Court Opinion

ID: 4338961
Source: CourtListenerOpinion
Date Created: 2018-11-14 04:10:39.404129+00
Date Added: 2024-06-11T14:19:57.660210
License: Public Domain

T.C. Memo. 2012-8

                       UNITED STATES TAX COURT

          MARSHALL AND JUDITH COHAN, ET AL.,1 Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent

     Docket Nos.    19849-05, 19854-05,   Filed January 10, 2012.
                    19857-05.

     Kenneth A. Glusman, Kelly M. Townsend, Jason T. Bell, and

Edward DeFranceschi, for petitioners.

     Carina J. Campobasso and Michael R. Fiore, for respondent.

                              CONTENTS

FINDINGS OF FACT...........................................     6

     I.       Preliminary Matters............................   6

     1
      Cases of the following petitioners are consolidated
herewith: John and Janet Aldeborgh, docket No. 19854-05; and
Robert and Susan Hughes, docket No. 19857-05.
                               - 2 -

II.      The Farm.......................................       7

        A.   Description..................................     7
Barb. 1969 Agreement...............................     8

III.     Other Owners of Adjoining Land................. 11

IV.      Formation of HCAC.............................. 12

V.       Actions Taken With Respect to the Farm......... 13

VI.      Negotiations With TNC.......................... 14

VII.     Final Agreement................................ 21

VIII.    The Closing.................................... 25

        A.   Overview..................................... 25

        B.   Four   Properties Transferred to HCAC..........   26
              1.    Blue Heron..............................   26
              2.    Sanderling..............................   26
              3.    Lots 2 and 3............................   27

        C.   Horse Barn Lease............................. 27

        D.   Aldeborgh Lease.............................. 28

        E.   Lot 29 Option................................ 29

        F.   Wild Right-of-Way Relocation and
             Other Road Modifications..................... 30

        G.   New Beach Rights............................. 30

        H.   Release of the Reciprocal Right.............. 31

        I.   Land Bank Fees............................... 31

        J.   Legal Fees Reimbursement..................... 31

IX.     Postclosing Negotiations........................ 32

X.      Federal Income Tax Reporting.................... 36

XI.     Notices of Deficiency........................... 38
                                 - 3 -

OPINION.................................................... 41

     I.      Burden of Proof................................ 41

     II.     Charitable Contribution Deductions............. 42

            A.   Background................................... 42

            B.   Section 170 and Regulations.................. 43

            C.   Analysis.....................................   45
                  1. Good-Faith Estimate.....................    46
                  2. Reasonable Reliance.....................    53
                  3. Substantial Compliance Doctrine.........    55
                  4. Conclusion..............................    56

     III.    Valuation...................................... 57

            A.   Background................................... 57

            B.   Fair Market Value Standard...................   58
                  1. Overview................................    58
                  2. Common Approaches for Determining Fair
                      Market Value............................   60
                       a. Overview...........................    60
                       b. Market Approach....................    60
                       c. Income Approach....................    61
                       d. Asset-Based Approach...............    61

            C.   Experts...................................... 61

            D.   Overview of Expert Testimony................. 63
                  1. Mr. LaPorte............................. 63
                  2. Mr. Czupryna............................ 64

            E.   Valuation of the Four Properties.............   66
                  1. Blue Heron..............................    66
                       a. Mr. LaPorte’s Appraisal............    66
                       b. Mr. Czupryna’s Appraisal...........    67
                  2. Sanderling..............................    69
                       a. Mr. LaPorte’s Appraisal............    69
                       b. Mr. Czupryna’s Appraisal...........    70
                  3. Lots 2 and 3............................    71
                       a. Mr. LaPorte’s Appraisal............    71
                       b. Mr. Czupryna’s Appraisal...........    72
                  4. Analysis................................    73
                           - 4 -

      F.   Horse Barn Lease.............................   77
            1. Overview................................    77
            2. Land Value..............................    79
            3. Rate of Return..........................    81
            4. Vacancy Adjustment......................    82
            5. Conclusion..............................    82

      G.   Aldeborgh Lease..............................   83
            1. Overview................................    83
            2. Land Value..............................    84
            3. Discount for Restricted Use.............    85
            4. Fair Return Rate........................    86
            5. Inwood Annuity Factor...................    86
            6. Conclusion..............................    87

      H.   Wild Right-of-Way Relocation................. 87

      I.   New Beach Rights............................. 89

IV.    Gain From the Sale of the Rights of First
       Refusal........................................ 91

      A.   Overview..................................... 91

      B.   Amount Realized..............................   92
            1. Number of New Beach Rights..............    93
                 a. Petitioners’ Position..............    93
                 b. Respondent’s Position..............    97
            2. Release of the Reciprocal Right
                Encumbering the Aldeborgh
                Children’s Existing Properties..........   97

      C.   Adjusted Basis............................... 98
            1. Wallace & Co. Payment...................100
            2. Success Fee.............................101
            3. Tax Advice..............................102

V.     Character of Gain..............................103

VI.    Accuracy-Related Penalties.....................108

      A.   Overview.....................................108

      B.   In General...................................108

      C.   Respondent’s Initial Burden of Production....110

      D.   Analysis.....................................111
                                   - 5 -

     VII.   Remaining Arguments.............................115

             MEMORANDUM FINDINGS OF FACT AND OPINION

     MARVEL, Judge:    Respondent determined Federal income tax

deficiencies and section 6662(a)2 accuracy-related penalties as

follows:

Marshall and Judith Cohan, docket No. 19849-05

                                           Accuracy-related penalty
     Year             Deficiency                sec. 6662(a)

     2001          $1,794,445                     $358,889

John and Janet Aldeborgh, docket No. 19854-05

                                           Accuracy-related penalty
     Year             Deficiency                sec. 6662(a)

     2001             $363,562                     $72,639

Robert and Susan Hughes, docket No. 19857-05

                                           Accuracy-related penalty
     Year             Deficiency                sec. 6662(a)

     2001          $2,381,396                     $476,279

Petitioners filed petitions seeking redetermination of the

deficiencies and penalties.      We consolidated the cases for trial,

briefing, and opinion and shall refer to the consolidated cases

as this case throughout this opinion.

     2
      Section references are to the applicable versions of the
Internal Revenue Code (Code), and Rule references are to the Tax
Court Rules of Practice and Procedure. Some dollar amounts are
rounded to the nearest dollar.
                                - 6 -

      After concessions by the parties, discussed infra, the

issues for decision are:

      (1)   Whether Marshall and Judith Cohan (Marshall Cohans) and

Robert and Susan Hughes (Hugheses) may each claim a charitable

contribution deduction under section 170 relating to a

transaction between Herring Creek Acquisition Co., L.L.C. (HCAC),

and the Nature Conservancy (TNC) that occurred in 2001 (the 2001

transaction);

      (2)   whether petitioners failed to report taxable income

from the 2001 transaction;

      (3)   whether the income generated by the 2001 transaction is

taxable as ordinary income or as a long-term capital gain; and

      (4)   whether petitioners are liable for accuracy-related

penalties under section 6662(a) (section 6662(a) penalties).

                           FINDINGS OF FACT

I.   Preliminary Matters

      Some facts were stipulated.   We incorporate the stipulation

of facts, the first supplemental stipulation of facts, and the

second supplemental stipulation of facts into our findings by

this reference.

      Petitioners in each docket are a married couple.   Benjamin

and Hildegarde Cohan (Benjamin Cohans) are the parents of

petitioners Marshall Cohan (Mr. Cohan) and Janet Aldeborgh, and

the Benjamin Cohans are grandparents of petitioner Robert Hughes
                                - 7 -

(Mr. Hughes).    When the petitions were filed, the Marshall Cohans

resided in Florida, John and Janet Aldeborgh (Aldeborghs) resided

in Massachusetts, and the Hugheses resided in California.

      HCAC is a Massachusetts limited liability company.   The

parties stipulated that petitioners were its only members in

2001, and we so find.    HCAC redeemed the Aldeborghs’ interest on

October 16, 2001.    For Federal income tax purposes, HCAC reported

on its Form 1065, U.S. Return of Partnership Income, for 2001,

and we so find, that HCAC is a partnership not subject to the

TEFRA partnership audit and litigation procedures of sections

6221 through 6234.    See sec. 301.7701–3(b)(1)(i), Proced. &

Admin. Regs.

II.   The Farm

      A.   Description

      Herring Creek Farm (farm) is an approximately 220-acre

property in Edgartown, Massachusetts, on the southeast shoreline

of Martha’s Vineyard.3   The farm is in a neighborhood that fronts

Edgartown Great Pond on the west, Slough Cove on the north, and

Crackatuxet Cove and the Atlantic Ocean on the south.

      The farm sits in an ecologically significant area known as

the Katama maritime sand plains.    The Katama maritime sand plains

      3
      Martha’s Vineyard is a triangular island approximately 4
miles south of Cape Cod, Massachusetts, and is surrounded by
Nantucket Sound, Vineyard Sound, and the Atlantic Ocean. The
island is 97.72 square miles and has more than 150 miles of
coastline.
                               - 8 -

include a rare type of soil that is found only in Martha’s

Vineyard, except perhaps that it may be found to a limited extent

in Nantucket, and a number of natural communities such as

grasslands and heathlands dominated by shrubs and oak trees.      The

Katama maritime sand plains also host many rare, threatened, and

endangered species.

     B.   1969 Agreement

     One or more members of the Wallace family (Wallace family)

purchased the farm from the Benjamin Cohans in 1969.4   At that

time, the Wallace family (through a trustee) entered into a

December 30, 1969, agreement (1969 agreement) with the Benjamin

Cohans, the Marshall Cohans, and the Aldeborghs.   Hildegarde

Cohan, the Marshall Cohans, and the Aldeborghs owned land

adjoining the farm.

     Among other things, the 1969 agreement limited development

of the farm and the adjoining properties owned by the Benjamin

Cohans, the Marshall Cohans, and the Aldeborghs and granted both

to the Wallace family, as one party, and to the Benjamin Cohans,

to the Marshall Cohans, and to the Aldeborghs, as three separate

groups constituting the second party, certain rights to purchase

the other party’s property if it was offered for sale before

January 1, 2010.   The rights received by the Benjamin Cohans, the

     4
      The Wallace family purchased and owned the farm primarily
through trusts.
                               - 9 -

Marshall Cohans, and the Aldeborghs (rights of first refusal)

applied to approximately 175 acres of the farm (encumbered land)

and generally prevented the Wallace family from selling or

transferring the encumbered land without first offering it to the

Benjamin Cohans, the Marshall Cohans, the Aldeborghs, and any

issue of the Benjamin Cohans or any spouse of such issue.5    This

offer was required to be made to each of these offerees only to

the extent that he, she, or they continued to own adjoining land

with a dwelling thereon.   Any offer that the Wallace family made

which was subject to the rights of first refusal could be

accepted in the following order of priority as long as the

accepting offeree (or offerees in the case of a joint acceptance

by spouses) continued to own adjoining land with a dwelling

thereon:   (1) Benjamin and/or Hildegarde Cohan, (2) Janet and/or

John Aldeborgh, (3) Marshall and/or Judith Cohan, and (4) any

issue (who is not then under a legal disability) of the Benjamin

Cohans, the Marshall Cohans, or the Aldeborghs, or a spouse (who

is not then under a legal disability) of that issue.   The 1969

agreement further provided that if such an offer was properly

made and not timely accepted within 60 days (or was accepted

within 60 days but the resulting sale was not effected pursuant

to the terms of the agreement), the Wallace family could sell any

     5
      We say “generally” because the rights of first refusal did
not apply to transfers among members of the Wallace family or to
any of their issue or spouses of their issue.
                               - 10 -

or all of the encumbered land to any person under any terms that

the Wallace family desired (as long as the sale was timely

recorded in accordance with the 1969 agreement) and that the

rights of first refusal would no longer apply to that sold

property.   The 1969 agreement fixed the sale price incident to

the rights of first refusal at the sum of the reproduction cost

of any house or other structure on the land plus an amount for

the land equal to:

                Amount per acre      Termination date

                      $7,000            Jan.   1,   1980
                       8,000            Jan.   1,   1990
                       9,000            Jan.   1,   2000
                      10,000            Jan.   1,   2010

As relevant here, the rights of first refusal effectively

foreclosed the possibility that the Wallace family would sell the

encumbered land to an unrelated third party without the

acquiescence of all of the offerees because the value of the

encumbered land so significantly exceeded the set price that the

rights of first refusal would be expected to be exercised.

     Under the 1969 agreement the Wallace family received a

reciprocal right of first refusal on the adjoining property owned

by Hildegarde Cohan, the Marshall Cohans, and the Aldeborghs

(reciprocal right).    The terms of the reciprocal right paralleled

the terms of the rights of first refusal.      The reciprocal right,

which also expired on January 1, 2010, prevented the Benjamin

Cohans, the Marshall Cohans, and the Aldeborghs from selling or
                                - 11 -

transferring their property to an unrelated third party without

first offering it to the Wallace family for the just-discussed

price set forth in the 1969 agreement.       As was similarly true in

the case of the rights of first refusal, the reciprocal right did

not preclude the Benjamin Cohans, the Marshall Cohans, and the

Aldeborghs from transferring their property to any of their issue

or to a spouse of that issue.

       Under the 1969 agreement the Benjamin Cohans, the Marshall

Cohans, and the Aldeborghs, and the issue of any of those persons

and a spouse of the issue, also received personal rights to use a

private beach (1969 beach rights).       They continued to have the

1969 beach rights as long as they owned their property adjoining

the farm and maintained a dwelling on that property.

III.    Other Owners of Adjoining Land

       In 1990 the Hugheses purchased a lot adjoining the farm.

The purchase was from a family not subject to the 1969 agreement.

The reciprocal right did not attach to the Hugheses’ property.

       In or slightly before 1995 the Aldeborghs’ children and

their spouses, John and Vicki Aldeborgh, Erik and Joanne

Aldeborgh II, and Robert and Mary St. John (collectively,

Aldeborgh children), became owners of parts of the Aldeborghs’

property.    The portion of the property that the Aldeborgh

children received from the Aldeborghs which was subject to the

1969 agreement remained subject to that agreement.
                                - 12 -

      Other residential lots adjoining the farm were owned by

families not relevant to our discussion.     Several of those lots

fronted Edgartown Great Pond or Slough Cove.     None of those lots

was subject to the 1969 agreement.

