Gates v. Commissioner

DAVID A. GATES AND CHRISTINE A. GATES, PETITIONERS
v. COMMISSIONER OF INTERNAL REVENUE,
RESPONDENT
Docket No. 19350–05. Filed July 1, 2010.

Ps owned and used a house as a principal residence for 2
years. Ps wanted to enlarge and remodel the house but were
advised by an architect that more stringent building and
permit restrictions had been enacted since the house was
built. In 1999, rather than remodel the house, Ps voluntarily
demolished it and constructed a new house on the property.
Ps never occupied the new house, and in 2000 they sold it for
$1,100,000. Ps realized capital gain of $591,406 on the sale of
the new house. On their untimely 2000 Federal income tax
return Ps did not report any of the gain from the sale of the
new house. Ps subsequently agreed that $91,406 of the gain
was taxable, but they claimed that $500,000 of the gain was
excludable from income under sec. 121(a), I.R.C. In a notice
of deficiency, R determined that Ps are not entitled to the
$500,000 exclusion under sec. 121(a), I.R.C., and that Ps are
liable for a deficiency in income tax and an addition to tax
under sec. 6651(a)(1), I.R.C., for 2000. Held: Ps may not
exclude from their income, under sec. 121(a), I.R.C., the gain
on the sale of the new house because the new house was
never used as Ps’ principal residence. Held, further, Ps are
liable for the addition to tax under sec. 6651(a)(1), I.R.C., for
failure to timely file their 2000 Federal income tax return.

George J. Tomlinson, Jr., for petitioners.
Kris H. An and Jonathan H. Sloat, for respondent.

1

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 2 135 UNITED STATES TAX COURT REPORTS (1)

OPINION

MARVEL, Judge: Respondent determined a deficiency in
petitioners’ Federal income tax of $112,553 and an addition
to tax under section 6651(a)(1) 1 of $11,211 for 2000. Peti-
tioners filed a timely petition contesting respondent’s deter-
mination.
After concessions, 2 the issues for decision are: (1) Whether
petitioners may exclude from gross income $500,000 of cap-
ital gain from the sale in 2000 of property on Summit Road
in Santa Barbara, California (Summit Road property), under
section 121(a); and (2) whether petitioners are liable for the
section 6651(a)(1) addition to tax.

Background
The parties submitted this case fully stipulated pursuant
to Rule 122. We incorporate the stipulation of facts into our
findings by this reference. Petitioners resided in California
when the petition was filed.
On December 14, 1984, petitioner David A. Gates (Mr.
Gates) purchased the Summit Road property for $150,000.
The Summit Road property included an 880-square-foot two-
story building with a studio on the second level and living
quarters on the first level (original house). 3
On August 12, 1989, Mr. Gates married petitioner Chris-
tine A. Gates. Petitioners resided in the original house for a
period of at least 2 years from August 1996 to August 1998.
In 1996 petitioners decided to enlarge and remodel the
original house, and they hired an architect. The architect
advised petitioners that more stringent building and permit
restrictions had been enacted since the original house was
built. 4
Subsequently, petitioners demolished the original house
and constructed a new three-bedroom house (new house) on
1 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 Proce-
dure.
2 Petitioners concede that the destruction of the original house does not qualify as an involun-

tary conversion under sec. 1033. Petitioners further concede a $12,010 operating loss adjust-
ment.
3 The previous owner of the house had converted the first level from a two-car garage to living

quarters in 1972.
4 The record does not establish whether the new building and permit restrictions prevented

petitioners from remodeling and expanding the original house.

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 (1) GATES v. COMMISSIONER 3

the Summit Road property. 5 The new house complied with
the building and permit requirements existing in 1999.
During 1999 petitioners had outstanding mortgage loans, but
the record does not disclose the identity of the property or
properties that secured the mortgage loans or the dates,
amounts, or purposes of the loans. 6
Petitioners never resided in the new house. 7 On April 7,
2000, petitioners sold the new house for $1,100,000. The sale
resulted in a $591,406 gain to petitioners.
On April 15, 2001, petitioners applied for an automatic
extension of time for filing their 2000 Form 1040, U.S. Indi-
vidual Income Tax Return (2000 return). However, peti-
tioners failed to file their 2000 return by the August 15,
2001, due date. On September 17, 2001, petitioners filed
their 2000 return. 8
On their 2000 return, petitioners did not report as income
any of the $591,406 capital gain generated from the sale of
the Summit Road property. Petitioners subsequently agreed
that $91,406 of the gain should have been included in their
gross income for 2000, but they asserted that the remaining
gain of $500,000 was excludable from their income under sec-
tion 121. On September 9, 2005, respondent mailed peti-
tioners a notice of deficiency for 2000 that increased
petitioners’ income by $500,000 9 and explained that peti-
tioners had failed to establish that any of the gain on the
sale of the Summit Road property was excludable under sec-
tion 121. Respondent also determined an addition to tax
under section 6651(a)(1) for petitioners’ failure to timely file
their 2000 return.
Petitioners timely petitioned this Court seeking a redeter-
mination of the deficiency and addition to tax. Petitioners
5 The footprint of the new house has a very different shape from that of the original house,

and it appears to be two to three times larger than the footprint of the original house. Only
about one-half of the land area of the original house overlaps with the land area covered by
the new house, and no part of the original foundation perimeter corresponds to the foundation
perimeter of the new house.
6 Although petitioners suggest in their posttrial brief that the loans were related to the demo-

lition of the old house and the construction of the new house, there is no credible evidence in
the record that permits us to make any finding about the nature and use of the loans.
7 During the demolition and construction period, petitioners resided at a location that does not

appear in the record. The record does not contain any information regarding whether or when
petitioners purchased and moved into a new principal residence.
8 Petitioners’ 2000 return was postmarked on Sept. 5, 2001.
9 In the notice of deficiency respondent determined a $500,000 adjustment because petitioners

had conceded a $91,406 capital gain adjustment.

