstances described in the cases cited

by petitioners are factually distinguishable from the

circumstances surrounding the execution of the assignment and

assumption agreement. Those cases are, therefore, inapposite.11

(3) The Effective Date Included in the Assignment and
Assumption Agreement Was Not a Mutual Mistake
Reformable by Parol Evidence Under Georgia Law

As noted supra, petitioners also argue, and respondent

disputes, that the specification in the assignment and assumption

agreement of a January 1, 1997, effective date was a mistake that

may be reformed under Georgia Law. Although we agree with

petitioners that the resolution of the issue is governed by

Georgia law, see, e.g., Estate of Holland v. Commissioner, T.C.

11
Also inapposite are the cases petitioners cite for the
proposition that Georgia’s parol evidence rule does not preclude
evidence of the actual execution date of a document. See, e.g.,
Smith v. Smith, 156 S.E.2d 901, 902 (Ga. 1967); Irwin v. Dailey,
118 S.E.2d 827, 829-830 (Ga. 1961). The issue in this case is
not the execution date of the assignment and assumption
agreement.
 - 40 -

Memo. 1997-302 (issue of whether decedent’s conveyance with

respect to her Atlanta, Georgia, residence to her children could

be reformed to carry out her actual intention to convey a life

estate rather than the fee simple interest mistakenly specified

in the conveyance governed by Georgia law), we disagree that the

effective date provision was a drafting error or mistake subject

to reformation under Georgia law.

Ga. Code Ann. sec. 23-2-21 (1982) provides as follows:

What mistakes relievable in equity; power to relieve to be
exercised cautiously.

(a) A mistake relievable in equity is some
unintentional act, omission, or error arising from
ignorance, surprise, imposition, or misplaced confidence.

(b) Mistakes may be either of law or of fact.

(c) The power to relieve mistakes shall be exercised
with caution; to justify it, the evidence shall be clear,
unequivocal, and decisive as to the mistake.

Ga. Code Ann. sec. 23-2-31 (1982) provides, in pertinent

part: “Equity will not reform a written contract unless the

mistake is shown to be the mistake of both parties”. See also

Cox v. Smith, 260 S.E.2d 310, 312-313 (Ga. 1979) (“A ‘mutual

mistake’ in an action for reformation means one in which both

parties had agreed on the terms of the contract, but by mistake

of the scrivener the true terms of the agreement were not set

forth.”); Prince v. Friedman, 42 S.E.2d 434, 436 (Ga. 1947)

(“jurisdiction [to reform a contract in equity for mutual
 - 41 -

mistake] will always be cautiously exercised, and to justify it

the evidence must be clear, unequivocal, and decisive.”).

In this case, there is not “clear, unequivocal, and

decisive” evidence of mutual mistake as required by Georgia law.

The assignment and assumption agreement plainly states that it is

to be effective as of January 1, 1997. It is a brief (two-page)

agreement, which makes it unlikely that Ms. Moore was distracted

by excessive verbiage so that she failed to notice the effective

date provision in the very first sentence of the agreement.

Dr. Joffe testified that he and Ms. Moore agreed to his

transfer of a 10-percent membership interest in the LLC to her in

1997 and that, beginning in 1997, the LLC distributions would

reflect that shift in membership interest. T. Mills Fleming (Mr.

Fleming), an attorney representing Ms. Moore and Dr. McKernan in

connection with the sale of their membership interests to

Surgicoe, testified that the assignment and assumption agreement

was drafted in order to verify to Surgicoe, in writing, that the

proceeds from the sale of the LLC membership interests should be

allocated on a 68-20-12-percent basis among Drs. Joffe and

McKernan and Ms. Moore, respectively. He further testified that

the January 1, 1997, effective date was inserted “because that’s

what the parties represented was the effective date of the

transfer of those interests from 88-10-2 to the 68-20-12.”

Kenneth R. Schwartz (Mr. Schwartz), at the time an associate at
 - 42 -

Mr. Fleming’s firm, worked with Mr. Fleming in his representation

of Ms. Moore and Dr. McKernan. He wrote the initial draft of the

assignment and assumption agreement. He testified that he and

Mr. Fleming assumed that the January 1, 1997, effective date

reflected “the way they [Drs. Joffe and McKernan and Ms. Moore]

had been treating it”; i.e., their respective membership

interests. The testimony of Dr. Joffe, Mr. Fleming, and Mr.