IV.   Formation of HCAC

      The Wallace family eventually desired to develop the farm as

a residential subdivision and made several attempts to do so.

Petitioners were against any such development.6    The Wallace

family and petitioners disputed whether the rights of first

refusal were enforceable.

      On or about January 4, 1996, petitioners formed HCAC to

acquire the farm and otherwise to protect the rights of first

refusal against challenges by the Wallace family to the validity

of the 1969 agreement.     In exchange for equal partnership

interests in HCAC, the Marshall Cohans and the Aldeborghs

assigned their rights of first refusal to HCAC (with each of the

parties to HCAC’s “Operating Agreement” agreeing that the value

of these rights was $25,000) and the Hugheses contributed

$25,000.     Later, on a date that does not appear in the record,

the Aldeborgh children assigned HCAC their rights of first

refusal, but they did not (and never did) receive an interest in

HCAC.     Mr. Hughes, a managing member of HCAC, held power of

attorney to assert and defend the rights of first refusal.

      6
        The Benjamin Cohans were both deceased as of this time.
                              - 13 -

V.   Actions Taken With Respect to the Farm

      In 1996 the Wallace family filed a lawsuit against

petitioners and HCAC (Wallace litigation) seeking to invalidate

the 1969 agreement so that the Wallace family could develop the

farm.   The Massachusetts Superior Court eventually upheld the

validity of the agreement.

      As of 1996 the farm consisted of a central field, an east

field, various lots, and a private beach.     Improvements on the

farm included, among other structures, four existing houses;

i.e., two houses referred to as Blue Heron and Sanderling and two

additional houses fronting Edgartown Great Pond.     The central

field, so called because it was at the center of the farm,

consisted of approximately 89 acres of undeveloped agricultural

land and included a horse barn.   The east field comprised

approximately 62 acres of undeveloped natural grassland east of

the central field.   The private beach included approximately 20

acres south of Crackatuxet Cove fronting the Atlantic Ocean.

      The four properties owned by the Aldeborghs and the

Aldeborgh children (collectively, Aldeborgh families) were

approximately 3 or 4 acres each and were on the southerly side of

Crackatuxet Cove Road.   The Marshall Cohans owned an

approximately 4.8-acre waterfront lot north of the central field

with a 2,000-square-foot one-story home and a pool.     The Hugheses

owned an approximately 1-acre lot abutting the central field with
                                - 14 -

a 1,500-square-foot Cape Cod style home.     (The six properties

owned by petitioners and the Aldeborgh children are collectively

referred to in this opinion as petitioners’ and the Aldeborgh

children’s existing properties.)

      Mr. Hughes opposed the Wallace family’s proposed development

of the farm.   Concerned that the Wallace family would continue

advancing their development plans after the rights of first

refusal expired on January 1, 2010, Mr. Hughes began seeking a

buyer who was willing to purchase the farm from the Wallace

family and then conserve and protect the farm.

      In 2000 a realtor on Martha’s Vineyard told Mr. Hughes that

he had a prospective buyer, David Peters (Mr. Peters), a real

estate developer with a limited liability company named MV

Regency Group, L.L.C. (Regency).     (Subsequent reference to Mr.

Peters includes Regency.)     Mr. Hughes met and talked with Mr.

Peters, but Mr. Hughes eventually terminated discussions with Mr.

Peters because Mr. Hughes was not satisfied with Mr. Peters’

ambiguous plans for the farm.

VI.   Negotiations With TNC

      Around the time Mr. Hughes ended discussions with Mr.

Peters, Mr. Hughes received a telephone call from Tom Chase (Mr.

Chase), a program director for TNC, who told Mr. Hughes about

TNC’s conservation buyer program.     TNC is an international

conservation organization dedicated to preserving biological
                              - 15 -

diversity by protecting lands and waters that species, plants,

animals, and natural communities need to survive.   TNC executes

its mission by acquiring land or interests in land that may be

used to manage biological diversity.   A conservation buyer is

someone who acquires property subject to conservation

restrictions.   At all relevant times, TNC was a section 501(c)(3)

organization eligible to receive tax-deductible contributions

under section 170.

     TNC became interested in acquiring the farm because of its

location in maritime sand plains, which exist in only a few

places in the world.   TNC was familiar with the farm’s location

because it had worked on a nearby habitat known as the Katama

Airfield.   TNC’s plan for the farm involved restoring it to its

natural state and then reintroducing native plant species.    In

order to acquire the farm from the Wallace family, however, TNC

first had to deal with the rights of first refusal.

     Mr. Hughes considered TNC an attractive buyer of the farm

because of TNC’s commitment to preservation and conservation.

Mr. Hughes approved of TNC’s plan for the farm, and HCAC and TNC

began negotiating with respect to the rights of first refusal.

     Nutter, McClennen & Fish, LLP (Nutter), and specifically

Nutter’s partners Daniel Gleason (Mr. Gleason), Joseph Shea (Mr.

Shea), and Karl Fryzel (Mr. Fryzel) represented HCAC during the

negotiations.   Melissa McMorrow (Ms. McMorrow), an associate at
                              - 16 -

Nutter, conducted research in connection with the 2001

transaction.   Frank Giso (Mr. Giso) of Choate, Hall & Stewart,

LLP (Choate), represented TNC.   His partner, Kenneth Glusman (Mr.

Glusman), provided tax advice to TNC.

     On October 10, 2000, HCAC and TNC reached an agreement

(October 2000 agreement) in which HCAC agreed to sell the rights

of first refusal to TNC.   In return for the rights of first

refusal, HCAC would receive the following consideration from TNC:

(1) Sanderling and the lot it was on (Sanderling), (2) Blue Heron

and the lot it was on (Blue Heron), or alternatively a 4.9-acre

lot with a house and other improvements thereon, (3) lot 2, which

was an unimproved buildable lot, (4) lot 3, which was an

unimproved buildable lot, (5) reimbursement of $1.6 million for

legal expenses incurred during the Wallace litigation (past legal

fees), (6) reimbursement for legal fees incurred in connection

with the October 2000 agreement (current legal fees), (7)

separate beach rights appurtenant to Blue Heron, Sanderling, lot

2, and lot 3 (collectively, four properties), respectively, and

to each of petitioners’ and the Aldeborgh children’s existing

properties (new beach rights),7 (8) a 30-year lease, with a

30-year renewal option, for the eastern half of a horse barn on

the central field (horse barn lease), (9) a 30-year lease, with a

     7
      The new beach rights allowed the landowner to use a private
portion of South Beach, which was owned by TNC.
                                - 17 -

30-year renewal option as to lot 102,8 a 4.15-acre lot abutting

the Aldeborghs’ existing property (Aldeborgh lease), (10)

reimbursement for certain State and Federal taxes incurred by

members of HCAC (tax make-whole payment); (11) indemnification

regarding any taxes, including penalties and interest, resulting

from the 2001 transaction (tax indemnification); and (12)

relocation of a driveway used by neighbors (Wild right-of-way

relocation).   Sanderling, Blue Heron, lots 2 and 3, and the

leasehold interests were part of the farm, and TNC could convey

them only if it acquired those properties from the Wallace

family.

      In the agreement, TNC also agreed to impose conservation and

development restrictions (collectively, conservation

restrictions) on the farm when acquired.    The parties to the

agreement also agreed that they would permit some limited

additional development of the farm, and they specifically

recognized that TNC would convey certain development rights to

HCAC and to other third parties.    One of the third parties to

whom TNC would convey development rights was TNC’s benefactor,

Roger Bamford (Mr. Bamford).9    Under the agreement Mr. Bamford

      8
       Lot 102 is also sometimes referred to in the record as lot
32.
      9
      In 2001 Mr. Bamford was a senior vice president and the
principal architect of the Server Technologies Division at
Oracle, a large software company. He eventually helped TNC pay
                                                   (continued...)
                              - 18 -

would receive a right, exercisable after 2020, to build a house,

with certain restrictions, on a parcel of the farm.

     The October 2000 agreement included a $1 million breakup fee

provision that would be triggered if the parties did not close by

December 22, 2000.   The agreement provided that the December 22,

2000, date could be extended three times for 30 days each if,

among other things, TNC deposited $50,000 per extension in an

escrow account.   If the parties to the agreement closed by

December 22, 2000, or the extended date if applicable, the

breakup fee (inclusive of the $1 million and any amount paid for

an extension, with interest accrued on those funds) would be

applied to the cash reimbursement for past legal fees.   If the

parties to the agreement did not close in time, the fee would be

forfeited to HCAC.   TNC initially placed $1 million in escrow to

cover the breakup fee.   HCAC and TNC did not close by the

     9
      (...continued)
for the farm by making gifts to TNC and by later purchasing one
of the existing homes on the farm. Mr. Bamford became interested
in acquiring property on Martha’s Vineyard after renting a house
on the farm. In 2000 Mr. Bamford met Mr. Chase, who later
informed him about TNC’s conservation plan for the farm, and Mr.
Bamford began negotiating with TNC. On Oct. 18, 2000, TNC and
Mr. Bamford agreed that Mr. Bamford would (1) lend TNC up to $40
million to finance TNC’s purchase of the farm from the Wallace
family, (2) lend TNC money to cover TNC’s obligation to pay
HCAC’s legal fees and any other costs, expenses, and payments
that TNC owed to HCAC, and (3) share with TNC in the tax
indemnification agreement for any obligation TNC owed to HCAC
over $1 million and up to $25 million. On Oct. 30, 2000, Mr.
Bamford signed another indemnity agreement in which he agreed to
indemnify HCAC up to $24 million for certain future risks in
connection with the 2001 transaction.
                              - 19 -

December 2000 closing date because the Wallace family rejected

TNC’s offer to purchase the farm.   TNC exercised the first of the

three 30-day extensions.

     In November 2000 and January 2001, the Wallace family

received approval from the Martha’s Vineyard Commission and from

the Edgartown Planning Board, respectively, to develop the farm

into a 33-lot residential subdivision.   Nine and one-half of

these 33 proposed lots were not subject to the rights of first

refusal, and the Wallace family could have sold those nine and

one-half lots, either developed or undeveloped, notwithstanding

any objection from HCAC.

     HCAC and TNC did not close by the end of the first extended

date, and TNC exercised the second 30-day extension.   TNC was

continuing to negotiate with the Wallace family, and the Wallace

family shortly thereafter offered to sell the farm to TNC, but

only if the transaction included Mr. Peters, and later the

F.A.R.M. Institute (FARM Institute).   The FARM Institute is a

nonprofit organization devoted to promoting and invigorating

sustainable agriculture on Martha’s Vineyard by engaging

community participation in its operations.   The FARM Institute

provides a working/teaching farm where the community can

participate as students in the activities and actual workings of

a farm.   The FARM Institute desired to purchase part of the farm

to provide its programs (including growing crops and raising
                               - 20 -

animals such as beef and dairy cattle, sheep, goats, and

chickens) upon it.

     On January 29, 2001, TNC agreed in principal to buy the farm

from the Wallace family, and the Wallace family (through a

trustee) agreed in principal to sell the farm to TNC.    However,

the deal was not consummated before the end of the second 30-day

extension period.    HCAC agreed to leave the breakup fee in escrow

until TNC reached a definite agreement with the Wallace family.

On April 24, 2001, the Wallace family (through a trustee) and TNC

reached a final agreement reflecting the sale (Wallace

agreement).   Mr. Bamford, Mr. Peters, and the FARM Institute were

integral parts of the agreement.    Mr. Peters was acting through

Regency on behalf of himself and other third parties (including

late-night-show host David Letterman).

     The Wallace agreement allowed more development of the farm

than the October 2000 agreement contemplated.    The Wallace

agreement let TNC transfer a total of 10 lots to HCAC and to

other named parties.    Mr. Peters would eventually receive 4 of

those 10 lots, and Mr. Bamford would receive 2 of the 10 lots.

Mr. Bamford and Mr. Peters would each have construction rights to

build houses, with certain restrictions, on their lots.    The FARM

Institute would receive 1 of the 10 lots (i.e., a 6.75-acre lot)

and a 99-year lease on the central field to operate a farm for

educational purposes.    The FARM Institute planned to use its
                               - 21 -

property semipublicly, operating a modest working farm on the

property as an educational resource for students.     The FARM

Institute agreed, however, to restrict the number of students

visiting its property at any given time, to limit the number of

animals kept on the property, to restrict school trips during

certain months, and to minimize vehicular disturbances.     HCAC

would receive the remaining three lots; namely, Sanderling, lot

2, and lot 3.10

VII.    Final Agreement

       Because of the additional development authorized by the

Wallace agreement, TNC and HCAC had to renegotiate the October

2000 agreement.    TNC and HCAC began a series of difficult and

complex negotiations in which they attempted to reach an

agreement regarding the additional development authorized by the

Wallace agreement.    At this time, Mr. Giso introduced to one of

HCAC’s attorneys the idea of treating and reporting the 2001

transaction as a bargain sale gift.     Mr. Giso believed that a

bargain sale gift would enable HCAC to claim a charitable

contribution deduction to the extent that the fair market value

of the rights of first refusal exceeded the fair market value of

the consideration HCAC received.    Mr. Giso and Mr. Birle, both on

behalf of TNC, recognized that TNC would be obligated to

       10
      Blue Heron was not a numbered lot under the limited
development plan.
                                    - 22 -

reimburse petitioners for any tax petitioners paid on the

transfer to TNC of the rights of first refusal, and Mr. Giso and

Mr. Birle aimed to structure the transaction to minimize or

eliminate the amount of any such reimbursement.

        On June 29, 2001, HCAC and TNC reached a final agreement

(final agreement) regarding the rights of first refusal.           In the

final agreement, HCAC agreed to convey the rights of first

refusal to TNC for the following:        (1) The four properties, (2)

the horse barn lease, (3) the Aldeborgh lease, (4) a conditional

option to acquire lot 29 (the lot 29 option),11 (5) the Wild

right-of-way relocation, (6) new beach rights, (7) past and

current legal fees (as modified below), (8) a tax make-whole

payment, and (9) tax indemnification.