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 4 135 UNITED STATES TAX COURT REPORTS (1)

assert that respondent erred in determining that they were
not entitled to exclude $500,000 of the gain under section
121. Petitioners also argue that because they are not liable
for a deficiency, respondent erred in determining that they
were liable for the section 6651(a)(1) addition to tax.

Discussion
I. Burden of Proof
Ordinarily, the Commissioner’s determination is entitled to
a presumption of correctness, Rapp v. Commissioner, 774
F.2d 932, 935 (9th Cir. 1985), and the burden of proving
error in the determination generally rests with the taxpayer,
Rule 142(a). Petitioners argue that because respondent’s
determination in the notice of deficiency is arbitrary, exces-
sive, and without foundation, respondent’s determination is
not entitled to any presumption of correctness and that
respondent bears the burden of proof. 10 Petitioners also con-
tend that respondent has failed to meet his burden of pro-
ducing evidence in support of his determination that peti-
tioners have unreported income.
Petitioners do not dispute that they received proceeds from
the sale of the Summit Road property or that the sale
resulted in gain that is taxable to them unless some part of
the gain is excluded under section 121(a). Accordingly, we
hold that respondent’s determination is entitled to the
presumption of correctness and that petitioners have the bur-
den of proof. We note, however, that this case is fully stipu-
lated and that there is no disputed issue of fact that might
be affected by our assignment of the burden of proof.
II. Sale of the Summit Road Property
Gross income means all income from whatever source
derived, unless excluded by law. See sec. 61(a); sec. 1.61–1(a),
Income Tax Regs. Generally, gain realized on the sale of
property is included in a taxpayer’s income. Sec. 61(a)(3).
Section 121(a), however, allows a taxpayer to exclude from
income gain on the sale or exchange of property if the tax-
payer has owned and used such property as his or her prin-
10 Petitioners do not contend that sec. 7491(a) shifts the burden of proof to respondent, and

petitioners have not established that the requirements of sec. 7491(a) have been met. Moreover,
because there are no factual issues in dispute, sec. 7491(a) does not apply.

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 (1) GATES v. COMMISSIONER 5

cipal residence for at least 2 of the 5 years immediately pre-
ceding the sale. Section 121(a) specifically provides:
SEC. 121(a). EXCLUSION.—Gross income shall not include gain from the
sale or exchange of property if, during the 5-year period ending on the date
of the sale or exchange, such property has been owned and used by the tax-
payer as the taxpayer’s principal residence for periods aggregating 2 years
or more. [Emphasis added.]

The maximum exclusion is $500,000 for a husband and wife
who file a joint return for the year of the sale or exchange.
Sec. 121(b)(2). A married couple may claim the $500,000
exclusion on the sale or exchange of property they owned and
used as their principal residence if either spouse meets the
ownership requirement, both spouses meet the use require-
ment, and neither spouse claimed an exclusion under section
121(a) during the 2-year period before the sale or exchange.
Sec. 121(b)(2)(A).
The issue presented arises from the fact that section 121(a)
does not define two critical terms—‘‘property’’ and ‘‘principal
residence’’. Section 121(a) simply provides that gross income
does not include gain from the sale or exchange of property
if ‘‘such property’’ has been owned and used by the taxpayer
‘‘as the taxpayer’s principal residence’’ for the required statu-
tory period.
Respondent contends that petitioners did not sell property
they had owned and used as their principal residence for the
required statutory period because they never occupied the
new house as their principal residence before they sold it.
Respondent’s argument interprets the term ‘‘property’’ to
mean, or at least include, a dwelling that was owned and
occupied by the taxpayer as his ‘‘principal residence’’ for at
least 2 of the 5 years immediately preceding the sale.
Respondent urges this Court to conclude that a qualifying
sale under section 121(a) is one that includes the sale of a
dwelling used by the taxpayer as his principal residence.
Because petitioners never resided in the new house before its
sale in 2000, respondent maintains that the new house was
never petitioners’ principal residence.
Predictably, petitioners disagree. Petitioners argue that
any analysis of section 121(a) must recognize that the exclu-
sion thereunder applies to the gain on the sale of property
that was used as the taxpayer’s principal residence. Peti-

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 6 135 UNITED STATES TAX COURT REPORTS (1)

tioners’ argument focuses on two facts—petitioners used the
original house as their principal residence for the period
required by section 121(a) and they sold the land on which
the original house had been situated. Petitioners contend
that the term ‘‘property’’ includes not only the dwelling but
also the land on which the dwelling is situated. Petitioners
seem to argue that the requirements of section 121(a) are
satisfied if a taxpayer lived in any dwelling on the property
for the required 2-year period even if that dwelling is not the
dwelling that is sold. Petitioners contend that because they
used the original house and the land on which it was situ-
ated as their principal residence for the required term, the
Summit Road property qualifies as their principal residence
and $500,000 of the gain generated by the sale of the prop-
erty is excluded under section 121.
Because section 121 does not define the terms ‘‘property’’
and ‘‘principal residence’’, we must apply accepted principles
of statutory construction to ascertain Congress’ intent. It is
a well-established rule of construction that if a statute does
not define a term, the term is given its ordinary meaning.
See Perrin v. United States, 444 U.S. 37, 42 (1979); Nw.
Forest Res. Council v. Glickman, 82 F.3d 825, 833 (9th Cir.
1996); Keene v. Commissioner, 121 T.C. 8, 14 (2003). It is also
well established that a court may look to sources such as
dictionaries for assistance in determining the ordinary
meaning of a term. See Muscarello v. United States, 524 U.S.
125, 127–132 (1998). We look to the legislative history to
ascertain Congress’ intent if the statute is ambiguous. See
Burlington N. R.R. v. Okla. Tax Commn., 481 U.S. 454, 461
(1987). Exclusions from income must be construed narrowly,
and taxpayers must bring themselves within the clear scope
of the exclusion. See Commissioner v. Schleier, 515 U.S. 323,
328 (1995); Dobra v. Commissioner, 111 T.C. 339, 349 n.16
(1998) (citing Graves v. Commissioner, 89 T.C. 49, 51 (1987),
supplementing 88 T.C. 28 (1987)).
The American Heritage Dictionary of the English Lan-
guage 1405 (4th ed. 2000) defines ‘‘property’’ as ‘‘Something
owned; a possession’’, ‘‘A piece of real estate’’, and ‘‘The right
of ownership; title.’’ Merriam-Webster’s Collegiate Dictionary
935 (10th ed. 1997) defines ‘‘property’’ as ‘‘a quality or trait
belonging and esp. peculiar to an individual or thing’’ and
‘‘something owned or possessed; specif: a piece of real estate’’.