Schwartz constitutes evidence that there was an understanding

among the members of the LLC (and certainly on Dr. Joffe’s part)

that the purpose and effect of the assignment and assumption

agreement was to formalize their prior oral agreement to have Dr.

Joffe transfer 10-percent membership interests to Dr. McKernan

and Ms. Moore, effective January 1, 1997.

Dr. Joffe’s 1997-2000 Federal income tax returns would

reflect whether he respected the LLC Schedule K-1 attributions to

him, for those years, of an 88-percent membership interest in the

LLC. Respondent argues that petitioners could have subpoenaed

Dr. Joffe and required him to produce his tax returns. Indeed,

Dr. Joffe did testify, as respondent’s witness, and was subject

to cross-examination by petitioners’ counsel. Petitioners asked

him no questions about his 1997-2000 returns. Petitioners’

failure to question Dr. Joffe with respect to his returns or

require him to produce those returns raises an inference that

they would reflect Dr. Joffe’s belief that he, in fact, possessed
 - 43 -

a 68-percent membership interest as of January 1, 1997. See

Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165

(1946) (“the failure of a party to introduce evidence * * *

which, if true, would be favorable to him, gives rise to the

presumption that if produced it would be unfavorable”), affd. 162

F.2d 513 (10th Cir. 1947).

Neither the Moore letter nor the Joffe memorandum provides

convincing evidence that a mutual mistake resulted in the

assignment and assumption agreement’s recitation of an effective

date of January 1, 1997, for the transfer of interests in the LLC

by Dr. Joffe to Ms. Moore and Dr. McKernan. Both documents

postdate January 1, 1997. Ms. Moore testified that the Moore

letter related to a plan that was never implemented to distribute

percentages to other physicians that had been loyal and faithful

to the LLC. The letter is confusing in that it speaks in terms

of percentage distributions “should the * * * [LLC] be sold or

distributions be made”. (Emphasis added.) The letter does not

answer the question: Distributions of what? Sale proceeds?

Annual profits? The percentages are identified as percentages of

net profit. The letter was written to a lawyer asking for advice

on how to accomplish a change to the status quo. Ms. Moore may

have in part been concerned with keeping the 10-percent interest

in profits that Dr. Joffe testified she was to get beginning in

1997. The Joffe memorandum can be interpreted as confirming a
 - 44 -

prior agreement that Dr. Joffe would give Ms. Moore an additional

10 percent of the net proceeds of any sale of the LLC, and the

failure to reference interim distributions (in addition to sale

proceeds) could have been an oversight or simply poor

draftsmanship by the doctor. Neither alone nor together are the

two documents inconsistent with the conclusion, supported by both

the assignment and assumption agreement and the LLC’s 1998-2000

distributions to Dr. Joffe, Dr. McKernan, and Ms. Moore

(discussed infra) that, before the end of 1997, those three

individuals agreed to Dr. Joffe’s transfer of an additional 10-

percent LLC membership interest to each of the other two, and

that those transfers were to be effective as of January 1, 1997;

i.e., they would result in a 10-percent increase for Dr. McKernan

and Ms. Moore and a 20-percent decrease for Dr. Joffe in their

respective shares of LLC profit (or loss) for the entire year.

Such an agreement could have been finalized at any time during

1997, not necessarily on or before January 1 of that year as

petitioners suggest. We find that the Moore letter and the Joffe

memorandum fail to provide “clear, unequivocal, and decisive”

evidence of mutual mistake.

Nor do the Schedules K-1 attached to the LLC’s 1997-2000

returns, the Kelly correspondence, or the SouthTrust Bank credit

report provide such evidence.
 - 45 -

John Carpentier (Mr. Carpentier) of the accounting firm of

Tarpley & Underwood, P.C. the firm that prepared the LLC’s 1996-

2000 Federal income tax returns, testified that he prepared the

1996 return and reviewed the subsequent returns. Because no one

contacted him to say that the percentage membership interests of

the three members changed after 1996, the firm continued in the

post-1996 returns to reflect the 88-10-2-percent membership

interest allocation on the Schedules K-1 issued to Drs. Joffe and

McKernan and Ms. Moore. Mr. Kelly (the lawyer), in his October

28, 1997, letter to Ms. Moore, states: “We understand that [the

LLC is owned by Drs. Joffe and McKernan and Ms. Moore on an 88-

10-2 percentage basis].” The fact that neither Mr. Carpentier

nor Mr. Kelly was made aware of any agreement that might have

altered those percentage interests is not evidence that that

agreement did not exist, only that it was not communicated to

those individuals.