     The final agreement was like the October 2000 agreement but

contained some notable differences.          First, the final agreement

included the following clause:

          WHEREAS, the LLC has expressed the willingness to
     make a bargain sale gift to TNC of the appraised fair
     market value of the 1969 Agreement in excess of the
     value of the cash and real estate conveyances expressly
     described below in this Agreement.

The final agreement further provided that any tax savings

resulting from a charitable contribution deduction for HCAC would

benefit TNC by reducing the tax make-whole payment that TNC owed

HCAC.        Second, it gave HCAC the lot 29 option.   Third, it

        11
             The record sometimes refers to lot 29 as “lot 99”.
                              - 23 -

increased the current and past legal fees reimbursement.   The

October 2000 agreement required TNC to pay the first $250,000 of

HCAC’s current legal fees and 50 percent of the excess and to

reimburse HCAC $1.6 million for past legal fees.   The final

agreement required TNC to pay the first $325,000 of HCAC’s

current legal fees and 50 percent of the excess and to reimburse

HCAC for past legal fees of $1.7 million.

     Shortly after HCAC and TNC reached the final agreement, Mr.

Hughes asked Thomas Wallace (Mr. Wallace) of Wallace & Co., Inc.,

to value the consideration that HCAC was to receive under the

final agreement.   On July 16, 2001, Mr. Wallace issued his

opinion (Wallace letter) regarding the value of the consideration

as follows:
                               - 24 -

                  Property       Fair market value

              Blue Heron1            $1,000,000
              Sanderling1             2,400,000
              Lot 21                  1,100,000
              Lot 31                  1,300,000
              Lot 29 option             100,000
              Horse barn lease          500,000
              Aldeborgh lease           450,000
              Eight beach rights2     3,200,000
                Total                10,050,000
          1
           Mr. Wallace’s valuations of Blue Heron and
     Sanderling included the new beach rights that attached
     thereto, while his valuations of lots 2 and 3 excluded
     them. The valuations of these four properties excluded
     any increase in value associated with the conservation
     restrictions.
          2
           The eight beach rights included the six new beach
     rights that attached to petitioners’ and the Aldeborgh
     children’s existing properties and the two new beach
     rights that attached to lots 2 and 3.

     Mr. Wallace also opined on several other aspects of the 2001

transaction.    He estimated the conservation restrictions added

between $750,000 and $2 million to the value of each lot abutting

the property on which the conservation restrictions were placed.

Mr. Wallace valued the Wild right-of-way relocation between

$200,000 and $300,000 and a private way relocation and closure

between $100,000 and $300,000.      Finally, he opined that the

nondevelopment of lot 102, the lot subject to the Aldeborgh

lease, would increase the value of the abutting lots, which

included the Aldeborghs’ existing property, by an additional 10

to 20 percent of the increase in value from the conservation

restrictions.
                                - 25 -

     After the parties began focusing on the value of the

consideration, Mr. Shea insisted that TNC establish an escrow

account to fund the tax make-whole payment and to deposit funds

into it before the closing.     After several days of negotiating,

Mr. Shea told Mr. Giso that $3,299,000 would be sufficient to

cover the tax liability from the 2001 transaction, and TNC

deposited that amount into the escrow account before the closing

date.

VIII.        The Closing

        A.     Overview

        The 2001 transaction closed on July 20, 2001.12   The

following actions occurred during the closing:     (1) TNC executed

documents imposing conservation restrictions on the farm,

including the four properties; (2) HCAC, petitioners, the

Aldeborgh children, and TNC executed an agreement, “Assignment

and Assumption of 1969 Agreement (HCAC ET AL. TO TNC)”, in which

HCAC transferred the rights under the 1969 agreement, including

the rights of first refusal, to TNC;13 (3) TNC executed a

document terminating the rights under the 1969 agreement; and (4)

TNC executed various deeds and leases conveying portions of the

        12
      At the same time, and incident thereto, the Wallace family
sold the farm to TNC for a deeded price of approximately $64
million.
        13
      The parties agree that the fair market value of the rights
of first refusal was then $14 million.
                                - 26 -

farm (including the four properties then subject to the

restrictions imposed by TNC) in accordance with the final

agreement.14

     B.   Four Properties Transferred to HCAC

           1.   Blue Heron

     Blue Heron is at 7 Butler’s Cove Rd. (on the corner of

Slough Cove Rd. and Butler’s Cove Rd.), adjacent to the FARM

Institute’s property.   Blue Heron consists of 1.9 acres of land

north of the central field and a small 1,608-square-foot two-

story house that is approximately 200 years old.    The first floor

of the house has a kitchen, dining room, breakfast nook, bedroom,

television room, and bathroom.    The second floor has three

bedrooms and a bathroom.     The house has two broken fireplaces and

a full basement.   Blue Heron is not waterfront property, but it

has deeded private beach rights as a result of the 2001

transaction.

           2.   Sanderling

     Sanderling, at 19 Butler’s Cove Rd., consists of 3.9

acres of land north of the central field and an 1,826-square-foot

two-story house which is approximately 200 years old.    The

house’s first floor includes a kitchen, a dining room, a living

     14
      The final agreement provided that TNC would convey to HCAC
a quitclaim deed for Sanderling and for lots 2 and 3 and an
option to purchase Blue Heron for $1 exercisable from Sept. 15,
2001, for consideration of $1. On Feb. 7, 2002, HCAC exercised
the option to acquire Blue Heron.
                                  - 27 -

room, two bedrooms, and a bath.       The second floor has two

bedrooms and a bath.    The house has a full basement and an

attached one-car garage.       Its exterior is wood shingle siding.

Sanderling is not waterfront property, but it has deeded private

beach rights as a result of the 2001 transaction.

            3.   Lots 2 and 3

     Lots 2 and 3 are waterfront lots north of the central field

on Butler’s Cove Rd.     The respective lots are undeveloped 3.14-

and 3-acre lots on Slough Cove and have approximately the same

footage fronting Edgartown Great Pond.       Both lots are approved

for the building of a single-family residence.       The topography of

each lot is relatively flat, so the gradient of the land does not

obstruct the view of the central field from the envelopes of the

lots.     Each lot includes deeded private beach rights as a result

of the 2001 transaction.       Lot 2 is adjacent to the FARM Institute

property.

     C.     Horse Barn Lease

     On July 20, 2001, as part of the 2001 transaction, TNC

leased to HCAC half of the horse barn on the central field for 30

years with a 30-year renewal option.       The horse barn lease

requires HCAC to pay rent of $1 per year.       The horse barn lease

has two elements.

     The first element of the horse barn lease is the right to

use the eastern half of the horse barn to stable up to eight
                                - 28 -

horses, for personal storage, and for related and incidental

uses.     The horse barn is approximately 6,000 square feet; and

when the lease was executed, and as of the appraisal date, the

eastern half of the horse barn had no stalls.     The lease does not

preclude the lessee from erecting stalls in the eastern half of

the horse barn.

     The second element of the horse barn lease is the right to

use part of the grazing and paddock area adjacent to the barn for

grazing and for exercising HCAC’s horses.     Under the lease, HCAC

may use a fraction of the grazing and paddock area equal to the

number of its horses stabled in the horse barn (up to 8) over the

total horses stabled (up to 24).     At full capacity, therefore,

HCAC may not use more than 33 percent of the grazing and paddock

area (8/24 = 33 percent).     The horse barn lease does not indicate

the size of the grazing and paddock area as it existed in 2001,

but it provides that TNC may relocate the horse barn and the

grazing and paddock area and that the relocated grazing and

paddock area may not exceed 6.5 acres.

     D.     Aldeborgh Lease

        On July 20, 2001, as part of the 2001 transaction, TNC

leased lot 102 to HCAC for 30 years with a 30-year renewal

option.     The Aldeborgh lease requires HCAC to pay rent of $1 per

year.     The Aldeborgh lease allows HCAC to construct a “barn”, not

to exceed 1,500 square feet, on a 10,000-square-foot building
                                 - 29 -

envelope within the ground leased premises.15      The Aldeborgh

lease defines the ground leased premises to include lot 102 and

access and egress on the existing driveway.

     The Aldeborgh lease provides that the ground leased premises

shall be used for construction, repair, replacement, and use of a

barn for personal property storage and for related and incidental

uses.     The Aldeborgh lease provides that HCAC has a right to

quiet enjoyment over the ground leased premises and assumes

responsibility for all real and personal property taxes,

maintenance, and improvements on the ground leased premises.

     E.     Lot 29 Option

     TNC granted HCAC the lot 29 option as part of the 2001

transaction.     Lot 29 is a 4.02-acre lot that abuts the Hugheses’

property and is subject to the conservation restrictions.

     The Hugheses’ property does not meet the minimum size that

Edgartown’s zoning ordinances require for building a residence,

but their property and lot 29 together exceed the required

minimum lot size.     The lot 29 option allows HCAC to acquire lot

29 for $1 to rebuild the Hugheses’ home if the Hugheses’ home

were destroyed or became uninhabitable and their property did not

meet the required minimum lot size.       The parties stipulated that

in 2001 the fair market value of the lot 29 option was $4,000.

     15
          We note that there are 43,560 square feet in an acre.
                              - 30 -

     F.   Wild Right-of-Way Relocation and Other Road
          Modifications

     As part of the 2001 transaction, TNC agreed to relocate a

driveway (Wild driveway) at the demand of HCAC.   Many years ago,

Mr. Cohan purchased a 20-foot strip of land from Mr. Wild, the

owner of the adjacent property.   At that time, Mr. Wild had a

right-of-way that he and his family used to access their property

(Wild right-of-way).   The Wild right-of-way intersected the

Marshall Cohans’ property and Sanderling and was used by four

property owners, including the Marshall Cohans.

     In October 2002 the Wild driveway was relocated at a cost of

$3,751.   Afterwards, Mr. Wild and his family no longer used the

Marshall Cohans’ property to access their property.   The

contractor billed TNC for the cost of the Wild right-of-way

relocation.

     In addition to the relocation of the Wild driveway, TNC

agreed to pay up to $100,000 for modifications of several other

driveways and roads, including a partial closure of Great Plains

Way near the Aldeborghs’ property and a partial relocation of

Butler’s Neck Road near the Hugheses’ property.

     G.   New Beach Rights

     As part of the 2001 transaction, TNC conveyed to HCAC

separate private beach rights that attached to each of

petitioners’ and the Aldeborgh children’s existing properties.

TNC also conveyed separate private beach rights that attached to
                                - 31 -

each of the four properties.     These 10 sets of private beach

rights, i.e., the new beach rights, could be transferred only

with the lots to which they were attached.     The new beach rights

are in addition to the personal beach rights described in the

1969 agreement.

     H.   Release of the Reciprocal Right

     On July 20, 2001, as part of the 2001 transaction, TNC

released the reciprocal right in full.     The release allowed the

Marshall Cohans and the Aldeborgh families to sell or transfer

their existing properties to any third party without first having

to offer the properties to the Wallace family for the price fixed

in the 1969 agreement.     The parties agree that the fair market

value of the release of the reciprocal right was $1,155,450 as of

July 20, 2001.

     I.   Land Bank Fees

     As part of the 2001 transaction, TNC paid to the Martha’s

Vineyard Land Bank Commission, on behalf of HCAC, $127,500 of

land bank fees due on the transfer of the four properties.

Martha’s Vineyard land bank fees are transfer fees imposed on the

purchaser of real property on Martha’s Vineyard.     TNC paid

$10,000 of the $127,500 in 2001 and the rest in 2002.

     J.   Legal Fees Reimbursement

     As part of the 2001 transaction, TNC reimbursed HCAC $1.7

million for past legal fees and $402,755 for current legal fees.
                                   - 32 -

IX.     Postclosing Negotiations

        Robert P. LaPorte, Jr., CRE, MAI (Mr. LaPorte),16 agreed

with TNC to provide his appraisal services in connection with the

2001 transaction.       On August 10, 2001, Mr. Gleason faxed to Mr.

LaPorte (with copies to Mr. Hughes and to Erik Aldeborgh II) a

letter identifying items in addition to the four properties that

Mr. LaPorte should consider in his appraisal of the consideration

that HCAC received from TNC (Mr. Gleason’s request).       The items

were:        (1) The new beach rights; (2) the horse barn lease and the

Aldeborgh lease; (3) enhancements from the conservation

restrictions to the values of petitioners’ and the Aldeborgh

children’s existing properties and to the values of the four

properties; (4) closure and relocation of a road; and (5) an

easement to cross central field on foot or by bicycle.       On August

15, 2001, after Mr. Gleason discussed the matter with Mr.

LaPorte, Mr. Gleason hand-delivered to Mr. LaPorte a followup

letter (followup letter) requesting an opinion on the impact of

the release of the reciprocal right on the value of the Marshall

Cohans’ and the Aldeborgh families’ existing properties and

        16
      The designation “CRE” means “Counselor of Real Estate”.
The designation “MAI” is awarded to qualifying members of the
Appraisal Institute (the body that resulted from the merger of
the American Institute of Real Estate Appraisers and the Society
of Real Estate Appraisers) and is viewed as the most highly
regarded appraisal designation within the real estate appraisal
community. See Schwartz v. Commissioner, T.C. Memo. 2008-117,
affd. 348 Fed. Appx. 806 (3d Cir. 2009); Estate of Auker v.
Commissioner, T.C. Memo. 1998–185.
                                - 33 -

enclosing a map showing the locations of those properties, the

Hugheses’ property, the Aldeborgh lease, and a roadway

relocation.    Mr. Gleason noted in the letter that Mr. LaPorte was

traveling to Martha’s Vineyard the next day and asked that the

two meet one day later “before a draft of your report is

circulated”.   On August 16, 2001, Mr. LaPorte faxed Mr. Gleason’s

request and followup letter to Mr. Giso.

     By letters dated August 24, 2001, addressed to Hans Birle

(Mr. Birle), TNC’s deputy general counsel, Mr. LaPorte opined

that the items TNC asked him to appraise had the following fair

market values:

                     Property        Fair market value

                 Blue Heron               $625,000
                 Sanderling              1,000,000
                 Lot 2                   2,250,000
                 Lot 3                   2,500,000
                 New beach rights1         750,000
                 Reciprocal right        1,220,000
                   Total                 8,345,000
     1
      These new beach rights pertain only to the six existing
properties owned by petitioners and the Aldeborgh children.