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 (1) GATES v. COMMISSIONER 7

Black’s Law Dictionary 1335–1336 (9th ed. 2009) defines
‘‘property’’ as ‘‘The right to possess, use, and enjoy a deter-
minate thing (either a tract of land or a chattel)’’ and ‘‘Any
external thing over which the rights of possession, use, and
enjoyment are exercised’’.
The American Heritage Dictionary of the English Lan-
guage 1395 (4th ed. 2000) defines ‘‘principal’’ in its first defi-
nition as ‘‘First, highest, or foremost in importance, rank,
worth, or degree; chief.’’ Similar definitions appear in other
dictionaries. See, e.g., Merriam-Webster’s Collegiate Dic-
tionary 926 (10th ed. 1997); Black’s Law Dictionary 1312 (9th
ed. 2009).
The American Heritage Dictionary of the English Lan-
guage 1483 (4th ed. 2000) defines ‘‘residence’’ as ‘‘The place
in which one lives; a dwelling’’ and ‘‘The act or a period of
residing in a place.’’ Merriam-Webster’s Collegiate Dictionary
996 (10th ed. 1997) defines ‘‘residence’’ as ‘‘1 a: the act or fact
of dwelling in a place for some time b: the act or fact of living
or regularly staying at or in some place for the discharge of
a duty or the enjoyment of a benefit’’ and ‘‘3 a: building used
as a home: DWELLING [synonym]’’. See also Black’s Law Dic-
tionary 1423 (9th ed. 2009). When the dictionary definitions
of ‘‘principal’’ and ‘‘residence’’ are combined, we conclude that
‘‘principal residence’’ may have two possible meanings. It can
either mean the chief or primary place where a person lives
or the chief or primary dwelling in which a person resides.
Likewise, the term ‘‘property’’ as used in section 121(a) can
refer more broadly to a parcel of real estate, or it can refer
to the dwelling (and related curtilage) 11 used as a taxpayer’s
principal residence.
Because there is more than one possible meaning for both
the term ‘‘property’’ and the term ‘‘principal residence’’, we
cannot conclude that the meaning of section 121(a) is clear
and unambiguous. Section 121(a) is not explicit as to
whether Congress intended section 121 to apply to a sale of
property when the property sold does not include the
dwelling that the taxpayer used as a principal residence for
the period that section 121(a) requires. Because section
121(a) is ambiguous, we may examine the legislative history
11 Black’s Law Dictionary 441 (9th ed. 2009) defines ‘‘curtilage’’ as ‘‘The land or yard adjoining

a house, usu. within an enclosure.’’

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 8 135 UNITED STATES TAX COURT REPORTS (1)

of section 121 and its predecessor provisions to ascertain
Congress’ intent regarding the proper tax treatment of prin-
cipal residence sales.
Until 1951 any gain realized on the sale of a principal resi-
dence was taxed as capital gain. S. Rept. 781, 82d Cong., 1st
Sess. (1951), 1951–2 C.B. 458, 482. In 1951 Congress recog-
nized that many taxpayers faced hardship as a result of tax
on gain realized on the sale of their principal residences—
especially where a taxpayer was compelled to sell his prin-
cipal residence and move to a new one because of a change
in circumstances such as an increase in family size or reloca-
tion for employment—and granted relief by enacting section
112(n)(1) (former section 112(n)(1)). Revenue Act of 1951, ch.
521, sec. 318, 65 Stat. 494; S. Rept. 781, supra, 1951–2 C.B.
at 482. Former section 112(n)(1) 12 provided that no gain on
the sale of a principal residence was recognized if a taxpayer
purchased a new residence for a price at least equal to the
selling price of the old residence within the period specified
therein. Unlike section 121(a), which excludes gain from the
sale of property used as a principal residence, former section
112(n)(1) provided for a deferral of gain from the sale of a
principal residence. 13 In the Internal Revenue Code of 1954,
ch. 736, 68A Stat. 306, former section 112(n)(1) was
recodified as section 1034 (former section 1034). 14
In 1964 Congress enacted section 121 (former section 121)
as part of the Revenue Act of 1964, Pub. L. 88–272, sec. 206,
12 As enacted in 1951, former sec. 112(n)(1) provided as follows:
SEC. 112(n). GAIN FROM SALE OR EXCHANGE OF RESIDENCE.—
(1) NONRECOGNITION OF GAIN.—If property (hereinafter in this subsection called ‘‘old resi-
dence’’) used by the taxpayer as his principal residence is sold by him and, within a period
beginning one year prior to the date of such sale and ending one year after such date, property
(hereinafter in this subsection called ‘‘new residence’’) is purchased and used by the taxpayer
as his principal residence, gain (if any) from such sale shall be recognized only to the extent
that the taxpayer’s selling price of the old residence exceeds the taxpayer’s cost of purchasing
the new residence.
13 The taxpayer had to reduce the basis in the new residence by the amount of gain excluded

under former sec. 112(n)(1). S. Rept. 781, 82d Cong., 1st Sess. (1951), 1951–2 C.B. 458, 483.
14 In 1954 sec. 1034(a) read as follows:

SEC. 1034. SALE OR EXCHANGE OF RESIDENCE
(a) NONRECOGNITION OF GAIN.—If property (in this section called ‘‘old residence’’) used by the
taxpayer as his principal residence is sold by him after December 31, 1953, and, within a period
beginning 1 year before the date of such sale and ending 1 year after such date, property (in
this section called ‘‘new residence’’) is purchased and used by the taxpayer as his principal resi-
dence, gain (if any) from such sale shall be recognized only to the extent that the taxpayer’s
adjusted sales price * * * of the old residence exceeds the taxpayer’s cost of purchasing the new
residence.

