T.C. Summary Opinion 2011-14
UNITED STATES TAX COURT
RALPH E. CRANDALL, JR., AND DENE D. DULIN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 29479-08S. Filed February 15, 2011.
Ralph E. Crandall, Jr., and Dene D. Dulin, pro sese.
Timothy Berry, for respondent.
PANUTHOS, Chief Special Trial Judge: This case was heard
pursuant to the provisions of section 7463 of the Internal
Revenue Code in effect when the petition was filed.1 Pursuant to
section 7463(b), the decision to be entered is not reviewable by
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year at issue. All
Rule references are to the Tax Court Rules of Practice and
Procedure.
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any other court, and this opinion shall not be treated as
precedent for any other case.
Respondent determined a deficiency of $14,475 in
petitioners’ 2005 Federal income tax and an accuracy-related
penalty of $2,895. After concessions,2 the sole issue for
decision is whether petitioners are entitled to nonrecognition of
gain under section 1031 for a 2005 real estate transaction.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. Petitioners resided in
California at the time the petition was filed.
Petitioners owned an undeveloped parcel of property in Lake
Havasu City, Arizona (Arizona property). Petitioners held the
Arizona property for investment. Petitioners desired to own
investment property closer to their California residence. After
receiving some limited advice concerning a tax-free exchange of
properties, petitioners took steps to sell the Arizona property
and purchase new property with the intention of executing a tax-
free exchange. On March 4, 2005, petitioners sold the Arizona
property for $76,000. The buyers of the property paid
petitioners $10,000, and the remaining $66,000 was placed in an
2
Respondent conceded the accuracy-related penalty.
Petitioners conceded respondent’s disallowance of deductions on
their Schedule A, Itemized Deductions.
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escrow account with Capital Title Agency, Inc. (Capital Title).
At petitioners’ direction $61,743.25 was held in the escrow
account. Capital Title initially released $4,256.75 to
petitioners. Petitioners’ basis in the Arizona property was
$8,500.
In furtherance of the purchase petitioners made payments3 to
Chicago Title Co. (Chicago Title) and placed in an escrow account
as follows:
Date Amount
Jan. 4, 2005 $10,000.00
Mar. 14, 2005 (three separate payments) 24,700.00
4,256.75
294.00
1
Mar. 18, 2005 61,550.00
100,800.75
1
This payment was transferred from the Capital Title escrow
account to the Chicago Title escrow account as petitioners
directed.
The Capital Title and Chicago Title escrow agreements did not
reference a like-kind exchange under section 1031, nor did they
expressly limit petitioners’ right to receive, pledge, borrow, or
otherwise obtain the benefits of the funds.
Discussion
In general, the Commissioner’s determination set forth in a
notice of deficiency is presumed correct, and the taxpayer bears
3
The payments are labeled “Deposits” in the escrow
agreement.
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the burden of showing that the determination is in error. Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Pursuant
to section 7491(a), the burden of proof as to factual matters
shifts to the Commissioner under certain circumstances.
Petitioners did not allege that section 7491(a) applies. See
sec. 7491(a)(2)(A) and (B). Therefore, petitioners bear the
burden of proof. See Rule 142(a).
The general rule regarding recognition of gain or loss on
the sale or exchange of property is that the entire amount of the
gain or loss is recognized. Sec. 1001(c). An exception to the
general rule is found in section 1031.
Section 1031 provides that no gain or loss is recognized
when business or investment property is exchanged solely for
other business or investment property of like kind. The
regulations define “like kind” as a reference to the nature or
character of the property and not the property’s grade or
quality. Sec. 1.1031(a)-1(b), Income Tax Regs. In order to take
advantage of the nonrecognition provisions of section 1031
through a deferred exchange, a taxpayer must satisfy a number of
technical requirements.1 Sec. 1031(a)(3); sec. 1.1031(k)-1,
Income Tax Regs.
1
The timing requirements of sec. 1031(a)(3) are not at
issue.
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A deferred exchange is defined as “an exchange in which,
pursuant to an agreement, the taxpayer transfers property held
for * * * investment * * * and subsequently receives property to
be held * * * for investment”. Sec. 1.1031(k)-1(a), Income Tax
Regs. To qualify as a deferred exchange the transaction must be
an exchange of property, not a transfer of property for money.
Id. The reinvestment of the proceeds from a cash sale of one
property into a second property of like kind will not qualify as
a section 1031 exchange. Greene v. Commissioner, T.C. Memo.
