Wagensen v. Comm'r of Internal Revenue

• Decision Date: 09 July 1980
• Docket Number: 8201-78.,Docket Nos. 5367-78
• Citation: 74 T.C. 653
• Parties: FRED S. WAGENSEN, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

74 T.C. 653

FRED S. WAGENSEN, PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket Nos. 5367-78

8201-78.

United States Tax Court

Filed July 9, 1980.

Held: The exchange by petitioner of his Wagensen Ranch for the Napier Ranch and cash was an exchange of like-kind property within the meaning of sec. 1031, I.R.C. 1954, and petitioner recognized no gain in excess of the amount of cash he received on the exchange. That petitioner intended, when he acquired the Napier Ranch, eventually to transfer it to his children does not render the section inapplicable. Held, further, the ranching partnership of which petitioner was a partner carried its breeding cattle in an inventory used to determine its profits; therefore, an investment credit is not allowable with respect to the cattle. Sec. 1.48-1(b)(1), Income Tax Regs. Frank M. Cavanaugh, for the petitioner.

Richard D. D'Estrada, for the respondent.

FEATHERSTON, Judge:

In these consolidated cases, respondent determined deficiencies of $353,881, $1,806, and $1,444 in petitioner's Federal income taxes for 1974, 1975, and 1976, respectively. The issues for decision are:

(1) Whether section 1031¹ applies to an exchange of petitioner's ranch for another ranch and cash where he subsequently gave the ranch and some of the cash to his children.

(2) Whether a partnership in which petitioner is a partner is entitled to investment credit on livestock that the partnership included in inventory.

FINDINGS OF FACT

Petitioner Fred S. Wagensen was a legal resident of Gillette, Wyo., when he filed his petition. He filed his individual Federal income tax returns for 1974, 1975, and 1976 with the Internal Revenue Service Center, Ogden, Utah.

Petitioner, age 83 at the time of trial, was involved in ranching in Campbell County, Wyo., for over 50 years. Since at least 1956, petitioner operated a cattle ranching business in partnership with his son, Donald. The partnership, known as the Wagensen Ranch partnership, filed returns for 1974, 1975, and 1976. All of the real property used by the partnership was owned by petitioner and his wife as joint tenants until her death in 1972. Thereafter, until November 8, 1974, the property was owned solely by petitioner. The partnership paid the property taxes on the real property used by it. During 1974 through 1976, petitioner continued to operate the cattle-ranching business in partnership with his son.

During the late 1960's, the Carter Oil Co. (Carter) purchased at auction from the Federal Government a 20-year lease covering coal underlying one of the ranches owned by petitioner known as the Wagensen or Rawhide Ranch. During the period 1970 to 1973, petitioner negotiated with Carter and other companies for the sale of petitioner's ranch. Consistently throughout the negotiations, Carter indicated its willingness to pay cash, but petitioner made it clear that he wanted to receive, in exchange, other property on which to continue his ranching business. In early 1973, petitioner and Carter agreed that petitioner would transfer the Wagensen Ranch to Carter in exchange for another designated ranch if Carter could acquire that ranch. Carter was unable to acquire that ranch, however, and the agreement terminated.

On September 19, 1973, petitioner entered into a contract with Carter setting forth the terms on which Carter would acquire the Wagensen Ranch. Under the contract, petitioner executed a deed to Carter for the ranch. The value placed on the ranch by the contract was $3 million. The contract directed that the deed be placed in escrow until the date of closing, at which time it would be delivered to Carter. The contract obligated Carter to acquire and transfer to petitioner a maximum of five properties which were satisfactory to him. If the total purchase price of the properties transferred to petitioner was less than the value of the Wagensen Ranch, Carter would pay the difference in cash at closing. If the purchase price exceeded the Wagensen Ranch's value, petitioner would pay the difference. If no lands satisfactory to petitioner were acquired within 5 years, then Carter would pay cash of $3 million to petitioner.

The contract further provided that, upon each conveyance of lands by Carter to petitioner, Carter would be entitled to possess, for purposes of coal mining, a portion of the Wagensen Ranch approximately equal in value to the land transferred to petitioner. To the extent that Carter used portions of the Wagensen Ranch prior to the transfer of property to petitioner, Carter was obligated to pay rent of $5 per acre per year. To avoid disrupting petitioner's cattle operations until new property was acquired, the agreement also granted petitioner a 10-year renewable lease on the ranch subject to Carter's rights. The lease was terminable at will by Carter.