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 (1) GATES v. COMMISSIONER 9

78 Stat. 38, to provide older taxpayers tax relief on the sale
of their principal residences. 15 Former section 121 was sub-
sequently amended, see Technical and Miscellaneous Rev-
enue Act of 1988, Pub. L. 100–647, sec. 6011(a), 102 Stat.
3691; Economic Recovery Tax Act of 1981, Pub. L. 97–34, sec.
123(a), 95 Stat. 197; Revenue Act of 1978, Pub. L. 95–600,
sec. 404(a), 92 Stat. 2869; Tax Reform Act of 1976, Pub. L.
94–455, sec. 1404(a), 90 Stat. 1733, and as amended, per-
mitted an individual, on a one-time basis, to elect to exclude
from gross income up to $125,000 of gain from the sale or
exchange of a principal residence if the taxpayer (1) had
attained age 55 before the sale and (2) had owned the prop-
erty and used it as a principal residence for 3 or more of the
5 years immediately preceding the sale.
In the Taxpayer Relief Act of 1997 (TRA 1997), Pub. L.
105–34, sec. 312(a) and (b), 111 Stat. 836, 839, Congress
again amended former section 121 and repealed former sec-
tion 1034. Section 121 as amended by TRA 1997 (section 121)
provides that a taxpayer generally may exclude up to
$250,000 of gain realized on the sale or exchange of a prin-
cipal residence occurring after May 6, 1997, each time the
taxpayer sells or exchanges a principal residence and meets
the eligibility requirements under section 121. Section 121
applies to petitioners’ sale of the Summit Road property.
The legislative history of section 121 supports a conclusion
that Congress intended the terms ‘‘property’’ and ‘‘principal
residence’’ to mean a house or other dwelling unit in which
the taxpayer actually resided. In explaining the 1997 amend-
ment to section 121, the House Committee on the Budget
used the terms ‘‘home’’ and ‘‘house’’ and their derivations
interchangeably with the term ‘‘principal residence’’:
Calculating capital gain from the sale of a principal residence is among
the most complex tasks faced by a typical taxpayer. Many taxpayers buy
and sell a number of homes over the course of a lifetime, and are generally
15 In 1964 sec. 121 read as follows:
SEC. 121. GAIN FROM SALE OR EXCHANGE OF RESIDENCE OF INDIVIDUAL WHO HAS
ATTAINED AGE 65.
(a) GENERAL RULE.—At the election of the taxpayer, gross income does not include gain from
the sale or exchange of property if—
(1) the taxpayer has attained the age of 65 before the date of such sale or exchange, and
(2) during the 8-year period ending on the date of the sale or exchange, such property has
been owned and used by the taxpayer as his principal residence for periods aggregating 5
years or more.

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 10 135 UNITED STATES TAX COURT REPORTS (1)

not certain of how much housing appreciation they can expect. Thus, even
though most homeowners never pay any income tax on the capital gain on
their principal residences, as a result of the rollover provisions and the
$125,000 one-time exclusion, detailed records of transactions and expendi-
tures on home improvements must be kept, in most cases, for many dec-
ades. To claim the exclusion, many taxpayers must determine the basis of
each home they have owned, and appropriately adjust the basis of their
current home to reflect any untaxed gains from previous housing trans-
actions. This determination may involve augmenting the original cost basis
of each home by expenditures on improvements. In addition to the record-
keeping burden this creates, taxpayers face the difficult task of drawing
a distinction between improvements that add to basis, and repairs that do
not. The failure to account accurately for all improvements leads to errors
in the calculation of capital gains, and hence to an under- or overpayment
of the capital gains on principal residences. By excluding from taxation
capital gains on principal residences below a relatively high threshold, few
taxpayers would have to refer to records in determining income tax con-
sequences of transactions related to their house.

* * * * * * *
Present law also may discourage some older taxpayers from selling their
homes. Taxpayers who would realize a capital gain in excess of $125,000
if they sold their home and taxpayers who have already used the exclusion
may choose to stay in their homes even though the home no longer suits
their needs. * * *
[H. Rept. 105–148, at 347 (1997), 1997–4 C.B. (Vol. 1) 319, 669;
emphasis added.]

The legislative history demonstrates that Congress intended
the term ‘‘principal residence’’ to mean the primary dwelling
or house that a taxpayer occupied as his principal residence.
Nothing in the legislative history indicates that Congress
intended section 121 to exclude gain on the sale of property
that does not include a house or other structure used by the
taxpayer as his principal place of abode. Although a principal
residence may include land surrounding the dwelling, the
legislative history supports a conclusion that Congress
intended the section 121 exclusion to apply only if the
dwelling the taxpayer sells was actually used as his principal
residence for the period required by section 121(a).
The conclusion that we reach from an examination of the
legislative history surrounding the enactment of section 121
is bolstered by and is consistent with regulations promul-
gated under the predecessor provisions of section 121. Sec-
tion 1.121–3(a), Income Tax Regs., under former section 121,
provided that the term ‘‘principal residence’’ has the same