Mr. LaPorte did not contemporaneously appraise the other items

identified in Mr. Gleason’s request.17

     After Mr. LaPorte issued his appraisal reports, TNC’s and

HCAC’s attorneys continued negotiating the perceived bargain sale

     17
      Mr. LaPorte, at petitioners’ request, appraised the horse
barn lease, the Aldeborgh lease, and the roadway relocations
after this litigation commenced.
                              - 34 -

gift component of the final agreement.   They exchanged a series

of communications on that subject and particularly the tax make-

whole payment.   On September 14, 2001, Mr. Giso hand-delivered to

Mr. Gleason a letter stating that Mr. Fryzel is “having some

trouble with the notion that HCAC should report a bargain sale

gift in connection with this transaction.”   Mr. Giso reminded Mr.

Gleason that TNC’s tax indemnification obligation continued

through the later of the closing of an audit of the transaction

or the closing of the period in which to audit the transaction

and that this obligation was secured by the funds placed in

escrow.   HCAC’s and TNC’s attorneys estimated petitioners’ tax

liability resulting from the 2001 transaction, and they agreed

that the tax make-whole payment was $1,484,000 “based on current

facts and circumstances”.   They also agreed that the

indemnification provisions continued in full force and effect in

the event of a Federal or a State tax audit.

     On December 21, 2001, HCAC and TNC executed an “Agreement

Regarding Bargain Sale Gift and Tax Payments” (bargain sale gift

agreement).   They calculated in the bargain sale gift agreement

that the bargain sale gift amount was as follows:
                              - 35 -

  Value of rights of first refusal                     $14,000,000
  Less: Consideration received
    Four properties                         $6,375,000
                                          1
    Cash payments to or on behalf of HCAC    2,102,755
    Beach rights/enhancements                  750,000
    Release of reciprocal right              1,220,000
    Tax make-whole payment                   1,484,000 11,931,755
      Bargain sale gift amount                           2,068,245
     1
      These payments included past legal fees of $1.7 million and
current legal fees of $402,755.

HCAC and TNC used Mr. LaPorte’s August 24, 2001, appraisals and

the currently agreed amount of the tax make-whole payment to

calculate the bargain sale gift amount.18   The bargain sale gift

agreement required that HCAC report the gain on the transfer to

TNC of the rights of first refusal as long-term capital gain for

tax purposes.

     On or around March 8, 2002, Dennis Wolkoff (Mr. Wolkoff), a

TNC vice president and its director of conservation real estate

for the eastern region, sent HCAC a letter (gift letter) related

to the 2001 transaction.   The gift letter, which was reviewed by

Mr. Birle and by Mr. Wolkoff, stated that the difference between

the value of the rights of first refusal and the value of the

consideration received represented a bargain sale gift to TNC.

The gift letter stated that HCAC received $11,931,755 in

     18
      Petitioners now concede that the following items of
consideration HCAC received in the 2001 transaction should have
been (but were not) included in the calculation of the bargain
sale gift amount: (1) The horse barn lease, (2) the Aldeborgh
lease, (3) the Wild right-of-way relocation, (4) the lot 29
option, and (5) the land bank fees paid during 2001 and 2002.
                               - 36 -

consideration for the rights of first refusal and included the

following calculation:

     Four properties                                 $6,375,000
     Cash payments to or on behalf of HCAC            3,586,755
     Beach rights/enhancements                          750,000
     Release of reciprocal right                      1,220,000
       Total                                         11,931,755

The letter stated that but for this $11,931,755 of consideration,

“No other goods or services were provided by TNC to HCAC in

connection with this transaction.”      The statement of the value of

consideration reported in the gift letter came directly from the

bargain sale gift agreement.

X.   Federal Income Tax Reporting

      Steven Ridgeway (Mr. Ridgeway) is a certified public

accountant who was HCAC’s accountant and tax return preparer for

its 2001 taxable year.   On or around January 30, 2002, Mr.

Ridgeway faxed to Mr. Hughes a letter describing petitioners’

reporting positions regarding HCAC.

      HCAC reported on its 2001 return that the transfer of the

rights of first refusal was a bargain sale gift.     With respect to

the gift, HCAC claimed a charitable contribution deduction of

$2,068,245, which represented the bargain sale gift amount

calculated in the gift letter and in the bargain sale gift

agreement.   With respect to the sale, HCAC reported a net long-

term capital gain of $9,136,593 calculated as follows:
                              - 37 -

     Four properties                          $6,375,000
     Cash payments for current and past
       legal fees                              2,102,755
     Tax make-whole payment                    1,484,000
       Total sale price                        9,961,755
     Basis in the rights of first refusal       (825,162)
       Long-term capital gain                  9,136,593

     The $825,162 basis that HCAC reported for the rights of

first refusal included:   (1) $728,963 of fees paid to Nutter in

2001, (2) $404 in bookkeeping and accounting expenses, (3)

$41,627 paid to Horsley & Witten, Inc. (Horsley & Witten), for

environmental studies, (4) $35,000 paid to Wallace & Co., and (5)

$19,169 paid to the Private Merchant Banking Co. (PMBC).19    Mr.

Hughes paid all of those expenses from his personal account,

except for the PMBC expense, which HCAC paid from its account.

The Nutter fees represent:   (1) $566,030 of capital expenditures

includable in the basis of the rights of first refusal, (2)

$36,662 for tax advice, (3) a $100,000 “success fee” for which

there was no written contract (this “fee” was paid pursuant to an

oral agreement between Mr. Hughes and Nutter, and the amount

thereof was not set until after the 2001 transaction), (4) $6,000

in section 212 expenses of HCAC, (5) $6,607 in section 212

     19
      Although HCAC reported a basis of $825,162 on its return,
the underlying expenditures that the parties stipulated HCAC
claimed on its return actually totaled $825,163.
                               - 38 -

expenses of the Marshall Cohans, and (6) $13,664 of nondeductible

personal expenditures.20

      HCAC issued to each couple a Schedule K-1 (Form 1065),

Partner’s Share of Income, Credits, Deductions, etc., for 2001

reflecting that couple’s share of long-term capital gain and

charitable contribution deduction as follows:

                          Long-term            Charitable
      Petitioners       capital gain      contribution deduction

  Hugheses               $4,881,399             $1,034,123
  Marshall Cohans         3,416,195              1,034,123
  Aldeborghs                839,000                  -0-

On their 2001 Federal income tax returns, petitioners reported

the amounts shown on their respective Schedules K-1.    The

Marshall Cohans attached the gift letter to their 2001 Federal

income tax return to substantiate their claimed charitable

contribution deduction resulting from the 2001 transaction.      The

Hugheses did not do similarly.

XI.    Notices of Deficiency

       By notices of deficiency, respondent (1) disallowed the

charitable contribution deductions that HCAC, the Hugheses, and

the Marshall Cohans claimed with respect to the 2001 transaction,

       20
      Sec. 212 generally authorizes a deduction for ordinary and
necessary expenses paid or incurred during the taxable year for
the production or collection of income; for the management,
conservation, or maintenance of property held for the production
of income; or in connection with the determination, collection,
or refund of any tax.
                              - 39 -

(2) determined that HCAC and petitioners had realized $15,381,755

of ordinary income on HCAC’s “conveyance” to TNC of the rights of

first refusal, instead of the reported $9,136,593 net capital

gain,21 and (3) determined that each couple was liable for a

section 6662(a) penalty.   Respondent did not include in the

notices of deficiency an explanation of how he calculated the

$15,381,755 of ordinary income (or alternatively net long-term

capital gain).   We infer from the record, however, that the

consideration and the value of that consideration included in

calculating the $15,381,755 (and the parties’ positions with

respect thereto) are as follows:

     21
      Respondent determined alternatively that HCAC’s net long-
term capital gain was $15,381,755, rather than $9,136,593 as
reported, because HCAC failed to report certain consideration it
received in the 2001 transaction and did not establish its
reported basis of $825,162.
                                       - 40 -
                           HCAC’s tax Notices of Respondent’s    Petitioners’
      Consideration          return   deficiency trial position trial position
                                                       1
  Blue Heron                $625,000      $625,000      $915,000      $625,000
                                                     2
  Sanderling               1,000,000     1,000,000    1,400,000      1,000,000
                                                     3
  Lot 2                    2,250,000     2,250,000    2,900,000      2,250,000
                                                     4
  Lot 3                    2,500,000     2,500,000    3,200,000      2,500,000
  Tax make-whole payment   1,484,000     1,484,000     1,484,000     1,484,000
  Past legal fees          1,700,000     1,700,000     1,700,000     1,700,000
  Current legal fees         402,755       402,755       402,755       402,755
  New beach rights
    received as to the
    existing properties       -0-        2,400,000       1,400,000       -0-
  Reciprocal right            -0-        1,220,000       1,155,450       -0-
  New beach rights
    received as to the
    existing properties
    as initially valued
    by Mr. Laporte on
    Aug. 24, 20015            -0-         750,000           -0-          -0-
  Horse barn lease            -0-         500,000         120,000       54,000
  Aldeborgh lease             -0-         450,000          85,000       18,000
  Lot 29 option               -0-         100,000           4,000        4,000
  Wild right of way
    relocation                 -0-           -0-          3,751           -0-
  Land bank fees               -0-           -0-         10,000          10,000
    Total                  9,961,755    15,381,755   14,779,956      10,047,755
      1
       Includes $650,000 of value (before consideration of any value for the
conservation restrictions included in the 2001 transaction or for the new
beach rights), $65,000 of value from the imposition of the conservation
restrictions on July 20, 2001, and $200,000 of value for the new beach rights
received in the 2001 transaction as to Blue Heron.
      2
       Includes $1 million of value (before consideration of any value for the
conservation restrictions included in the 2001 transaction or for the new
beach rights), $200,000 of value from the imposition of the conservation
restrictions on July 20, 2001, and $200,000 of value for the new beach rights
received in the 2001 transaction as to Sanderling.
      3
       Includes $2.25 million of value (before consideration of any value for
the conservation restrictions included in the 2001 transaction or for the new
beach rights), $450,000 of value from the imposition of the conservation
restrictions on July 20, 2001, and $200,000 of value for the new beach rights
received in the 2001 transaction as to lot 2.
      4
       Includes $2.5 million of value (before consideration of any value for
the conservation restrictions included in the 2001 transaction or for the new
beach rights), $500,000 of value from the imposition of the conservation
restrictions on July 20, 2001, and $200,000 of value for the new beach rights
received in the 2001 transaction as to lot 3.
      5
       These new beach rights were also valued in the Wallace letter dated
July 16, 2001, at $400,000 apiece (or a total of $2.4 million).
                              - 41 -

                              OPINION

I.   Burden of Proof

      A taxpayer generally has the burden of proving that the

Commissioner’s determination is in error.     Rule 142(a)(1).   If,

however, a taxpayer produces credible evidence with respect to

one or more factual issues relevant to ascertaining the

taxpayer’s Federal income, estate, or gift tax liability, the

burden of proof may shift to the Secretary22 as to that issue (or

those issues).   See sec. 7491(a)(1).    The burden of proof will

shift to the Secretary if the taxpayer meets the following

requirements of section 7491(a)(2):     (1) The taxpayer

substantiates any item as required by the Code, (2) the taxpayer

maintains all records required by the Code, and (3) the taxpayer

cooperates with the Secretary’s reasonable requests for

witnesses, information, documents, meetings, and interviews.

Section 7491(a)(2)(C) also provides that, in order to shift the

burden of proof, a taxpayer that is a partnership, a corporation,

or a trust (other than a qualified revocable trust as defined in

section 645(b)(1)) must meet the requirements of section

7430(c)(4)(A)(ii) (which in turn references the net-worth

requirements of 28 U.S.C. sec. 2412(d)(2)).

      22
      The term “Secretary” means the Secretary of the Treasury
or his delegate. Sec. 7701(a)(11).
                               - 42 -

      Petitioners do not contend that section 7491(a)(1) applies.

In addition, petitioners have not established that they satisfied

the requirements of section 7491(a)(2).    We hold that section

7491(a)(1) does not apply to shift the burden of proof to

respondent.    See Goosen v. Commissioner, 136 T.C. 547, 558

(2011); Stipe v. Commissioner, T.C. Memo. 2011-92.

      Petitioners make one argument as to which party bears the

burden of proof with respect to the deficiencies.    Specifically,

they argue that respondent must prove that their properties were

enhanced in value through the conservation restrictions arising

from the 2001 transaction in determining the amount of any

charitable contribution deduction resulting from that

transaction.    We need not and do not address that argument

because we hold infra that petitioners failed to meet the

requirements under section 170(f)(8) for any charitable

contribution deduction as to the 2001 transaction.

II.   Charitable Contribution Deductions

      A.   Background

      We now decide whether petitioners have proven that

respondent erroneously disallowed the charitable contribution

deductions claimed under section 170 in connection with the 2001

transaction.    HCAC allocated HCAC’s claimed charitable

contribution deduction one-half to the Hugheses and one-half to
                               - 43 -

the Marshall Cohans.   Each couple deducted the amounts allocated

to them.