Similarly, the December 1998 SouthTrust Bank credit report

supporting the $50,000 March 1999 loan to the LLC determined that

Dr. Joffe still owned 88 percent of the LLC, apparently on the

basis of the LLC’s 1995 return, which describes the 1995 member

sales that increased Dr. Joffe’s membership interest in the LLC

to 88 percent. There is no evidence that Dr. Joffe told
 - 46 -

SouthTrust Bank in 1998 that he continued to hold an 88- percent

membership interest.12

In each instance petitioners cited, the reference to a

continuing 88-10-2-percent division of the LLC membership

interests is simply based upon the lack of any information to the

contrary. None of the documents petitioners cite provides

“clear, unequivocal, and decisive evidence” that Dr. Joffe and

Ms. Moore had not agreed to the transfer of a 10-percent

membership interest in the LLC from the former to the latter as

of January 1, 1997.

Lastly, the LLC’s 1998-2000 distributions are consistent

with an agreement, at least as early as 1998, to allocate the LLC

membership interests on a 68-20-12-percent basis among Drs. Joffe

and McKernan and Ms. Moore, respectively. Petitioners argue that

those so-called disproportionate distributions (disproportionate

to the 88-10-2-percent split alleged by petitioners) were merely

a means of compensating Dr. McKernan and Ms. Moore for the

pledging of LLC assets and the use of LLC funds to discharge

debts incurred by Dr. Joffe’s failed Cincinnati Surgery Center

and were not the result of a prior transfer of 10-percent LLC

12
Neither is there any support in the record for
petitioners’ argument that Dr. Joffe pledged an 88-percent
interest in the LLC as security for the March 1999 loan to the
LLC. As noted supra, both the note Dr. Joffe executed on behalf
of the LLC and the SouthTrust Bank credit report (under the
heading “Collateral”) describe the loan as “Unsecured”.
 - 47 -

membership interests from Dr. Joffe to Dr. McKernan and Ms.

Moore. Petitioners cite section 8.5 of the LLC operating

agreement as permitting interim distributions not in accordance

with the recipients’ membership interests. In further support of

their argument, petitioners rely on the following language taken

from a footnote to the LLC’s financial statements for 1997 and

1998, which were reviewed by the LLC’s outside accountants

Tarpley & Underwood, P.C.:

as a part of * * * [a] refinancing [of long-term debt],
one of the members [Dr. Joffe] refinanced other debt,
on which the member and the * * * [LLC] are
contingently liable in the amount of $3,054,972 at
December 31, 1998. Principal and interest payments may
be paid personally by the member by distributions from
the * * * [LLC]. Proportionate cash distributions will
be made to other members of the * * * [LLC].

We do not agree with petitioners that the foregoing

accountant’s language describes a disproportionate increase in

the distributions to Dr. McKernan and Ms. Moore and a

corresponding disproportionate decrease in the distributions to

Dr. Joffe. In fact, the reference to “proportionate cash

distributions * * * to other members” is consistent with the

notion that Dr. McKernan and Ms. Moore were to receive interim

distributions proportionate (not disproportionate) to their

membership interests.13 Moreover, section 8.5 of the LLC

13
Assuming arguendo that the enhanced financial benefit to
Dr. McKernan and Ms. Moore was motivated by the LLC’s potential
responsibility for Dr. Joffe’s personal debt, as argued by
(continued...)
 - 48 -

operating agreement is consistent with a general requirement that

interim distributions to members of the LLC be proportionate to

their membership interests. The operative language provides as

follows:

Members * * * may make Distributions to the Members in
accordance with their Membership Interests. Such
distributions shall be in cash or Property (which need
not be distributed proportionately) or partly in both,
as determined by the Manager.