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 (1) GATES v. COMMISSIONER 11

meaning as in section 1034 and the regulations thereunder.
Section 1.1034–1(c)(3)(i), Income Tax Regs., under former
section 1034 (section 1034 regulations), provided that
whether property was used by the taxpayer as his principal
residence depended on all the facts and circumstances in
each case, including the good faith of the taxpayer. The sec-
tion 1034 regulations further provided that property used by
the taxpayer as his principal residence may include a house-
boat, a house trailer, or stock held by a tenant-stockholder in
a cooperative housing corporation, if the dwelling which the
taxpayer is entitled to occupy as such stockholder is used by
him as his principal residence. The focal point of the section
1034 regulations was the dwelling unit a taxpayer uses as
his principal residence. The section 1034 regulations
reinforce our conclusion that to obtain the benefits of former
section 1034, a taxpayer who sells a dwelling must have
actually used it as his principal residence.
Our conclusion regarding the meaning that Congress
attaches to the terms ‘‘property’’ and ‘‘principal residence’’ in
section 121(a) is also consistent with caselaw interpreting
former section 1034, as in effect before its repeal. This Court
held that in order to qualify under former section 1034, a
taxpayer had to sell a dwelling that he used as his principal
residence. 16 In Hughes v. Commissioner, 54 T.C. 1049, 1050
16 We have found only one case where the taxpayers were permitted to exclude gain on a sale

of land that did not occur simultaneously with the sale of the taxpayers’ principal residence.
See Bogley v. Commissioner, 263 F.2d 746 (4th Cir. 1959), revg. 30 T.C. 452 (1958). In Bogley
v. Commissioner, supra at 747, the taxpayers attempted to sell the entire 13-acre parcel on
which their principal residence was situated, but they were able to sell only the dwelling and
3 acres surrounding the dwelling. Less than 1 year later, the taxpayers sold the remaining 10
acres. Id. The Court of Appeals for the Fourth Circuit concluded that the character of the
10 acres never changed and held that the sale of the 10 acres qualified as a sale of the tax-
payers’ principal residence. Id. at 748.
Courts have distinguished Bogley on the grounds that in Bogley the sale of the 10 acres was
not a sale of land alone as the dwelling was also sold albeit in a transaction separate from the
sale of the 10 acres. See Hughes v. Commissioner, 54 T.C. 1049, 1055 (1970), affd. per curiam
450 F.2d 980 (4th Cir. 1971); O’Barr v. Commissioner, 44 T.C. 501, 503 (1965). This Court has
stated that Bogley does not support the position that a sale of land alone without a sale of the
dwelling qualifies for the sec. 1034 exclusion. See Hughes v. Commissioner, supra at 1054–1056.
Bogley is distinguishable from this case because petitioners did not sell the original house and
the land in separate but related transactions as the taxpayers did in Bogley.
Regulations under amended sec. 121, as currently in effect, provide that if a taxpayer meets
certain requirements, gain from the sale of land alone may qualify for the sec. 121 exclusion.
Sec. 1.121–1(b)(3), Income Tax Regs. However, to qualify under this provision of the regulations,
the taxpayer must still sell a ‘‘dwelling unit’’ that meets the requirements under sec. 121 within
2 years before or after the sale of the land. Sec. 1.121–1(b)(3)(i)(C), Income Tax Regs. The regu-
lations under amended sec. 121 are effective for sales on or after Dec. 24, 2002. Sec. 1.121–1(f),
Income Tax Regs.

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 12 135 UNITED STATES TAX COURT REPORTS (1)

(1970), affd. per curiam 450 F.2d 980 (4th Cir. 1971), the tax-
payers agreed to exchange premises A, on which the dwelling
that served as their principal residence was situated, for
cash and the right to occupy premises B as their new prin-
cipal residence. Before the exchange, the taxpayers moved
the dwelling from premises A to premises C and began using
the dwelling on premises C as income-producing property. Id.
at 1053. Relying on former section 1034, the taxpayers
excluded gain realized on the exchange of premises A (with-
out the dwelling) for premises B and cash. Id. at 1053. They
argued that premises A without the dwelling was as much a
part of their principal residence as the dwelling and that the
land should be treated as their old residence for purposes of
section 1034. Id. at 1054. This Court disagreed with the tax-
payers and held that they were not entitled to the exclusion
because the dwelling that was used as their principal resi-
dence was never sold or disposed of as required by former
section 1034. Id.
In O’Barr v. Commissioner, 44 T.C. 501 (1965), the tax-
payers sold a portion of a tract of land on which their prin-
cipal residence was situated. However, the portion of land
sold did not include the residence. Id. Relying on former sec-
tion 1034, the taxpayers excluded gain from the sale of the
land. Id. at 502. The taxpayers argued that the controlling
fact was how the land had been used before the sale and not
whether the land included a dwelling when it was sold.
According to the taxpayers, the land that was sold had been
part of the property used as their principal residence and
that use entitled them to claim the benefit of former section
1034. Id. In its analysis of former section 1034, this Court
stated that ‘‘The only logical interpretation of section 1034 is
that it will only apply in situations where a taxpayer has dis-
posed of his old dwelling.’’ Id. at 503. Because the taxpayers
did not dispose of their dwelling, the Court concluded that
former section 1034 was inapplicable. Id. Other cases have
followed Hughes and O’Barr. See, e.g., Boesel v. Commis-
sioner, 65 T.C. 378, 390 (1975) (essential element of a resi-
dence is the dwelling, not the land on which it is situated);
Hale v. Commissioner, T.C. Memo. 1982–527 (‘‘The sale of a
taxpayer’s residence requires the sale of a structure which is
used as a principal place of abode, and we have held that the