On January 18, 1974, Carter executed a deed to property, known as the Napier Ranch, to petitioner. The deed was recorded on January 31, 1974. The cost of the Napier Ranch was $995,487. After the purchase of the Napier Ranch, petitioner and Carter continued to search for additional ranching properties through September 1974. No ranches satisfactory to petitioner, however, were found, and thus, Carter did not purchase any more property for petitioner.

Subsequent to the Napier Ranch acquisition, petitioner discussed with his accountant the amount of gift tax that would be due if he transferred his property to his children. In early fall 1974, petitioner decided not to seek additional land but instead to accept the cash due in order to pay taxes and ensure solvency in case of difficult times such as a drought. On September 21, 1974, petitioner informed Carter of his decision to take the remaining cash. Shortly thereafter, he also informed his children, Donald and Opel, that he intended to transfer one-half of the Napier Ranch and $500,000, subject to their obligation to pay the gift tax thereon, to each of them. At no time had the children taken part in the negotiations with Carter.

Petitioner, prior to his wife's death, had discussed with her the possibility of transferring their property to their children to reduce their estate taxes. Throughout the negotiations with Carter, petitioner intended eventually to transfer his property to his children. Nevertheless, at no time prior to petitioner's announcement did his children have any indication that the gift would be made.

On October 15, 1974, Carter paid petitioner $2,004,513.76, representing the balance due petitioner under the September 19, 1973, agreement, and Carter received the Wagensen Ranch deed from escrow. On that same day, petitioner transferred $1 million to Opel and Donald and his wife. On November 8, 1974, petitioner executed deeds to Opel and Donald and his wife conveying approximately one-half of the Napier Ranch to each.

Petitioner filed a gift tax return for the calendar quarter ended December 1974 reflecting payment of gift tax by the donees on the transfer of the cash and property in the amount of $419,068.08. Petitioner, in his 1974 income tax return, reported a capital gain of $2,000,902, consisting of the cash received less cost or other basis and expense of sale, on the exchange.

During 1974 through 1976, all of the Wagensen Ranch partnership livestock, including the breeding livestock, was included in the inventory of the partnership. No depreciation was claimed by the partnership on its livestock.

OPINION

1. Like-Kind Exchange

Section 1031² provides that an exchange of like-kind property (not including stock in trade or other property held primarily for sale) held for use in a trade or business or investment is a nontaxable event. If cash or other property which does not qualify as like-kind property is included in the exchange, gain is recognized to the extent of the cash or other property received.

Respondent does not contend that the properties exchanged are not like kind, that the receipt of cash disqualifies the transaction, or that the property was held primarily for sale.³ Rather, respondent argues that the transaction fails to qualify under section 1031 on the theory that petitioner intended to make a gift of the acquired property and thus did not hold it for investment or use in trade or business as is required by the statute. We hold for petitioner.

One of the primary purposes for allowing the deferral of gain in a like-kind exchange is to avoid imposing a tax upon a taxpayer who, while changing his form of ownership, is continuing the nature of his investment. H. Rept. 704, 73d Cong., 2d Sess. (1934), 1939-1 C.B. (Part 2) 554, 564. Jordan Marsh Co. v. Commissioner, 269 F.2d 453, 455 (2d Cir. 1959), revg. a Memorandum Opinion of this Court on another point; Biggs v. Commissioner, 69 T.C. 905, 913 (1978). In Koch v. Commissioner, 71 T.C. 54, 63-64 (1978), we explained:

The basic reason for allowing nonrecognition of gain or loss on the exchange of like-kind property is that the taxpayer's economic situation after the exchange is fundamentally the same as it was before the transaction occurred. “(I)f the taxpayer's money is still tied up in the same kind of property as that in which it was originally invested, he is not allowed to compute and deduct his theoretical loss on the exchange, nor is he charged with a tax upon his theoretical profit.” * * * The rules of section 1031 apply automatically; they are not elective. * * * The underlying assumption of section 1031(a) is that the new property is substantially a continuation of the old investment still unliquidated. * * *

In the present case, the exchange did not constitute a cashing in on petitioner's investment except to the extent of the approximately $2 million which he reported as capital gain. To the contrary, the exchange actually increased petitioner's ranching property acreage. The Wagensen Ranch had approximately 5,000 acres, and the Napier Ranch had approximately 18,000 acres. The value of the Wagensen Ranch in excess...