DeCleene v. Comm'r of Internal Revenue

• Decision Date: 17 November 2000
• Docket Number: No. 24459–97.,24459–97.
• Citation: 115 T.C. No. 34,115 T.C. 457
• Parties: Donald DECLEENE and Doris Decleene, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

115 T.C. 457

115 T.C. No. 34

Donald DECLEENE and Doris Decleene, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 24459–97.

United States Tax Court.

Nov. 17, 2000.

Taxpayers petitioned for redetermination of deficiencies arising from disregarded like-kind exchange. The Tax Court, Beghe, J., held that: (1) in matter of first impression, transaction arranged directly with second party to exchange, without participation of third-party exchange facilitator, was a sale since taxpayer never divested himself of beneficial ownership of the replacement property, but (2) accuracy-related penalty was not warranted.

Decision for IRS in part, and for taxpayer in part. P had operated his business on the M Street property since 1977. In 1992, P purchased the unimproved L Drive property as replacement property. In September 1993, P and WLC, who wished to acquire M Street, agreed that M Street and unimproved L Drive were of equal value, $142,400; P quitclaimed title to L Drive to WLC for a deferred cash consideration of $142,400, to be paid at a second closing; WLC agreed to build a building on L Drive to P's specifications and in December 1993 to reconvey L Drive to P, with the substantially completed building on it, in exchange for M Street. These transactions closed as agreed. While WLC held title to L Drive, P retained beneficial ownership thereof and was responsible for all transaction costs and carrying charges. Construction was financed by a note and mortgage guaranteed by P that were nonrecourse as to WLC, and P assumed personal liability for them at the second closing, when WLC paid P the cash consideration of $142,400.Held: The subject transactions were a sale of M Street to WLC for $142,400, as determined by R, rather than a sale of unimproved L Street, followed by a reverse like-kind exchange of M Street for improved L Street under sec. 1031(a), I.R.C., as reported by P. Because P never divested himself of beneficial ownership of L Street, P could not acquire improved L Street as replacement property in exchange for his relinquishment of M Street to WLC. Held, further, P is not liable for the accuracy-related penalty under sec. 6662(a), I.R.C.Brian R. Mudd, for petitioners.

Michael J. Calabrese, for respondent.

BEGHE, J.

Respondent determined for the taxable year 1993 that petitioners had a Federal income tax deficiency of $23,796 and were liable for a section 6662(a) ¹ accuracy-related penalty of $4,759.

The sole substantive issue for decision is whether the subject transactions qualified as a taxable sale of the Lawrence Drive property and a like-kind section 1031(a)(1) exchange of the McDonald Street property, as petitioners reported them, or was a taxable sale of the McDonald Street property, as respondent determined. We uphold respondent's determination that the transactions resulted in a sale of the McDonald Street property, but we hold for petitioners on the penalty issue.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulations of fact and the accompanying exhibits are incorporated herein by this reference. Petitioners are husband and wife who resided in Green Bay, Wisconsin, at the time they filed their petition.

Since 1969, petitioner Donald DeCleene (petitioner) has owned and operated a trucking/truck repair business. In 1976 and 1977, petitioner purchased improved real property located on McDonald Street, Green Bay (the McDonald Street property). He used the McDonald Street property for his business operations.

In 1993, petitioners owned and worked as employees of DeCleene Truck Repair and Refrigeration, Inc. (Refrigeration). Petitioner served as president. Refrigeration installs and repairs truck refrigeration units and performs general truck repairs. Through December 29, 1993, Refrigeration rented the McDonald Street property from petitioner as its business premises. Petitioner computed his adjusted basis for the McDonald Street property, including the depreciated cost of improvements, as being $59,831 at the time he disposed of that property on December 29, 1993.

In 1992, petitioner was looking for land to which he could move his business.

On September 30, 1992, petitioner purchased 8.47 acres of unimproved real property on Lawrence Drive in De Pere, Wisconsin (the Lawrence Drive property), a suburb of Green Bay. Petitioner described the Lawrence Drive property as a “very good spot” that he “took advantage of”. Petitioner promptly sold 2.09 acres of the Lawrence Drive property to an unrelated corporation. Petitioner's adjusted basis of the Lawrence Drive property that he purchased and retained, with allocated fees and other closing costs, was $137,027.

Petitioner partially financed the purchase of the Lawrence Drive property with a $100,000 loan from Bank One, Green Bay, Bank One, Green Bay received petitioner's note and a mortgage on the Lawrence Drive property as security for its loan.