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 (1) GATES v. COMMISSIONER 13

sale of land without the structure does not constitute a sale
of a residence within the meaning of section 1034.’’).
Former section 1034 required that a taxpayer sell ‘‘prop-
erty * * * used by the taxpayer as his principal residence’’
in order to qualify for deferral. In 1997, when Congress
amended section 121 and repealed section 1034, TRA 1997
sec. 312(a) and (b), Congress continued to use the wording of
former section 1034 to describe the type of property that
qualified for exclusion treatment under section 121(a) if
sold—‘‘property * * * used by the taxpayer as the taxpayer’s
principal residence’’. Congress did not give any indication in
the legislative history of section 121 that it intended that
wording to have a meaning for the purpose of section 121 dif-
ferent from the meaning it had been accorded under former
section 1034; nor did Congress state that it disagreed with
the interpretation of that wording in cases that had inter-
preted former section 1034. We infer from the consistent use
of the phrase ‘‘property * * * used by the taxpayer as his
principal residence’’ in former section 1034 and in section 121
as amended by Congress in 1997 that Congress intended the
comparable wording in the two sections to be interpreted
comparably.
Although we recognize that petitioners would have satis-
fied the requirements under section 121 had they sold or
exchanged the original house instead of tearing it down, we
must apply the statute as written by Congress. Rules of
statutory construction require that we narrowly construe
exclusions from income. Commissioner v. Schleier, 515 U.S.
at 328. Under section 121(a) and its legislative history, we
cannot conclude on the facts of this case that petitioners sold
their principal residence. 17 Accordingly, we hold that peti-
17 Sec. 121(c) provides that a taxpayer who fails to meet the ownership or use requirements

under sec. 121(a) because of ‘‘a change in place of employment, health, or, to the extent provided
in regulations, unforeseen circumstances’’ is entitled to a prorated exclusion under sec. 121(a).
The prorated exclusion is based on the period of a taxpayer’s ownership and use of the principal
residence. See sec. 121(c)(1). Because petitioners never used the new house as their principal
residence, they would not qualify for proration in any event. Even if they did, however, peti-
tioners did not introduce any credible evidence to support their claim to a prorated exclusion.
Petitioners argue that the unsustainable debt they incurred in constructing the new house is
an unforeseen circumstance that justifies an exclusion under sec. 121(a). However, petitioners
did not introduce any credible evidence regarding the debt they allegedly incurred or that the
debt was ‘‘unsustainable’’, or that unsustainable debt qualified as ‘‘unforeseen circumstances’’
within the meaning of sec. 121(c).

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 14 135 UNITED STATES TAX COURT REPORTS (1)

tioners may not exclude from income under section 121(a)
the gain realized on the sale of the Summit Road property. 18
III. Addition to Tax Under Section 6651(a)(1)
Section 6651(a)(1) authorizes the imposition of an addition
to tax for failure to file a timely return, unless it is shown
that such a failure is due to reasonable cause and not due
to willful neglect. United States v. Boyle, 469 U.S. 241, 245
(1985); United States v. Nordbrock, 38 F.3d 440, 444 (9th Cir.
1994); Harris v. Commissioner, T.C. Memo. 1998–332. A
failure to file a timely Federal income tax return is due to
reasonable cause if the taxpayer exercised ordinary business
care and prudence but nevertheless was unable to file the
return within the prescribed time. See sec. 301.6651–1(c)(1),
Proced. & Admin. Regs. Willful neglect means a conscious,
intentional failure to file or reckless indifference toward
filing. See United States v. Boyle, supra at 245.
If a taxpayer assigns error to the Commissioner’s deter-
mination that the taxpayer is liable for the addition to tax,
the Commissioner has the burden, under section 7491(c), of
producing evidence to show that the section 6651(a) addition
to tax applies. See Swain v. Commissioner, 118 T.C. 358,
364–365 (2002); Higbee v. Commissioner, 116 T.C. 438, 446
(2001). To meet his burden of production, the Commissioner
must come forward with sufficient evidence to show that it
is appropriate to impose the relevant penalty or addition to
tax. Higbee v. Commissioner, supra at 446. However, the
Commissioner is not required to introduce evidence regarding
reasonable cause, substantial authority, or similar defenses.
Id.
Petitioners admit that they did not file a timely Federal
income tax return for 2000. This is sufficient to satisfy
respondent’s burden of producing evidence that the section
6651(a)(1) addition to tax applies. Petitioners did not intro-
duce any evidence to prove that they had reasonable cause
for their failure to file their 2000 return timely. Con-
sequently, we sustain respondent’s determination.

18 Petitioners do not contend or provide any authority for the proposition that we should allo-

cate the gain between gain on the land and gain on the residence, or offer any evidence to sup-
port such an allocation.

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 (1) GATES v. COMMISSIONER 15

We have considered all the other arguments made by the
parties, and to the extent not discussed above, conclude those
arguments are irrelevant, moot, or without merit.
To reflect the foregoing,
Decision will be entered for respondent.
Reviewed by the Court.
COLVIN, COHEN, GALE, THORNTON, WHERRY, GUSTAFSON,
PARIS, and MORRISON, JJ., agree with this majority opinion.

COHEN, J., concurring: I agree with the majority and write
to explain my disagreement with the dissent.
The dissent argues that the holding of the majority is
inconsistent with the remedial purpose of section 121. This
Court’s assigned task in the first instance, however, is to
apply section 121 as written to the facts of this case. Section
121 requires that we examine the sale or exchange of prop-
erty and provides that if the property sold was owned and
used by the taxpayer as the taxpayer’s principal residence for
at least 2 of the 5 years preceding the sale or exchange, the
taxpayer qualifies for the exclusion under section 121(a).
The focal point of the section 121 analysis is the property
sold or exchanged. In this case the property sold consisted of
land that petitioners had used for the required period (old
land) and a new dwelling in which petitioners had never
resided (new house). After concluding that the term ‘‘prin-
cipal residence’’ means the dwelling (and associated land) in
which a taxpayer resided as his or her primary home, the
majority examined the facts to see whether what petitioners
sold qualified as a principal residence within the meaning of
section 121(a).
The fully stipulated facts reveal that the dwelling peti-
tioners sold was not used as their principal residence for the
required 2-year period. Petitioners demolished their former
principal residence and built a new, much larger house that
they never occupied. The facts are decisive and support the
holding of the majority.
The dissent maintains that, because petitioners owned and
used their former principal residence (old house, now demol-
ished, and old land) for the required 2-year period, the prop-