1991-403 (citing Carlton v. United States, 385 F.2d 238, 242 (5th
Cir. 1967), Coastal Terminals, Inc. v. United States, 320 F.2d
333, 337 (4th Cir. 1963), and Estate of Bowers v. Commissioner,
94 T.C. 582, 589 (1990)); Lee v. Commissioner, T.C. Memo. 1986-
294; Gibson v. Commissioner, T.C. Memo. 1982-342; sec. 1.1031(k)-
1(a), Income Tax Regs. Gain or loss may be recognized if the
taxpayer actually or constructively receives money that does not
meet the qualifications of section 1031(a) before the taxpayer
actually receives like-kind property. Sec. 1.1031(k)-1(a),
Income Tax Regs.
“The taxpayer is in constructive receipt of money or
property at the time the money or property is credited to the
taxpayer’s account, set apart for the taxpayer, or otherwise made
available so that the taxpayer may draw upon it at any time”.
Sec. 1.1031(k)-1(f)(2), Income Tax Regs. If the taxpayer’s
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control of receipt of the money or property is subject to
substantial limitations or restrictions, then there is no
constructive receipt. Id. To avoid being in constructive
receipt of money or property, a taxpayer may use a qualified
escrow account. Section 1.1031(k)-1(g)(3), Income Tax Regs.,
defines a qualified escrow account as the following:
(ii) A qualified escrow account is an escrow account
wherein--
(A) The escrow holder is not the taxpayer or a
disqualified person * * *, and
(B) The escrow agreement expressly limits the
taxpayer’s right to receive, pledge, borrow, or
otherwise obtain the benefits of the cash or cash
equivalent held in the escrow account * * *.
The taxpayer’s own limitation of use of the funds does not
convert the escrow account into a qualified escrow account.
Klein v. Commissioner, T.C. Memo. 1993-491.
The Arizona property and the California property are like-
kind properties. At issue is whether there was an exchange
within the meaning of the statute and the regulations.
We have no doubt that petitioners intended the transaction
to qualify under the provisions of section 1031. However, it is
well established that a taxpayer’s intention to take advantage of
tax laws does not determine the tax consequences of his
transactions. Bezdjian v. Commissioner, 845 F.2d 217 (9th Cir.
1988), affg. T.C. Memo. 1987-140; Carlton v. United States, supra
at 243 (citing Commissioner v. Duberstein, 363 U.S. 278, 286
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(1960)). To support their argument, petitioners testified that
the funds in the Capital Title escrow account were held solely
for the purchase of the California property and that they
received no proceeds from the sale of the Arizona property.
Respondent argues that petitioners’ transactions were a sale
and reinvestment of the proceeds because the Capital Title escrow
agreement did not expressly restrict petitioners’ access to and
use of the funds held in the escrow account. Respondent asserts
that petitioners were in constructive receipt of the proceeds
from the sale of the Arizona property and that the gain on the
sale must be recognized in 2005.
The underlying purpose of section 1031 is to permit a
taxpayer to defer gain with respect to “an ongoing investment,
rather than ridding himself of one investment to obtain another.”
Teruya Bros., Ltd. v. Commissioner, 580 F.3d 1038, 1042 (9th Cir.
2009) (citing Starker v. United States, 602 F.2d 1341, 1352 (9th
Cir. 1979) (“The legislative history [of sec. 1031] reveals that
the provision was designed to avoid the imposition of a tax on
those who do not ‘cash in’ on their investments in trade or
business property.”)), affg. 124 T.C. 45 (2005).
Neither escrow agreement expressly limited petitioners’
right to receive, pledge, borrow, or otherwise obtain the benefit
of the funds nor made any mention of a like-kind exchange.
Because of the lack of limitations, neither escrow account was a
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qualified escrow account. See Hillyer v. Commissioner, T.C.
Memo. 1996-214; Lee v. Commissioner, supra. Although petitioners
used the funds in the Capital Title escrow account to purchase
the California property, the lack of express limitations in the
escrow agreement results in petitioners’ being treated as having
constructively received the proceeds.
We conclude that the disposition of the Arizona property was
a sale and the funds deposited in the Capital Title escrow
account represent the receipt of the proceeds. See sec. 1001(c).
Consequently, this transaction does not qualify for section 1031
nonrecognition, and petitioners must recognize gain for 2005.
See sec. 1001(c). The Court notes that the tax consequences are
not what petitioners intended and the result may seem somewhat
harsh. However, Congress enacted strict provisions under section
1031 with which taxpayers must comply. We also note that
respondent has conceded the accuracy-related penalty.
We have considered the parties’ arguments and, to the extent
not discussed herein, we conclude the arguments are irrelevant,
moot, or without merit.
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To reflect the foregoing,
Decision will be entered
for respondent as to the
deficiency in income tax and
for petitioners as to the
accuracy-related penalty.