     B.    Section 170 and Regulations

     Section 170(a)(1) authorizes a deduction for charitable

contributions paid within a taxable year to or for the use of

organizations described in section 170(c).      However, a taxpayer

may not deduct any charitable contribution of $250 or more unless

the taxpayer substantiates the contribution with a

contemporaneous written acknowledgment from the charitable

organization.    Sec. 170(f)(8)(A).   The written acknowledgment

generally must include the following three things:     (1) The

amount of cash paid and a description (but not the value) of any

property other than cash contributed; (2) whether the donee

organization provided any goods or services in consideration for

the cash or property contributed; and (3) a description and good-

faith estimate of the value of any goods or services provided by

the donee organization.    Sec. 170(f)(8)(B).   A written

acknowledgment is contemporaneous if the taxpayer obtains the

acknowledgment on or before the earlier of the date on which the

taxpayer files a return for the taxable year in which the

contribution was made, or the due date (including extensions) for

filing such return.    Sec. 170(f)(8)(C).
                                   - 44 -

     A charitable organization provides goods or services in

consideration for a taxpayer’s payment if, at the time the

taxpayer makes the payment to the donee organization, the

taxpayer receives or expects to receive goods or services in

exchange for that payment.        Sec. 1.170A-13(f)(6), Income Tax

Regs.        Goods or services generally include cash, property,

services, benefits, and privileges, and goods or services

provided in a year other than the year in which the taxpayer

makes the payment.23       Sec. 1.170A-13(f)(5), (6), (8), Income Tax

Regs.        A good-faith estimate means the donee organization’s

estimate of the fair market value of the goods and services

provided, without regard to the manner in which the organization

made the estimate.        Sec. 1.170A-13(f)(7), Income Tax Regs.

     A taxpayer may rely on a contemporaneous written

acknowledgment for the fair market value of any goods or services

provided to the taxpayer by the charitable organization.        Sec.

1.170A-1(h)(4)(i), Income Tax Regs.         However, a taxpayer may not

use a charitable organization’s estimate of the value of goods or

services as the fair market value if the taxpayer knows, or has

reason to know, that the estimate is unreasonable.        Sec. 1.170A-

1(h)(4)(ii), Income Tax Regs.

        23
      Certain goods or services may be disregarded for purposes
of sec. 170(f)(8). Sec. 1.170A-13(f)(8), Income Tax Regs. None
of the exclusions applies here.
                                 - 45 -

     C.   Analysis

     HCAC received from TNC the gift letter describing the rights

of first refusal that HCAC transferred to TNC and disclosing some

of the items of consideration, and their estimated values, that

HCAC received in return.      TNC, however, did not disclose in the

gift letter several items of consideration, including the horse

barn lease, the Aldeborgh lease, the Wild right-of-way

relocation, the lot 29 option, and the land bank fees paid on

behalf of HCAC.      That nondisclosure, according to respondent,

precludes HCAC and petitioners from claiming a charitable

contribution deduction because HCAC did not receive an adequate

written acknowledgment as required under section 170(f)(8).24

Petitioners concede that HCAC received the omitted items of

consideration from TNC and that the omitted items were

erroneously excluded from the gift letter.

     We must decide whether the gift letter included a good-faith

estimate of the value of the consideration that HCAC received in

the 2001 transaction and whether HCAC, the Hugheses, or the

Marshall Cohans reasonably relied on that letter to claim their

charitable contribution deductions under section 170.      We decide

both inquiries in the negative.

     24
      Respondent also contends that the gift letter is deficient
because Mr. LaPorte’s appraisals of the four properties did not
account for the conservation restrictions. As discussed infra,
we conclude that Mr. LaPorte accounted for those restrictions in
his appraisals.
                                - 46 -

           1.   Good-Faith Estimate

      The Court has previously held that a taxpayer did not

satisfy the requirements under section 170(f)(8) when

consideration the taxpayer received was not disclosed in the

acknowledgment.     See, e.g., Addis v. Commissioner, 118 T.C. 528

(2002), affd. 374 F.3d 881 (9th Cir. 2004).    In Addis, the

taxpayers claimed a charitable contribution deduction for

payments to a charitable organization, which in turn used the

payments to pay premiums on a charitable split-dollar life

insurance policy for one of the taxpayers.     Id. at 529.   The

policy provided that a percentage of death benefits would go to

the charity and the rest to the taxpayers’ family trust.       Id.

The taxpayers reserved the right to borrow on or to surrender the

policy.   Id. at 532.   The taxpayers did not require that the

charity use the payments for the premiums but expected it to do

so.   Id. at 531.   The taxpayers received a receipt from the

charity stating that the charity provided no goods or services

for the payments.     Id.

      We analyzed whether the receipt satisfied the substantiation

requirements under section 170(f)(8).    We first concluded that

the taxpayers received from the charity the right to receive a

percentage of the death benefits on the insurance policy and that

the right constituted consideration.     Id. at 535-536.   We then

concluded that the charity’s failure to disclose the
                               - 47 -

consideration in the receipt meant that the charity also failed

to make a good-faith estimate of the value of the benefit it gave

to the taxpayers.    Id. at 536-537.    We noted that the failure to

disclose the consideration was in the interest of both the

taxpayers and the charity.    Id.   We disallowed the entire

charitable contribution deduction, stating that the written

acknowledgment did not include a good-faith estimate of the

benefits the taxpayers received and that the taxpayers

“unquestioningly and self-servingly” used that erroneous

acknowledgment to claim their charitable contribution deduction.

Id.

      The Court of Appeals for the Ninth Circuit affirmed our

disallowance of the entire deduction.     See Addis v. Commissioner,

374 F.3d at 887.    The court emphasized that section 170(f)(8) is

important to the effective administration of our self-reporting

tax system and that “‘the Government depends upon the good faith

and integrity of each potential taxpayer to disclose honestly all

information relevant to tax liability.’”      Id. at 884, 887

(quoting United States v. Bisceglia, 420 U.S. 141, 145 (1975)).

The taxpayers argued that they were entitled to rely on the

receipt and that the goods and services did not have to be

disclosed because they were insubstantial.     The court disagreed.

Id. at 887.   The court stated that the taxpayers had reason to

know that the receipt was wrong because they were privy to all
                              - 48 -

the details of the arrangement and that the taxpayers had reason

to know that the consideration they expected was substantial.

Id.

      The Addis case is instructive to our decision here.    TNC

aspired to structure the 2001 transaction to minimize or to

eliminate the portion of petitioners’ tax liabilities that TNC

agreed to pay, and TNC (through its officers and attorneys) knew

that any decrease in the value of consideration that HCAC

received would reduce those liabilities.25   In addition, after

the transaction was structured, TNC had an incentive to exclude

from the gift letter part of the consideration that TNC received

because the less consideration disclosed in the gift letter, the

more the gift letter would on its face support the reporting of a

greater charitable contribution deduction (and thus lesser

reimbursement).

      25
      TNC’s incentive was expressed in the final agreement as
follows:

      if it is determined that there is in fact a bargain
      sale gift being made by the LLC [HCAC] to TNC, then in
      determining the amount of a tax liability for which TNC
      is responsible hereunder, the tax savings from any
      charitable deductions * * * which are credited to the
      LLC as a result of such bargain sale gift shall be
      netted against any of the tax liabilities which may
      have been created by any of the other components of
      this transaction in order to determine the ultimate net
      tax liability for which TNC is responsible to indemnify
      the LLC.
                              - 49 -

     The postclosing negotiations illustrated the parties’

intentions regarding the gift letter.   They focused primarily on

drafting the bargain sale gift agreement, on which TNC based the

gift letter, and the attorneys for TNC and HCAC actively

negotiated the details and the contents of the bargain sale gift

agreement (and hence the gift letter) with TNC’s goal in mind.

To be sure, Mr. Hughes described the bargain sale gift agreement

as a “highly negotiated instrument” that involved “a lot of back

and forth with the appraiser”, and the following two examples

illustrate TNC’s and HCAC’s negotiations on the contents of that

agreement.   First, on October 23, 2001, Mr. Giso sent Mr. Birle

an October 23, 2001, memorandum with attached charts depicting

TNC’s and HCAC’s preliminary and final calculations of the

bargain sale gift amount.   TNC’s and HCAC’s calculations are

different because TNC and HCAC assigned different values to the

new beach rights, the release of the reciprocal right, the tax

make-whole payment, and the enhancement to petitioners’ existing

property (TNC and HCAC disputed whether the enhancement should be

taken into account at all).   Second, on November 26, 2001, Mr.

Bamford, who had a stake in the tax make-whole payment because he

agreed to give TNC the money to cover petitioners’ tax

liabilities resulting from the 2001 transaction, sent an email to

Mr. Giso, which was forwarded to Mr. Gleason.   The email stated:

     Rob [Hughes] said that after we agree on a cash payout,
     he’d try to increase the gift. I impressed upon him
                              - 50 -

     that unless we benefited somehow we would not be
     supportive in reducing the $10,450,000 that is used to
     derive the gift value, so we agreed that we’d get $.17
     credited against the TMW [tax make-whole] payment for
     every $1 that land value, legal fees, beach rights, and
     preemptive rights are reduced.

           *      *      *      *      *       *     *

     When they reevaluated their appraised values of those
     various categories, with the intent of coming up with a
     statement that TNC signs off on for the gift value, any
     reduction in the $10,450,000 is multiplied by .17, that
     amount is given to TNC, and the remainder of the escrow
     account goes to HCAC.

Both Mr. Giso’s memorandum and Mr. Bamford’s email illustrate

that TNC and HCAC negotiated which items of consideration, and

the value of that consideration, to include in the bargain sale

gift agreement (and hence in the gift letter).

     In addition, the attorneys for TNC and for HCAC were

intimately aware of the specific items of consideration that HCAC

received, and they were actively involved with Mr. LaPorte in his

appraisal assignment, including Mr. Gleason’s dictating to Mr.

LaPorte the items that he needed to appraise as consideration

that HCAC received for the transfer to TNC of the rights of first

refusal.   While Mr. LaPorte was preparing his appraisal of the

rights of first refusal and other items of consideration, Mr.

LaPorte received a copy of Mr. Gleason’s request which asked Mr.

LaPorte to consider, among other things, the omitted items.    Mr.
                              - 51 -

LaPorte also received a copy of Mr. Gleason’s followup letter.26

Mr. LaPorte faxed Mr. Gleason’s request and followup letter to

Mr. Giso.   Mr. Giso’s only explanation for omitting the Aldeborgh

lease and driveway relocations was that they “just fell off the

radar screen”.   He also explained that he assumed the lot 2 and 3

appraisals included the value of the horse barn.27   Although Mr.

Giso testified that his confusion resulted from the complexity of

the negotiations, we do not find Mr. Giso’s explanation on this

point to be credible and we decline to rely upon it.   See

Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 84-87

(2000), affd. 299 F.3d 221 (3d Cir. 2002).

     Mr. Wolkoff, who signed the final gift letter, and Mr.

Birle, who signed an earlier draft of the gift letter, also were

unable to explain the inadequacies in the gift letter.28     Both

     26
      The record does not specifically show why Mr. LaPorte
ignored those items after receiving Mr. Gleason’s request and
followup letter. The evidence, however, suggests that Mr.
LaPorte may have been instructed to do so. Mr. LaPorte
participated in several teleconferences with Mr. Giso and Mr.
Gleason regarding “Cohan/Aldeborgh appraisals” within days after
Mr. LaPorte faxed to Mr. Giso a copy of Mr. Gleason’s request and
followup letter. Although the substance of those conversations
is not clear from the record, the series of teleconferences after
Mr. Giso received a copy of those letters indicates that some
discussion likely involved the content of the letters.
     27
      Nothing in the record indicates an association between the
horse barn lease and lots 2 and 3.
     28
      The record does not show who drafted the gift letter. Mr.
Wolkoff explained that gift letters are prepared by TNC’s
regional counsel or someone working under him. Further, Mr.
                                                   (continued...)
                             - 52 -

reviewed either the final gift letter or the earlier draft.29

Mr. Birle stated that when he signed the earlier draft, he

“didn’t really give it that much thought”.   Mr. Wolkoff remembers

discussions regarding the horse barn, but he did not verify the

information in the gift letter.

     As unsatisfying as the explanations offered at trial

regarding the omissions in the gift letter (and in the bargain

sale gift agreement) were, the record nevertheless demonstrates

that TNC and HCAC negotiated the disclosure of the consideration,

and that both TNC and HCAC knew the gift letter excluded items of

consideration that HCAC received from TNC.   We so find.   In fact,

the record strongly suggests that representatives of TNC and HCAC

made a conscious decision to exclude items of consideration

received in the 2001 transaction in calculating the amount of the

bargain sale gift and to play the audit lottery with the hope of

minimizing the tax indemnification amount.   After a careful

review of the record, we conclude that the gift letter did not

include a description or a good-faith estimate of the total

     28
      (...continued)
Wolkoff stated, Mr. Birle worked mostly on this transaction and
either Mr. Birle or someone under his direction would have
prepared the letter. Mr. Birle, however, testified that someone
at Choate probably prepared the letter.
     29
       The earlier draft listed the same consideration value as
the final gift letter. The only difference was a calculation
error.
                                - 53 -

consideration (i.e., goods and services) that HCAC received in

the 2001 transaction.

            2.   Reasonable Reliance

     We next address whether HCAC, the Hugheses, or the Marshall

Cohans reasonably relied on the gift letter.      Like the taxpayers

in Addis v. Commissioner, 118 T.C. 528 (2002), HCAC received

benefits from TNC that were not disclosed in the gift letter.

HCAC bargained for those items in the October 2000 agreement and

the final agreement, and TNC agreed to convey those items to

HCAC.     Before the 2001 transaction closed, Mr. Hughes requested

and received the Wallace letter appraising, among other things,

the horse barn lease, the Aldeborgh lease, the lot 29 option, and

the Wild right-of-way relocation.30      Mr. Wallace reported that

the horse barn lease, the Aldeborgh lease, the lot 29 option, and

the Wild right-of-way relocation had a combined value of at least

$1.25 million.     In addition, Mr. Gleason requested but did not

receive from Mr. LaPorte an appraisal of the omitted items.      Mr.

Gleason sent Mr. Hughes a copy of his request.      Despite several

     30
      Mr. Wallace also valued the enhancements to petitioners’
and the Aldeborgh children’s existing properties. Although the
bargain sale gift agreement lists “beach rights/enhancements” of
$750,000, that amount represents only the beach rights. We need
not decide whether the enhancements should have been included in
calculating the bargain sale gift amount. However, TNC did not
request an appraisal regarding the enhancements. As Mr. Giso
mentioned in his Oct. 23, 2001, memorandum, he used a “plug”
number for the value of the enhancements only to achieve the
desired bargain sale gift amount.
                              - 54 -

requests for an appraisal of the omitted items, neither

petitioners nor HCAC’s attorneys questioned the gift letter’s

omissions.

     At trial Mr. Hughes could not (or would not) explain why the

bargain sale agreement and the gift letter excluded those items.