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 16 135 UNITED STATES TAX COURT REPORTS (1)

erty that they sold (new house and old land) qualifies for the
exclusion. The dissent argues that this result is consistent
with Congress’ intention to liberalize the exclusion rules in
1997 when it amended section 121. However, the dissent
ignores the fact that the term ‘‘principal residence’’ has been
consistently used by Congress since 1951, and there is no evi-
dence in the legislative history of the Taxpayer Relief Act of
1997 (TRA 1997), Pub. L. 105–34, sec. 312(a) and (b), 111
Stat. 836, 839, which amended section 121 and repealed sec-
tion 1034, to indicate that Congress intended to change the
meaning of the term ‘‘principal residence’’ sub silentio when
it amended section 121. Although section 121 as amended by
the TRA 1997 blended the approaches of former section 121
and former section 1034 to provide a simpler and more uni-
form treatment of gain generated by the sale of a prin-
cipal residence, Congress did not change the definition of
principal residence, a term it has used consistently since
1951 when section 112(n), the predecessor provision to
former section 1034, was first enacted.
The majority’s holding is consistent with caselaw that has
developed under the predecessor provisions of section 121,
most particularly former section 1034. The cases examine the
dwelling to decide whether the property sold was used as the
taxpayer’s principal residence. If a taxpayer sold a dwelling
that the taxpayer used as a principal residence, the taxpayer
qualified for the deferral provided by former section 1034 if
the other requirements of section 1034 (such as the timely
purchase of a qualifying replacement property) were met. If
a taxpayer sold some part of the underlying land but not the
dwelling that the taxpayer used as a principal residence, the
taxpayer could not defer the recognition of gain on the sale
because the taxpayer did not sell his or her principal resi-
dence. See, e.g., Hughes v. Commissioner, 54 T.C. 1049
(1970), affd. per curiam 450 F.2d 980 (4th Cir. 1971); O’Barr
v. Commissioner, 44 T.C. 501 (1965). If a taxpayer sold his
or her principal residence with part but not all of the under-
lying land and then sold the rest of the land close to the time
of the sale of the principal residence, at least one court has
held that the sales must be integrated in deciding whether
the gain on the sale of land could be deferred. Bogley v.
Commissioner, 263 F.2d 746 (4th Cir. 1959), revg. 30 T.C.
452 (1958). Although the Court of Appeals ultimately decided

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 (1) GATES v. COMMISSIONER 17

in Bogley that deferral was appropriate, the deferral was
predicated on the fact that the taxpayer had also sold the
principal residence in a related sale.
If petitioners had sold their old home instead of demol-
ishing it, they would have qualified for the section 121 exclu-
sion. That is not what they did. They demolished the old
home, constructed a new and larger dwelling, and then sold
the new dwelling without occupying it for the required 2-year
period. The dissent objects to the result and argues that the
majority’s analysis in this case will distort the result in other
cases in which the taxpayer should qualify for the section
121 exclusion. The response to this argument is straight-
forward—it is not this Court’s job to anticipate and decide
cases that are not yet before it. As the Supreme Court cau-
tioned in Dewsnup v. Timm, 502 U.S. 410, 416–417 (1992):
Hypothetical applications that come to mind and those advanced at oral
argument illustrate the difficulty of interpreting the statute in a single
opinion that would apply to all possible fact situations. We therefore focus
upon the case before us and allow other facts to await their legal resolu-
tion on another day.

We have often stated that we ‘‘must decide the case in the
light of what was done, not what might have been done.’’
Paula Constr. Co. v. Commissioner, 58 T.C. 1055, 1060
(1972), affd. per curiam without published opinion 474 F.2d
1345 (5th Cir. 1973); see also Rogers v. Commissioner, 44
T.C. 126, 136 (1965) (‘‘Our decision must be governed by
what was actually done, rather than by what might have
been done.’’), affd. per curiam 377 F.2d 534 (9th Cir. 1967).
The majority properly limits its analysis to the facts of this
case, which were fully stipulated, and to the issues raised by
the parties. Petitioners did not argue for a partial exclusion
of gain attributable to the sale of the land, nor did peti-
tioners introduce any evidence that would have permitted
the Court to allocate gain between the new house and the
land. Petitioners argued only that they were entitled to
the full exclusion under section 121. As the majority holds,
the property sold, i.e., the dwelling and related land, must
have actually been used as petitioners’ principal residence for
the required 2-year period. Because the new house peti-
tioners sold was never used as their principal residence, the
section 121 exclusion does not apply here. We may reach a

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 18 135 UNITED STATES TAX COURT REPORTS (1)

different conclusion in cases involving different facts if and
when the opportunity arises, but we should not distort the
result in this case by anticipating those cases.
GALE, THORNTON, MARVEL, WHERRY, GUSTAFSON, and
PARIS, JJ., agree with this concurring opinion.

HALPERN, J., dissenting: There is adequate ground for the
majority’s conclusion that, to qualify for the section 121
exclusion, the taxpayer must sell not only the land on which
her principal residence is located but also the principal resi-
dence itself. Nevertheless, I think that there is also adequate
ground for concluding that petitioners’ sale of the new house
qualified for that exclusion.
Interpretation Contrary to the Remedial Intent of Section
121(a)
The gain exclusion rule of section 121(a) applies if three
conditions are met: (1) There must be a sale or exchange
(without distinction, sale); (2) the sale must be of ‘‘property
* * * owned and used by the taxpayer as the taxpayer’s
principal residence’’ (the property use condition), and (3) the
property use condition must be satisfied for 2 out of the 5
years ending on the date of sale of the property (the temporal
condition). The majority focuses on the second condition (the
property use condition) and interprets the condition as being
satisfied only if the property sold constitutes, at least in part,
‘‘a house or other structure used by the taxpayer as his prin-
cipal place of abode.’’ Majority op. p. 10. The majority does
not rely on the text of the statute for that interpretation
(which text it concludes is ambiguous) but looks to a report
of the Committee on Ways and Means, House of Representa-
tives (included as part of H. Rept. 105–148, at 285 (1997),
1997–4 C.B. (Vol. 1) 319, 607, a report of the Committee on
the Budget, House of Representatives, accompanying H.R.
2014, 105th Cong., 1st Sess. (1997), which was enacted as
the Taxpayer Relief Act of 1997, Pub. L. 105–34, 111 Stat.
788), explaining the committee’s reasons for recommending
an amendment to section 121. The committee’s reasons are
principally the difficulties a homeowner faces in keeping
track of his basis in his home. The committee report lan-