By 1993, petitioner was ready to move his business to a new building to be constructed on the Lawrence Drive property.

After petitioner acquired the Lawrence Drive property, The Western Lime and Cement Co. (WLC) expressed interest in acquiring petitioner's McDonald Street property.

Petitioner discussed WLC's interest in the McDonald Street property with his accountant. The accountant suggested that petitioner could structure a like-kind exchange in which he would quitclaim the Lawrence Drive property to WLC, after which WLC would convey back to petitioner the Lawrence Drive property with a new building built thereon to petitioner's specifications, in exchange for the McDonald Street property.

On September 24, 1993, WLC made an offer—prepared by petitioner's attorney—which petitioner accepted, to purchase the Lawrence Drive property for $142,400; petitioner's acceptance contained an undertaking to “transfer building permit to Buyer on or before September 27, 1993”.² On September 24, 1993, petitioner quitclaimed title to the Lawrence Drive property to WLC, and WLC gave petitioner a fully nonrecourse noninterest bearing one payment note and mortgage on the Lawrence Drive property in the amount of $142,400. On that same day, petitioner assigned to Bank One, Green Bay, the WLC $142,400 note and mortgage. The WLC $142,400 note was due by its terms “upon the closing of an exchange transaction between” WLC and petitioner, or 6 months from the date of the note, “whichever is earlier”.

On September 24, 1993, WLC and petitioner also executed the Exchange Agreement regarding the McDonald Street property and the Lawrence Drive property. The Exchange Agreement was drafted by petitioner's attorney with input from WLC's attorney.

Paragraph 1 of the Exchange Agreement required petitioner to convey by warranty deed the McDonald Street property to WLC, “free and clear of all liens and encumbrances”, in exchange for WLC's paying its $142,400 note to petitioner and conveying the Lawrence Drive Property back to petitioner by quitclaim deed.

Paragraph 2 of the Exchange Agreement provided that petitioner would pay all costs relating to the transfers of the McDonald Street and Lawrence Drive properties.

In Paragraph 4 of the Exchange Agreement, petitioner made comprehensive warranties to WLC with respect to the McDonald Street property, but WLC expressly disavowed making any warranties to petitioner with respect to the Lawrence Drive property.

The Exchange Agreement provided that WLC would construct a building on the Lawrence Drive property to petitioner's specifications.

The Exchange Agreement provided that petitioner at the closing of the exchange would pay an amount representing the costs of the building on the Lawrence Drive property, as well as insurance premiums, real estate taxes, interest, and all other “soft” costs WLC might incur incident to the construction of the building.

Petitioner in the Exchange Agreement agreed to indemnify and hold WLC harmless against any damages sustained or incurred in connection with the construction and financing of the Lawrence Drive property.

Petitioner and WLC intended to close on the Exchange Agreement upon completion of construction of the building on the Lawrence Drive property “but not later than December 31, 1993”.

Bank One, Green Bay provided financing for the construction of the building on the Lawrence Drive property. On September 24, 1993, Bank One, Green Bay agreed to a construction loan of $380,000, naming WLC as borrower and petitioner as guarantor. This loan was nonrecourse as to WLC. On the same day WLC executed a note and mortgage to Bank One, Green Bay, which provided that WLC had no personal liability on the note secured by the mortgage and that the lender would look solely to the Lawrence Drive property securing the mortgage; petitioner guaranteed the $380,000 construction loan.

Bank One, Green Bay considered petitioner the source of repayment of the September 24, 1993, $380,000 construction loan. In connection with that loan, Bank One, Green Bay never obtained any financial statements from WLC. The check of the creditworthiness of WLC by the Bank One, Green Bay loan officer consisted of calling a branch bank to discuss WLC's business reputation.

The $380,000 note for the September 24, 1993 Bank One, Green Bay construction loan required no interest or principal payments during the time that WLC was expected to be the named borrower on the note; the note did not require payment of interest until March 23, 1994.

On September 24, 1993, the following other events occurred: Petitioner gave Bank One, Green Bay a new mortgage on the McDonald Street property securing a total obligation of $480,000, consisting of both his September 30, 1992, $100,000 note and the WLC nonrecourse note of $380,000 that he had guaranteed; WLC accepted the commitment of Bank One, Green Bay to provide a $380,000 loan for financing construction of the building on the Lawrence Drive property; WLC executed a corporate borrowing resolution...