The lack of any credible explanation of the exclusion is not

surprising given HCAC’s obligation to cooperate with TNC in

minimizing the tax liability resulting from the 2001 transaction.

TNC memorialized that obligation in the final agreement as

follows:

     The LLC [HCAC] will cooperate in good faith with TNC,
     * * *, to permit the conveyances * * * to be structured
     to minimize the state and federal tax impact on the LLC
     resulting from such transfers; provided, however, that
     nothing in this Section 7.1.5 shall be construed as
     requiring the LLC to take any action or to refrain from
     acting, if the LLC’s attorneys or tax advisers advise
     the LLC that such action or failure to act could result
     in civil or criminal penalties * * *.

HCAC, petitioners, and their attorneys knew about all of the

items of consideration in the final agreement, and they knew or

should have known that certain of those items were omitted in

calculating the bargain sale gift amount.   They also knew about

HCAC’s contractual obligation to cooperate in structuring the

bargain sale gift.   Under these circumstances we conclude that

neither HCAC, the Hugheses, or the Marshall Cohans reasonably

relied on the gift letter to calculate their charitable

contribution deductions.
                               - 55 -

          3.   Substantial Compliance Doctrine

     Although petitioners now concede that the omitted items

should have been included in the gift letter, they maintain that

we should uphold the charitable contribution deductions because

the value of the omitted consideration was minor relative to the

value of the rights of first refusal and the total consideration.

They cite Bond v. Commissioner, 100 T.C. 32 (1993), for their

position that substantial compliance is sufficient with respect

to section 170 and the regulations thereunder.

     In Bond v. Commissioner, supra, we addressed whether the

taxpayers substantiated their charitable contribution when they

failed to obtain and attach a separate qualified appraisal report

to their Federal income tax return as required under section

1.170A-13, Income Tax Regs.   The taxpayers included all required

information, except the appraiser’s qualifications, in their Form

8283, Noncash Charitable Contributions, which they attached to

their return, instead of in the separate qualified appraisal

report.   Id. at 42.   Recognizing that the taxpayers provided all

information “to establish the substance or essence of a

charitable contribution”, we concluded that the taxpayers

“substantially complied” with the regulations, and we upheld

their charitable contribution deduction.    Id.

     Bond is distinguishable from this case.      The taxpayers in

Bond failed to follow a formality but otherwise provided all
                                  - 56 -

information required to substantiate their charitable

contribution.      HCAC, the Hugheses, and the Marshall Cohans failed

to disclose anywhere on their returns information relating to the

total consideration received from TNC that was necessary for

determining the amounts, if any, of the charitable contribution

deductions.       Congress enacted section 170(f)(8) specifically to

require disclosure of such information.      See H. Rept. 103-111, at

785 (1993), 1993-3 C.B. 167, 361-362.      HCAC, TNC, the Hugheses,

and the Marshall Cohans, and their corresponding attorneys,

should have known (and in fact knew) that HCAC had received

consideration in the 2001 transaction that was not listed or

valued in the gift letter.       They nevertheless blindly relied on

the gift letter to calculate the charitable contribution

deductions.       We do not accept as credible their explanation for

this behavior, and we conclude that neither HCAC, the Hugheses,

or the Marshall Cohans substantially complied with section

170(f)(8).    Cf. Smith v. Commissioner, T.C. Memo. 2007–368, affd.

364 Fed. Appx. 317 (9th Cir. 2009).

             4.    Conclusion

     Because we find that (1) the gift letter did not include a

description or a good-faith estimate of the total consideration

as required under section 170(f)(8); and (2) any claimed reliance

on the letter was unreasonable, we hold that HCAC, the Hugheses,

and the Marshall Cohans failed to satisfy the requirements under
                               - 57 -

section 170(f)(8), and we sustain respondent’s disallowance of

the charitable contribution deductions.31   See Addis v.

Commissioner, 374 F.3d at 887 (“The deterrence value of section

170(f)(8)’s total denial of a deduction comports with the

effective administration of a self-assessment and self-reporting

system.”).

III.    Valuation

       A.   Background

       Respondent contends, and petitioners do not dispute, that

HCAC’s 2001 gross income includes the fair market values of the

       31
      Because we conclude that sec. 170(f)(8) disallows any
charitable contribution deduction, we need not and do not decide
whether HCAC made a bargain sale charitable contribution to TNC
or the amount of any such contribution. We note, however, that
it appears that such a contribution was not made. First, the
fair market value of the consideration that HCAC received in the
2001 transaction exceeded the $14 million fair market value of
the rights of first refusal. See United States v. Am. Bar
Endowment, 477 U.S. 105, 116-118 (1986). Second, HCAC seems to
have lacked the requisite intent to make a contribution, see id.,
in that HCAC decided to treat the 2001 transaction as a bargain
sale contribution at the suggestion of TNC’s counsel. This
suggestion (and HCAC’s decision to treat and report the 2001
transaction as such a contribution) occurred near the end of
HCAC’s and TNC’s renegotiation of a few of the terms of the
October 2000 agreement. Tellingly, incident to TNC’s ultimately
agreeing to pay a greater amount of HCAC’s legal costs than
previously agreed, TNC in the renegotiations aimed to structure
the 2001 transaction to minimize or eliminate its liability to
reimburse petitioners for their payment of Federal and State
income taxes stemming from the 2001 transaction. HCAC and TNC
both knew during the renegotiations that HCAC’s claim to a
charitable contribution deduction could reduce or eliminate that
liability and that TNC had effectively agreed to pay any tax,
interest, and penalty on any ultimate disallowance of the
reported deduction.
                                - 58 -

following property interests:     (1) Blue Heron, (2) Sanderling,

(3) lots 2 and 3, (4) the horse barn lease, (5) the Aldeborgh

lease, (6) the Wild right-of-way relocation, and (7) the new

beach rights.   The parties disagree, however, regarding the fair

market values of these property interests (collectively, the

disputed property interests).32

     B.   Fair Market Value Standard

           1.   Overview

     For Federal income tax purposes the relevant valuation

standard is “fair market value”, and that term denotes “the price

at which the property would change hands between a willing buyer

and a willing seller, neither being under any compulsion to buy

or sell and both having reasonable knowledge of relevant facts.”

Sec. 1.170A-1(c)(2), Income Tax Regs.; see Rolfs v. Commissioner,

135 T.C. 471, 489 (2010); Browning v. Commissioner, 109 T.C. 303,

314 (1997); cf. United States v. Cartwright, 411 U.S. 546, 551

(1973).   We decide the fair market value of the disputed property

interests as of the date of the 2001 transaction, on the basis of

a hypothetical willing buyer and a hypothetical willing seller.

See Doherty v. Commissioner, 16 F.3d 338, 340 (9th Cir. 1994),

     32
      Although respondent contends that the value of any
enhancements to petitioners’ and the Aldeborgh children’s
existing properties resulting from the conservation restrictions
imposed in the 2001 transaction must be taken into account in
determining HCAC’s charitable contribution, respondent does not
argue that the value of any such enhancements should be included
separately in gross income.
                              - 59 -

affg. T.C. Memo. 1992–98; Boltar, L.L.C. v. Commissioner, 136
T.C. 326, 336 (2011); Rolfs v. Commissioner, supra at 480-481;

Arbor Towers Associates, Ltd. v. Commissioner, T.C. Memo.

1999–213; sec. 1.170A-1(c)(1), Income Tax Regs; see also Estate

of Bright v. United States, 658 F.2d 999, 1005–1006 (5th Cir.

1981).   The characteristics of these hypothetical persons are not

necessarily the same as the personal characteristics of the

parties to the 2001 transaction, and we take the views of both

hypothetical persons into account.     See Estate of Bright v.

United States, supra at 1005–1006; Estate of Newhouse v.

Commissioner, 94 T.C. 193, 218 (1990); Estate of Scanlan v.

Commissioner, T.C. Memo. 1996–331, affd. without published

opinion 116 F.3d 1476 (5th Cir. 1997).    The fair market value of

property reflects its highest and best use as of the date of its

valuation, and no knowledge of future events affecting its value,

the occurrence of which was not reasonably foreseeable on the

valuation date, is given to the hypothetical persons.     Estate of

Newhouse v. Commissioner, supra at 218; cf. sec. 20.2031–1(b),

Estate Tax Regs.   The fair market value of property is not

affected by whether an owner has actually put the property to its

highest and best use.   The reasonable and objective possibilities

for the highest and best use of property control its value.      See

United States v. Meadow Brook Club, 259 F.2d 41, 45 (2d Cir.
                                   - 60 -

1958); Stanley Works & Subs. v. Commissioner, 87 T.C. 389, 400

(1986).

            2.   Common Approaches for Determining Fair Market Value

                 a.   Overview

     The Court usually considers one or more of three approaches

to determine fair market value:        (1) The market approach, (2) the

income approach, and (3) the asset-based approach.         Bank One

Corp. v. Commissioner, 120 T.C. 174, 306 (2003), affd. in part,

vacated in part sub nom. and remanded on another issue JPMorgan

Chase & Co. v. Commissioner, 458 F.3d 564 (7th Cir. 2006).        The

question of whether one or more of these approaches applies to a

case is a question of law.       See Powers v. Commissioner, 312 U.S.
259, 260 (1941); Bank One Corp. v. Commissioner, supra at 306.

We briefly discuss each of these approaches.

                 b.   Market Approach

     The market approach (or sales comparison approach as it is

sometimes called) is usually helpful in valuing residential

property.    This approach requires a comparison of the subject

property with similar properties sold in arm’s-length

transactions in the same timeframe.         Bank One Corp. v.

Commissioner, supra at 307.       This approach values the subject

property by taking into account the sale prices of the comparable

properties and the differences between the comparable properties

and the subject property.        Id.   This approach measures value
                                - 61 -

properly only when the comparable properties have qualities

substantially similar to those of the subject property.      Id.

                c.    Income Approach

     The income approach is usually helpful in valuing income-

producing property such as rental property.     This approach

relates to capitalization of income and discounted cashflow.          Id.

This approach values property by computing the present value of

the estimated future cashflow as to that property.     Id.   The

estimated cashflow is ascertained by taking the sum of the

present value of the available cashflow and the present value of

the residual value.     Id.

                d.    Asset–Based Approach

     The asset-based approach is usually helpful in valuing

property with new improvements, where the costs of the

improvements are readily accessible.     This approach generally

values property by determining the cost to reproduce it.        Id.

     C.   Experts

     Petitioners and respondent each called a witness to testify

as an expert on the valuation of the disputed property interests.

Petitioners’ witness, Mr. LaPorte, is among other things a

Massachusetts general certified real estate appraiser and a

senior vice president of Meredith & Grew, Inc., a Boston-based

company that provides worldwide real estate services.     Mr.

LaPorte’s specialty for 30 years has been working on field
                              - 62 -

variety appraisal and consulting assignments on projects in

various States including Massachusetts.   Respondent’s witness,

James J. Czupryna, ASA (Mr. Czupryna),33 is a Massachusetts

certified general real estate appraiser and an independent real

estate appraiser and consultant.   Mr. Czupryna is familiar with

and very knowledgeable about real estate values on Martha’s

Vineyard, and he has appraised a large number of properties on

Martha’s Vineyard.   Mr. Czupryna also has taught and written on

the methodology of valuing land subject to conservation

restrictions, and he regularly consults with property owners on

measuring the change in market value resulting from conservation

easements/restrictions.

     The Court recognized each of the proffered expert witnesses

as an expert on the valuation of the disputed property interests.

Each expert then testified upon direct examination primarily

through his expert report(s), see Rule 143(g)(1), which the Court

accepted into evidence.   We may accept or reject the findings and

conclusions of these experts, according to our own judgment.   See

Parker v. Commissioner, 86 T.C. 547, 561-562 (1986).   In

     33
       The designation “ASA” signifies membership in the
American Society of Appraisers. Mr. Czupryna is a senior member
with the American Society of Appraisers.
                               - 63 -

addition, we may be selective in deciding what parts (if any) of

their opinions to accept.34   See id.

     D.   Overview of Expert Testimony

           1.   Mr. LaPorte

     Mr. LaPorte appraised the four properties and reflected his

appraisals in a written appraisal report that he issued to TNC on

August 24, 2001 (consolidated plan report).   He used July 15,

2001, as the relevant valuation date.    Mr. LaPorte also appraised

the four properties assuming that the Wallace family would

develop the 33-lot subdivision, in order to value the rights of

first refusal; and he issued to Mr. Gleason a separate written

report reflecting those appraisals on August 24, 2001 (33-lot

subdivision report).

     As a preliminary matter, respondent asserts that Mr. LaPorte

used the wrong valuation date in the consolidated plan report.

According to respondent, Mr. LaPorte did not consider the

conservation restrictions because his valuation date was July 15,

2001, 5 days before TNC imposed the restrictions.   Although Mr.

LaPorte conceded at trial that he used the wrong valuation date

     34
      We note at the outset that both experts referred not to
“fair market value” but to “market value” or to “value”. While
the meaning of the latter two terms is not necessarily the same
as the meaning of the applicable term “fair market value”, we
find that, except as otherwise noted herein, the meanings are
sufficiently similar in the setting at hand to allow us to rely
on the experts’ opinions to decide the fair market values of the
disputed property interests.
                                 - 64 -

in his report, he testified that he considered the conservation

restrictions in his appraisals, and we find his testimony on this

point to be credible.     Mr. LaPorte’s consolidated plan report

confirms his testimony.     The report states in the “SUMMARY OF

IMPORTANT FACTS AND CONCLUSIONS” under “ENCUMBRANCES AND

EASEMENTS” that the properties were subject to various

conservation restrictions and easements.       The consolidated plan

report also notes that TNC anticipated a limited development

plan.     We conclude that Mr. LaPorte considered the conservation

restrictions in his appraisals in the consolidated plan report.

                  2.   Mr. Czupryna

        Mr. Czupryna appraised the four properties as of two dates:

(1) July 14, 2001, assuming development of the 33-lot subdivision

plan; and (2) July 20, 2001, after TNC imposed the conservation

restrictions that were part of the 2001 transaction.       He issued

his report on September 18, 2006.