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 (1) GATES v. COMMISSIONER 19

guage the majority quotes neither addresses the language of
the proposed amendment nor purports to exhaust the situa-
tions giving rise to the need for the amendment. It provides
insufficient grounds to conclude ‘‘that Congress intended the
section 121 exclusion to apply only if the dwelling the tax-
payer sells was actually used as his principal residence for
the period required by section 121(a).’’ Majority op. p. 10
(emphasis added).
While the majority is correct that the Supreme Court has
said that exclusions from income are to be narrowly con-
strued, Commissioner v. Schleier, 515 U.S. 323, 328 (1995)
(more precisely, the Court said: ‘‘ ‘the default rule of statutory
interpretation [is] that exclusions from income must be nar-
rowly construed’ ’’ (quoting United States v. Burke, 504 U.S.
229, 248 (1992) (Souter, J., concurring in judgment))), the
Supreme Court has also said that, if the meaning of a tax
provision liberalizing the law from motives of public policy is
doubtful, then it should not be narrowly construed, Helvering
v. Bliss, 293 U.S. 144, 150–151 (1934).
With that latter rule of construction in mind, consider a
taxpayer whose longtime home is demolished by a natural
disaster (a hurricane). The taxpayer lacks insurance. Never-
theless, she rebuilds on the same land (perhaps a bit further
from the ocean) and lives in the rebuilt house for 18 months,
and then she sells the house and land at a gain. Although
the taxpayer satisfies the property use condition, I assume
that, nevertheless, under the majority’s analysis, she gets no
exclusion because she fails the temporal condition; i.e., she
has not lived in the rebuilt house for 2 or more of the last
5 years. 1 I assume further that, if her house had been only
damaged (and not demolished), and she repaired it, she
would get an exclusion. That seems like an untenable
distinction to me. 2
1 Under the facts assumed, the destruction of the original house does not result in the conver-

sion of the house into similar property or into money. See sec. 1033(a). Therefore, the rebuilt
house is not property acquired after an involuntary conversion, and there would be no tacking
of the use and period of occupancy of the original house onto the rebuilt house for purposes of
sec. 121. See sec. 121(d)(5)(C).
2 It is no answer to that criticism to say, as Judge Cohen does, that it is not the Court’s job

to anticipate and decide cases that are not yet before it. We are a national court that treats
its own cases as precedent until we overrule ourselves by action of the Court Conference. This
case (and my arguments) have been before the Court Conference. We should recognize, as no
doubt the Commissioner and taxpayers will, the weight that the analysis in this case will carry
in similar situations under principles of stare decisis.

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 20 135 UNITED STATES TAX COURT REPORTS (1)

Difficult Interpretative Questions
The majority’s interpretation of the property use condition
naturally suggests that there is some recognizable difference
between remodeling a house and demolishing and rebuilding
the house. I assume the majority does not mean to suggest
that any remodeling of a home (1) terminates the use of that
home as the taxpayer’s principal residence and (2) resets the
temporal clock to zero time elapsed. If not, then is there
some level of remodeling that does (1) terminate the use of
the home as the taxpayer’s principal residence and (2) set the
temporal clock to zero? What about a taxpayer who, wanting
a bigger house, demolishes the old house (but not the founda-
tion) and constructs a larger (taller) house using the old
foundation? Is that remodeling or rebuilding? What about
keeping part of the foundation, and expanding horizontally?
If that is remodeling, then there may be an easy way for the
Court to reach a similar result in the case before us. The par-
ties have stipulated an exhibit, a blueprint, that shows foot-
prints of both the old and the new house. I have examined
the exhibit, and the footprints overlap. Might we not con-
clude that part of the foundation of the old house was incor-
porated into the new, thus making the case a remodeling
case and not a rebuilding case?
The majority’s report will undoubtedly raise the kind of
remodeling versus rebuilding questions that I have raised. I
think that the better course would be to avoid provoking
those questions.
Disposition of House Followed by Sale of Land
Cases, see, e.g., Bogley v. Commissioner, 263 F.2d 746 (4th
Cir. 1959), revg. 30 T.C. 452 (1958), suggest that, and the
regulations, sec. 1.121–1(b)(3), Income Tax Regs., confirm
that, if the principal residence consists of both land and
improvements, both a prior sale of the improvements and
part of the land and a subsequent sale of the remaining land
can qualify under section 121(a). Although petitioners are
perhaps at a disadvantage for not arguing it, it does not
seem to me to be an impossible stretch to view the demolition
of the original house as a sale for zero dollars followed by a
later sale of the land. There would then be a ground to apply
section 121(a) to the subsequent sale of the land. The demoli-

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 (1) GATES v. COMMISSIONER 21

tion/disposition of the original house would give rise to a non-
deductible loss, with the basis in the house going to the land.
See sec. 280(B). Any gain attributable to the original house
and land would be realized on the sale of the land (and new
house). That approach requires the allocation of the proceeds
between the new house and the land, which apparently peti-
tioners did not think to address.
Conclusion
I would treat the demolition and reconstruction of peti-
tioners’ house no differently from a renovation. As a second
best solution (if I had adequate information), I would treat
the original house as being sold for zero dollars upon its
demolition and apply section 121 to a subsequent sale of the
land (and new house).
WELLS, GOEKE, KROUPA, and HOLMES, JJ., agree with this
dissent.

f

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