A straightforward reading of the foregoing language leads to the

conclusion that the parenthetical clause modifies the word

“Property”, not the word “distributions”. Finally, accepting for

the sake of argument petitioners’ logic for disproportionate

distributions among the members of the LLC, they have failed to

show us how they arrived at an approximately 68-20-12 split that,

13
(...continued)
petitioners, rather than by “the past and future administrative
services of McKernan and Moore on behalf of the * * * [LLC]”, as
stated in the assignment and assumption agreement, it makes more
sense from an economic self-interest standpoint for Dr. McKernan
and Ms. Moore to have demanded increased membership interests
rather than so-called disproportionate distributions from the LLC
because the latter were likely to result in a return of capital
and, possibly, a negative capital account for either or both.
The resulting potential economic detriment of such an arrangement
is, in fact, illustrated by the 2000 sale of membership interests
in the LLC to Surgicoe. Sec. 3.5 of the Surgicoe purchase
agreement specifically requires that “the Sellers’ interests * *
* [be] fully paid and assessable”, which, in effect, supersedes
sec. 7.6 of the LLC operating agreement to the extent that it
provides that that agreement “shall not be construed as creating
a [capital account] deficit restoration obligation”. See also
sec. 12.3 of the LLC operating agreement, which limits the
distribution of assets, on the dissolution of the LLC, “to
Members in accordance with positive Capital Account balances”.
 - 49 -

coincidentally, mirrored the split under the assignment and

assumption agreement. Therefore, we view the LLC’s 1998-2000

distributions in relative percentages approximating 68, 20, and

12 among Drs. Joffe and McKernan and Ms. Moore, respectively, as

strong evidence that those distributions reflected a 68-20-12-

percent membership interest allocation in the LLC among those

individuals during those years.

In the light of the foregoing, we find no basis for

concluding that the effective date provision of the assignment

and assumption agreement was caused by a mutual mistake

reformable by parol evidence under Georgia law.

b. Dr. Joffe’s Transfers of Membership Interests Under
the Assignment and Assumption Agreement Were Not
Void Because of Noncompliance With Article 10 of
the LLC Operating Agreement

Petitioners argue that, because Dr. Joffe’s membership

interest transfers to Dr. McKernan and Ms. Moore failed to comply

with the requirements of article 10 of the LLC operating

agreement, governing dispositions of membership interests, and

article 6, governing meetings of LLC members, his purported

transfer to Ms. Moore, as of January 1, 1997, “is null and void

ab initio” pursuant to article 10.7. Petitioners’ argument

ignores established principles of Georgia law, which provide that

contractual provisions may be waived by the mutual consent of the

parties to the contract, and that such consent may be established
 - 50 -

by the parties’ course of conduct.14 See, e.g., Handex of Fla.,

Inc. v. Chatham County, 602 S.E.2d 660, 664 (Ga. Ct. App. 2004)

(“While a distinct stipulation in a contract may be waived by the

conduct of the parties, it must appear that it was the intention

of the parties to treat such stipulation as no longer binding.”);

Shalom Farms, Inc. v. Columbus Bank & Trust Co., 312 S.E.2d 138,

141 (Ga. Ct. App. 1983) (“To establish the existence of a quasi

new agreement would require * * * a showing of mutual * * *

intention to vary the terms of the original contract. * * *

Such a showing may be implied from the parties’ conduct”).

The parties to the assignment and assumption agreement,

constituting the entire membership of the LLC, voluntarily

executed that agreement in the absence of formal notice to the

manager of intent to dispose of membership interests and without

affording the LLC its right of prior purchase. See articles 10.2

and 10.3 of the LLC operating agreement. Moreover, Dr. Joffe, in

his capacity as manager of the LLC, executed a “Waiver of Notice

and Right to Purchase” (attached to the assignment and assumption

agreement) whereby the LLC formally waived its rights under

articles 10.2 and 10.3. We view those actions as constituting

14
The preamble to the LLC operating agreement states that
it “is entered into by and among the Company and the persons
executing this Agreement as Members”. Therefore, it is in the
nature of a contract the parties to which are the LLC and its
members. See Kinkle v. R.D.C., L.L.C., 889 So. 2d 405, 409 (La.
Ct. App. 2004) (“An operating agreement is contractual in nature;
thus, it * * * is interpreted pursuant to contract law.”).
 - 51 -

mutual consent or agreement, by the parties to the assignment and

assumption agreement, to waive the requirements of article 10 of

the LLC operating agreement.15 Therefore, the sales of LLC

membership interests pursuant to the assignment and assumption

agreement were not void by reason of noncompliance with the

aforesaid article 10.16

E. Conclusion

Ms. Moore owned a 12-percent membership interest in the LLC

during the years at issue (1999 and 2000).