        In his posttrial brief, respondent raises for the first time

whether Mr. Czupryna included the values of the new beach rights

that attached to each of the four properties in valuing the

properties as of July 20, 2001.       Respondent contends that Mr.

Czupryna did not include the values of those new beach rights in

the values he assigned to the four properties.       Respondent

contends that the value of each of the four properties reflected

in Mr. Czupryna’s July 20, 2001, appraisal must be increased by
                              - 65 -

$200,000 to reflect the value of the new beach rights that

attached to each property as a result of the 2001 transaction.

Respondent’s argument requires us to examine Mr. Czupryna’s

appraisal report to determine whether Mr. Czupryna included the

values of the new beach rights in the values he derived for the

four properties.   Respondent did not ask Mr. Czupryna about this

issue at trial.

     While Mr. Czupryna appraised the six new beach rights that

attached to petitioners’ and the Aldeborgh children’s existing

properties, it is readily apparent that he did not appraise the

new beach rights that attached to the four properties.

Respondent asks the Court to value the new beach rights that

attached to the four properties at the same value that Mr.

Czupryna ascertained for each of the new beach rights that

attached to the existing properties.   We agree that all of the

new beach rights have the same fair market value.   As we have

found, separate beach rights attached to the four properties and

to the six existing properties, and each of those rights

permanently allowed the same type and extent of access to the

same beach.   In addition, Mr. Hughes testified that his beach

rights had “immense value” and were “priceless”, and Mr. LaPorte,

in his report, did not differentiate among the new beach rights

that attached to the four properties and stated specifically that

the new beach rights that attached to three of the four
                                - 66 -

properties were the “same”.    Mr. LaPorte also testified that the

value of the new beach rights would be the same if none of those

rights was discounted to reflect any personal beach right held by

an owner of the property and that the undiscounted beach rights

were worth between $200,000 and $250,000.35

     We conclude that the new beach rights significantly enhanced

the values of the properties to which they attached by like

amounts and that the fair market value of each of the four

properties as ascertained by Mr. Czupryna must be increased to

include value for the beach rights that attached thereto.    We

turn now to decide the fair market values of the four properties.

     E.   Valuation of the Four Properties

           1.   Blue Heron

                 a.   Mr. LaPorte’s Appraisal

     In his consolidated plan report, Mr. LaPorte appraised Blue

Heron, with its new beach rights, at $625,000.   He determined

that Blue Heron’s highest and best use was as residential

property assuming either demolition and new construction or

substantial remodeling with additions.

     35
      Mr. Wallace also ascertained that each of the new beach
rights had significant value; and while he did not specifically
identify the value of the rights that attached to Blue Heron and
to Sanderling, he considered the separate beach rights that
attached to lots 2 and 3 to have the same $400,000 value as the
new beach rights that he determined attached to the six existing
properties.
                               - 67 -

     Using a market approach, Mr. LaPorte evaluated the following

three sales as comparable sales:

Date of sale    Land area       Price           Description

Jan. 26, 2000   5 acres        $659,000   This property is located at 38
                                          Slough Cove Rd. and has a view
                                          of Edgartown Great Pond. This
                                          property has no private beach
                                          access.

Feb. 12, 2001   1.5 acres      $600,000   This property is located at 63
                                          Slough Cove Rd., across from
                                          Blue Heron. This property is
                                          a buildable lot with no
                                          private beach access. This
                                          property and Blue Heron have
                                          identical public beach access.

Jan. 2, 2001    1.5 acres      $639,000   This property is located at 65
                                          Slough Cove Rd., adjacent to
                                          63 Slough Cove Rd. and
                                          opposite to Blue Heron. This
                                          property has no private beach
                                          rights.

Each of these properties was within 800 feet of Blue Heron.

     Mr. LaPorte opined that Blue Heron’s proximity to the FARM

Institute’s facilities would negatively affect the privacy of

Blue Heron, and he adjusted his appraisal accordingly, although

neither his appraisal nor his trial testimony indicated the size

of the adjustment.

                b.   Mr. Czupryna’s Appraisal

     Mr. Czupryna appraised Blue Heron at $715,000 as of July 20,

2001.   Like Mr. LaPorte, Mr. Czupryna used a market approach to

value Blue Heron.    His report listed the following “comparable

sales” of conventional building lots and waterfront lots and

estates:
                                       - 68 -
                          Conventional Building Lots

   Location           Land area (acres)     Date of sale          Selling price

63 Slough Cove Rd.         1.5              Feb. 12, 2001          $600,000
65 Slough Cove Rd.         1.5              Jan. 12, 2001           639,000
38 Slough Cove Rd.         5                Jan. 26, 2000           659,000

                             Waterfront Lot Sales

   Location          Land area (acres)      Date of sale          Selling price

19 Atlantic Dr.           2.23              Dec.   26,   2000     $1,500,000
29 Boldwater              9.8               Mar.   15,   2000      1,800,000
48 Witchwood Ln.          3                 Oct.   15,   1999      3,500,000
Turkey Land Cove          29.3              Jan.   10,   1998      3,150,000

                          Herring Creek Farm Re-Sales

   Location          Land area (acres)      Date of sale          Selling price

Lot 10                6.5                   July   20,   2001     $4,000,000
Lots 5 and 6          9.62 and 15.85        July   24,   2001      7,250,000
Lots 9 and 10        13.46 and 10.37        July   24,   2001     11,000,000
Lot 7                 8.81                  July   24,   2001     12,000,000

Mr. Czupryna’s report does not state whether he considered all of

his comparable sales in appraising Blue Heron (or any of the

other three properties).         The three sales listed as “Conventional

Building Lots” were the same sales that Mr. LaPorte relied upon

in his appraisal of Blue Heron.

     Mr. Czupryna concluded that the value of Blue Heron was

$650,000 without consideration of any enhanced value attributable

to the conservation restrictions arising out of the 2001

transaction.       With respect to the stated enhanced value, Mr.

Czupryna applied a 20-percent increase to the value of Sanderling

and lots 2 and 3 because the pastoral scenic vistas were

permanently preserved by the restrictions imposed on the

surrounding lots through the 2001 transaction.                  According to Mr.

Czupryna, conservation restrictions placed on property often
                                 - 69 -

increase (or enhance) the value of abutting property when the

restrictions preserve large tracts of highly visible land as open

space, or otherwise permanently preserve panoramic, open vistas

from the abutting property.     Such an increased value occurs, Mr.

Czupryna testified, because property owners like those on

Martha’s Vineyard are most concerned with land next to theirs

being developed (either residentially or commercially), and the

restrictions permanently protect the privacy and seclusion of,

and the scenic views from, the abutting property.    Mr. Czupryna

ascertained through his research that increase in value ranges

from at least 10 percent to 30 percent where conservation

restrictions are placed on water-oriented properties.    Mr.

Czupryna applied a 10-percent increase to the value of Blue Heron

because its otherwise 20-percent increase in value was lessened

by the fact that Blue Heron was proximate to the FARM Institute’s

property.

            2.   Sanderling

                  a.   Mr. LaPorte’s Appraisal

     In his consolidated plan report, Mr. LaPorte appraised

Sanderling, with its new beach rights, at $1 million.    He

determined that Sanderling’s highest and best use was as

residential property assuming either redevelopment or remodeling

with additions.
                               - 70 -

     Mr. LaPorte used a market approach to value Sanderling.

Although his report indicated that he based his conclusion on

comparable sales cited in his report and on other information on

residential sales, Mr. LaPorte did not specify the comparable

sales he relied on as he did for the other properties.

     Mr. LaPorte opined that the Sanderling house did not add

value to the property because the house, besides being undersized

for the location, had a broken septic system.   Mr. LaPorte did

not inspect the house’s interior.   Instead, he relied on

information obtained from the property’s caretaker who described

its condition as fair to average.   Mr. LaPorte acknowledged that

the property’s setting “is a noteworthy location”.

                b.   Mr. Czupryna’s Appraisal

     Mr. Czupryna appraised Sanderling at $1.2 million as of July

20, 2001.   Like Mr. LaPorte, Mr. Czupryna used a market approach

to value Sanderling.   Mr. Czupryna analyzed the same sales in

appraising Sanderling that he used in appraising Blue Heron.     Mr.

Czupryna concluded that the value of Sanderling was $1 million

without consideration of any additional value attributable to the

conservation restrictions arising out of the 2001 transaction,

and (as previously discussed) that the restrictions increased

that value by 20 percent.
                               - 71 -

          3.   Lots 2 and 3

                a.   Mr. LaPorte’s Appraisal

     In his consolidated plan report, Mr. LaPorte appraised lot 2

at $2.25 million and lot 3 at $2.5 million.     Both valuations

included the new beach rights appurtenant to the properties.      He

determined that the highest and best use for both lots was

residential use, and he assumed that each lot would be improved

by the construction of a single-family residence.     He concluded

that lot 3, the smaller of lots 2 and 3, was worth more than lot

2 because lot 2 abutted the FARM Institute’s property.

     As he did for the other properties, Mr. LaPorte used a

market approach to value the lots.      He considered the following

seven sales as comparable sales:
                                         - 72 -
Date of sale   Land area       Price                 Mr. LaPorte’s description

 July 2001     6.5 acres    $4 million        This lot, located on the farm, had greater
                                              privacy and was closer to the private
                                              beach than lots 2 and 3. It fronts
                                              Crackatuxet Cove and has views of the
                                              Atlantic Ocean.

 Mar. 2000     9.8 acres    $1.8 million      This lot, located at 29 Boldwater Rd., is
                                              a waterfront lot located in the Boldwater
                                              subdivision along the western shoreline of
                                              Edgartown Great Pond. This lot has boat
                                              access to a private beach.

 Dec. 2000     2.23 acres   $1.5 million      This lot, located at 19 Atlantic Dr., is a
                                              vacant residential lot with views of South
                                              Beach and the Atlantic Ocean. This lot
                                              has no private beach access, but it does
                                              have access to the public portion of South
                                              Beach.

 Oct. 1999     3 acres      $3.5 million      This lot, located at 48 Witchwood Lane,
                                              is a waterfront lot located in a small,
                                              high-priced subdivision off of Katama Rd.
                                              This lot is wooded and private and has
                                              access to and ownership of a private dock.

 Jan. 1998     29.3 acres    $3.15 million    This lot, located between Slough Cove and
                                              Turkey Lane Cove, is a waterfront lot on
                                              Edgartown Great Pond. This lot is more
                                              private than lots 2 and 3 and may have
                                              additional development capacity.

 Dec. 1999     0.79 acre    $1.575 million    This lot, located at 93 Edgartown Rd., is
                                              a waterfront lot fronting on Katama Bay
                                              and overlooking the Atlantic Ocean. This
                                              lot includes a modest house and access to
                                              the public portion of South Beach.

 May 2000      9 acres       $425,000         This lot, located at 6 Boldwater Rd., is
                                              an interior lot located in the Boldwater
                                              subdivision. This lot does not have a
                                              view of the water but has access to a
                                              common beach. Another similar lot was
                                              sold in 2000 for $430,000.

                   b.      Mr. Czupryna’s Appraisal

      Mr. Czupryna appraised lot 2 at $2.7 million and lot 3 at $3

million as of July 20, 2001.               Mr. Czupryna used a market approach

and analyzed five of the seven sales used by Mr. LaPorte (the

December 2000 sale, the March 2000 sale, the October 1999 sale,

the January 1998 sale, and the July 2001 sale).                  Mr. Czupryna

concluded that the respective values of lots 2 and 3 were $2.25
                                 - 73 -

million and $2.5 million without consideration of any additional

value attributable to the conservation restrictions arising out of

the 2001 transaction, and (as previously discussed) that the

restrictions increased each of those values by 20 percent.

          4.     Analysis

     Both experts opined that real estate on Martha’s Vineyard is

unique, exclusive, pricey, and in demand.    Mr. Czupryna testified

that Martha’s Vineyard is one of the most desirable resort areas

on the eastern coast of the United States, and he noted the

natural beauty of the land, the beaches, and the scenery.    Mr.

LaPorte testified that “Edgartown and the island of Martha’s

Vineyard * * * are commanding some of the highest prices in New

England for resort type properties”, that “There have been recent

acquisitions of properties in the multi-million dollar price

range”, and that “Despite the slowdown in the economy, brokers

indicate that there still remains a demand for exclusive

property.”     Mr. LaPorte testified that the farm has bucolic vistas

along Slough Cove Road and “is one of the most predominant

properties in Edgartown and on the island of Martha’s Vineyard”.

     Both experts used a market approach to value each of the

four properties, and they analyzed many of the same sales as

comparable sales.    Neither expert, however, explained how he

analyzed the sales upon which he relied, or fully explained the

adjustments he made to his comparable sales to arrive at his
                                 - 74 -

valuations.    Nevertheless, the two experts came up with similar

values for the properties before Mr. Czupryna adjusted the values

to take into account the enhancements in value resulting from the

conservation restrictions imposed as a result of the 2001

transaction.   Although both experts claimed to have taken into

account the conservation restrictions imposed as a result of the

2001 transaction, only Mr. Czupryna actually explained his

analysis and quantified the increased value resulting therefrom.

     A major difference in the experts’ appraisals of the four

properties is their analyses of the impact of the conservation

restrictions on the values of the properties.     Mr. LaPorte

acknowledged in his appraisal report the imposition of

conservation restrictions and the favorable impact they would

have on the value of property.     Mr. LaPorte also acknowledged

that the four properties benefited from the conservation

restrictions imposed through the 2001 transaction in that the

restrictions would “preserve the farm’s aesthetic quality,

provide exclusivity and beach access”.     Yet Mr. LaPorte did not

analyze or quantify the impact of those restrictions on the

values of the four properties.36    Mr. Czupryna, in contrast,

analyzed the impact of the conservation restrictions

and concluded that they resulted in enhancements in value with

     36
      In addition, while he referenced the new beach rights that
attached to the four properties, his appraisal report does not
explain or quantify how those rights affected his appraisal.
                               - 75 -

respect to each of the four properties.   He testified that

enhanced value inheres in the fair market values of comparable

properties, that these adjustments generally range from at least

10 percent to 30 percent, and that a 20-percent increase is

appropriate in the case of each of the four properties absent

special circumstances that would lessen the rate for one or more

of the properties.   He testified that one such special

circumstance is the fact that Blue Heron is proximate to the FARM

Institute’s property, which in turn deserves a reduction of the

20-percent rate to 10 percent in the case of Blue Heron.   He

testified that a 20-percent increase in value applied to

Sanderling and to lots 2 and 3.