III. The Installment Method Reporting Issue

A. Analysis

Respondent argues that petitioners are not entitled to

report their income from the sale of Ms. Moore’s membership

interest in the LLC under the installment method of section 453.

Respondent asserts that petitioners opted out of the installment

method, pursuant to section 453(d), “by reporting on their

original return all of the income they believed they received in

15
The waiver of articles 10.2 and 10.3 of the LLC
operating agreement necessarily rendered the balance of the
otherwise applicable provisions of article 10 inoperative.
16
Petitioners’ argument that Dr. Joffe’s purported
transfers of LLC membership interests as of Jan. 1, 1997, were
invalid does not extend to the validity of those same transfers
as of July 2000. There is no evidence that Dr. Joffe transferred
membership interests to Dr. McKernan and Ms. Moore other than by
means of the assignment and assumption agreement. Therefore,
petitioners’ argument that that agreement was void ab initio is
obviously inconsistent with their admission that the transfers
occurred in July 2000 pursuant to that same agreement.
 - 52 -

connection with the sale and not filing a Form 6252 [Installment

Sale Income] with their original return.”

Section 453(d) permits a taxpayer who has made an

installment sale to elect out of the installment method of

accounting, which, absent the election, would apply to the sale

pursuant to section 453(a). Section 15A.453-1(d)(3)(i),

Temporary Income Tax Regs., 46 Fed. Reg. 10718 (Feb. 4, 1981),

provides, in pertinent part:

A taxpayer who reports an amount realized equal to the
selling price including the full face amount of any
installment obligation on the tax return filed for the
taxable year in which the installment sale occurs will
be considered to have made an effective election [out
of the installment method] * * *

On their 2000 return, Schedule D, petitioners reported two

items of long-term capital gain: $631,590 described as

“partnership interest” and $16,790 described as “note payments”.

Both items were reported as gross sale price offset by zero

basis. The $631,590 approximates the $661,774.01 cash payment

from Surgicoe to Ms. Moore at the closing of the sale of her LLC

membership interest to Surgicoe that was specified in a

“Disbursement Authorization” dated July 29, 2000, and signed by

the parties to the Surgicoe purchase agreement.17 The $16,790

equals five payments of $3,358.03, the amount of the monthly

17
There is no explanation of the discrepancy between the
amount of the cash payment provided in the disbursement
authorization and the amount petitioners reported.
 - 53 -

payments, to be made the first of each month, beginning September

1, 2000, specified in Surgicoe’s promissory note to Ms. Moore.18

Therefore, it is clear that petitioners reported, on their 2000

return, no more than the cash payments received in 2000, not the

full amount of the selling price for Ms. Moore’s LLC membership

interest ($1,138,806.12) and not the full face amount of the

Surgicoe promissory note ($160,825.87). Under those

circumstances we find that petitioners did not elect out of the

installment method of reporting the income from Surgicoe’s

promissory note. See Estate of Wilkinson v. Commissioner, T.C.

Memo. 1993-463 (“The only method for electing out of the

installment method * * * is for taxpayers to report the full

amount of the sales price and the full amount of the income

associated with installment sales on timely filed tax returns for

the year of the sales.”).19

18
Assuming the monthly payments commenced on Sept. 1,
2000, as specified in Surgicoe’s promissory note, the fifth
payment would have been due Jan. 1, 2001. It appears, however,
that that payment was included in petitioners’ 2000 return.
19
Respondent cites petitioners’ failure to file a Form
6252, Installment Sale Income, as conclusive evidence that
“petitioners have not demonstrated that they intended to report
their transaction under the installment method.” Respondent does
not suggest that petitioners’ failure to file that form
constituted a procedural defect sufficient in itself to bar
petitioners’ use of the installment method, and, indeed, there is
no support in either sec. 453 or the regulations thereunder for
that position. As we conclude herein, it is a taxpayer’s
reporting of the full amount of the income derived from an
installment sale (not the taxpayer’s failure to file a Form 6252)
(continued...)
 - 54 -

B. Conclusion

Petitioners did not elect out of the installment method in

connection with Ms. Moore’s 2000 installment sale of her LLC

membership interest.

IV. Conclusion

To reflect the foregoing,

Decision will be entered

under Rule 155.

19
(...continued)
that is determinative of an intent to elect out of the
installment method.