     While neither expert gave us a truly convincing and well-

explained analysis of the process he used to arrive at his

valuation figures, we generally find Mr. Czupryna’s opinion on

this subject to be more persuasive than that of Mr. LaPorte.    The

scarcity on Martha’s Vineyard of unique, exclusive property such

as each of the four properties, coupled with the significant

restrictions affecting those properties resulting from the 2001

transaction, leads us to conclude, with a single exception, that

Mr. Czupryna’s conclusions of value for the four properties

reflect the prices at which the properties would change hands

between a hypothetical willing buyer and a hypothetical willing

seller, neither being under any compulsion to buy or to sell and
                               - 76 -

both having reasonable knowledge of relevant facts.   We therefore

adopt, with one exception, Mr. Czupryna’s valuations of the four

properties as set forth in his appraisal report; i.e., $715,000,

$1.2 million, $2.7 million, and $3 million for Blue Heron,

Sanderling, and lots 2 and 3, respectively.37   The single exception

is that we disagree with Mr. Czupryna’s conclusion that the 20-

percent enhancement rate should not be reduced to 10 percent in

the case of lot 2.   Lot 2 appears to be just as proximate to the

FARM Institute’s property as is Blue Heron, and we are persuaded

by the testimony of Mr. LaPorte that the enhanced value of lot 2

on account of the conservation restrictions is lessened by the

fact that some public activity was expected to occur on the FARM

Institute’s property.   For the reasons previously given, we will

increase Mr. Czupryna’s values to account for the value of the new

beach rights that attached to the four properties.

     37
      We note that these values, without consideration of the
enhanced values stemming from the restrictions, are consistent
with the corresponding sale(s) occurring in 2001, as adjusted
slightly to take into account the passage of time and the
difference in acreage between each property in question and that
of its corresponding 2001 comparable sale(s). While the experts
included as “comparable sales” properties that sold before 2001,
we consider those sales to be unrepresentative of the fair market
values of the four properties. We also note that the benchmark
20-percent increase in value on account of the restrictions is
reasonable on the basis of the record at hand, absent a special
circumstance such as the one that reduced that rate to 10 percent
in the case of Blue Heron.
                                - 77 -

     F.   Horse Barn Lease

           1.   Overview

     Mr. LaPorte appraised the leasehold interest under the horse

barn lease at $54,500,38 rounded, as of July 20, 2001.39   Mr.

Czupryna appraised the same leasehold interest at $120,000,

rounded,40 as of July 20, 2001.41   Mr. Czupryna explained that he

could not find any comparable rental values for valuing this

lease.

     Mr. LaPorte and Mr. Czupryna used the same method to appraise

the leasehold interest.    They both valued the horse barn and then

separately valued the lease of the grazing and paddock area.     They

agreed that the value of the leased half of the barn was $36,000.

They differed on the value of the right to use the grazing and

paddock area.

     38
      In his July 14, 2006, appraisal, Mr. LaPorte valued the
horse barn lease at $45,000. However, during testimony, Mr.
LaPorte corrected a calculation error to arrive at the $54,500.
     39
      As mentioned earlier, Mr. LaPorte, at the request of
petitioners, issued a retrospective appraisal of the horse barn
lease, the Aldeborgh lease, and the Wild right-of-way relocation
in preparation for this litigation.
     40
      Mr. Czupryna calculated that the value of the horse barn
lease was $120,953 and then rounded that amount down to $120,000.
     41
      Although Mr. Czupryna states in his report that he valued
the leasehold interest as of July 14, 2001, he acknowledges
earlier in the report that the leasehold interest did not arise
until July 20, 2001, when the horse barn lease was executed. We
consider the July 14, 2001, date to be a typographical error and
treat that date as July 20, 2001.
                                    - 78 -

     Using an income approach, Mr. LaPorte and Mr. Czupryna each

determined the value of the right to use the grazing and paddock

area.        They began their calculations with the value of the

underlying land and adjusted that value to arrive at the fair

market value of the horse barn lease.42       We compare their

calculations as follows:

        42
      The lease did not indicate the size of the grazing and
paddock area as it existed when the parties entered into the
lease. However, the lease provides that the relocated grazing
and paddock area would be no larger than 6.5 acres. Both experts
assumed in their appraisal reports that the grazing and paddock
area was 6.5 acres. We do the same.
                               - 79 -

                                  Mr. LaPorte   Mr. Czupryna

     Value of 6.5 acres             $129,225      $260,000
     Maximal use factor1               x .33         x .33
                                      42,644        85,800
     Fair annual return on land        x .07         x .08
     Annual land rent                  2,985         6,864
     Adjustment for infrequency
       of use                           x .50        ---
     Adjusted annual land rent2         1,493        6,864
     Inwood annuity factor for
       60 years at 8 percent3       x 12.3766    x 12.3766
     Present value of rent             18,478       84,953
     Depreciated cost of barn          36,000       36,000
       Fair market value               54,478      120,953
           1
           The maximal use factor represents HCAC’s right,
     with maximum use of the barn, to use 33 percent of the
     grazing and paddock area for its horses.
           2
           The corresponding monthly rent is approximately
     $124 and $572, respectively.
           3
           The Inwood annuity factor helps ascertain the
     value of the stream of income for the duration of the
     lease and the present value of the land at the time the
     owner regains full control of it (at the end of the
     lease and renewal option). See Estate of Folks v.
     Commissioner, T.C. Memo. 1982–43.

We now turn to discuss the three differences in those

calculations and our conclusion on the appropriate value.

           2.   Land Value

     The experts derived different values for the 6.5 acres of

land.   Mr. LaPorte valued the land at $19,881 per acre (6.5 x

$19,881 = $129,227 (as rounded)).    Mr. Czupryna valued the land

at $40,000 per acre (6.5 x $40,000 = $260,000).    According to Mr.

LaPorte’s appraisal report, Mr. LaPorte derived his per-acre

value from a 2001 appraisal of 100.6 acres of restricted land
                               - 80 -

assessed to TNC.    His report, however, does not identify the land

or the appraisal on which he relied.    Mr. Czupryna’s report

indicated that he based his valuation of the land on an analysis

of several comparable sales.    Although his report does not

identify the comparable sales, he testified that the comparable

sales were a sale of 103 acres of conservation-restricted land in

Chilmark (another town on Martha’s Vineyard), where the

unrestricted portion sold for approximately $37,000 per acre; two

parcels of conservation-restricted farmland located in Westport

(on the mainland opposite Martha’s Vineyard) that sold for

roughly $20,000 to $30,000; and other comparable sales of

conservation-restricted property in Massachusetts “at the high

end”.

       Mr. LaPorte’s value for the land strikes us as simply too

low.    Although neither expert fully explained how he arrived at

his per-acre value, real estate on Martha’s Vineyard is very

valuable (especially in that part of the island).    The evidence,

as unsatisfying as it is, leaves us with the distinct impression

that Mr. Czupryna’s per-acre value is more reliable than Mr.

LaPorte’s.    After analyzing the sales referenced by the experts,

and our decision with respect to the four properties, we conclude

that the applicable fair market value of the grazing and paddock

land was not less than $40,000 per acre.    We therefore adopt Mr.

Czupryna’s valuation of the land at $40,000.
                                - 81 -

          3.   Rate of Return

     Mr. LaPorte and Mr. Czupryna applied different fair annual

return rates to ascertain a fair annual rental return on the

land.   Mr. LaPorte used a 7-percent annual return rate.   Mr.

Czupryna used an 8-percent annual return rate.

     Mr. Czupryna testified that a fair annual return rate for

agricultural land ranges from 6 to 9 percent and that crop-

producing land generally yields a higher return than pasture

land.   He testified that restrictions placed on property by a

lease could decrease the fair rate of return.    He testified that

he set his rate at 8 percent because that rate represents a low-

risk rate that he previously used on land rentals to measure a

reasonable expectation that rental income would be received on

the rental property.   He testified that a 7- or 8-percent annual

rate reflected a fair return on agricultural land at that time.

He testified that the term “agricultural land” generally included

both land on which crops could be grown and land for grazing or

pasture and that rental values are greater for agricultural crop

land as opposed to other types of agricultural land.

     Under the terms of the lease, the 6.5 acres of land could be

used only for grazing and exercising horses.    The limited utility

of the land, therefore, supports the lower 7-percent annual

return rate used by Mr. LaPorte as opposed to the 8-percent
                                - 82 -

annual return rate used by Mr. Czupryna.     We therefore adopt Mr.

LaPorte’s 7-percent annual return rate as the appropriate rate.

          4.    Vacancy Adjustment

     The experts disagree on whether a vacancy adjustment applies

to decrease the projected annual land rent.     Mr. LaPorte applied

a 50-percent vacancy adjustment.     Mr. Czupryna applied no vacancy

adjustment.    Mr. LaPorte testified that his vacancy adjustment

takes into account a situation where a lessor could not lease the

property during every month of the lease’s term.

     Mr. LaPorte has failed to persuade us that a vacancy

adjustment is warranted on the facts before us.     The lease gave

HCAC the right to use half of the horse barn and a portion of the

grazing and paddock area essentially rent free for the next 60

years, and the appraisal of the lease should reflect that right.

Whether HCAC takes advantage of that right after entering into

the lease is irrelevant.     We hold that a vacancy adjustment is

not warranted in arriving at the fair market value of the

leasehold interest.

          5.    Conclusion

     The fair market value of the horse barn lease as of July 20,

2001, is $110,334 (($260,000 x .33 x .07 x 12.3766) + 36,000 =

$110,334).
                                - 83 -

     G.    Aldeborgh Lease

            1.   Overview

     Mr. LaPorte appraised the Aldeborgh lease at $18,000,

rounded, as of July 20, 2001.    Mr. Czupryna appraised the

Aldeborgh lease at $85,000, rounded, as of July 20, 2001.43

     Both experts used a market approach to ascertain the

applicable value of the land underlying the Aldeborgh lease and

then an income approach to ascertain the value of the Aldeborgh

lease.    The experts applied the same general formula under their

income approaches.    Their calculations are as follows:

                                 Mr. LaPorte   Mr. Czupryna

     Value of underlying land    $27,659         $166,000
     Discount for use
       limitation at 35 percent   (9,681)           ---
     Adjusted value of
       underlying land            17,978          166,000
     Fair annual return on land    x .07            x .08
     Annual rent1                  1,258           13,280
     Discount for use
       limitation at 50 percent    ---             (6,640)
     Adjusted land rent            1,258            6,640
     Inwood annuity factor
       for 60 years           x 14.03918        x 12.3766
       Fair market value          17,668           82,180
     1
      The corresponding monthly rent is approximately $105 and
approximately $1,107, respectively.

     43
      Although Mr. Czupryna again stated that he used the July
14, 2001, date as his valuation date, the leasehold interest did
not exist until July 20, 2001, when the lease was executed. We
again consider the July 14,2001, date as a typographical error
and treat the valuation date as July 20, 2001.
                                - 84 -

We now turn to discuss the four differences in those calculations

and our conclusion on the appropriate value.

            2.   Land Value

     The experts disagree on the appropriate value of the land

underlying the Aldeborgh lease.    Mr. LaPorte valued the land at

$27,659.    Mr. Czupryna valued the land at $166,000.   Mr. LaPorte

derived his value by determining that the land was worth $2.77

per square foot, rounded, which he reportedly ascertained from

his $500,000 appraisal of lot 102 as part of his 33-lot

subdivision plan report.44    He next applied the unrounded square-

foot value to the 10,000-square-foot building envelope and valued

the building envelope at $27,659 (10,000 x $2.7659).    Mr.

Czupryna valued the land by multiplying the entire 4.15 acres of

lot 102 by $40,000 per acre (the same per-acre value that he used

for the horse barn lease).

     The Aldeborgh lease provides that the ground leased premises

include lot 102, and, contrary to Mr. LaPorte’s calculations, the

lease does not restrict the leased land only to the building

envelope.    Mr. Czupryna, by contrast, concluded that the

underlying land subject to the Aldeborgh lease includes the

     44
      The square-foot value of lot 102, assuming the entire lot
is worth $500,000, equals $2.7659 (($500,000/(43,560 sq. ft/acre
x 4.15 acres of lot 102)). Mr. LaPorte actually appraised lot
102 at $750,000 in his 33-lot subdivision report. While the
record sometimes refers to lot 102 as lot 32, the record does not
show why Mr. LaPorte used $500,000 as his appraised value.
                               - 85 -

entire 4.15 acres of lot 102.45   We agree.   We further agree with

Mr. Czupryna’s $40,000 per-acre valuation of the underlying land

for the same reasons stated with regard to the valuation of the

land subject to the horse barn lease.    We conclude that lot 102

was worth $166,000 for purposes of valuing the Aldeborgh lease

($40,000/acre x 4.15 acres).

           3.   Discount for Restricted Use

     Each expert applied a discount to reflect the restrictions

on use set forth in the Aldeborgh lease, e.g., that construction

on lot 102 is limited to the building of a barn (primarily for

the storage of the lessee’s personal property and related and

incidental uses) of no more than 1,500 square feet on a specific

10,000-square-foot section of the lot.    However, each expert

applied a different discount rate to arrive at his adjusted land

rent.46   Mr. LaPorte applied a 35-percent discount rate.   Mr.

     45
      Mr. Czupryna appropriately accounts for HCAC’s restricted
use of the entire lot by discounting the projected annual rent
through the use limitation discount rate.
     46
      The experts also applied their discount rates to different
bases. Mr. LaPorte ascertained his adjusted land rent by using a
formula that applied his discount rate to the value of the
underlying land and then multiplied the result by his fair return
rate. Mr. Czupryna ascertained his adjusted land rent by using a
formula that multiplied the value of the underlying land by his
annual return rate and then applied his discount rate. From a
mathematical point of view, neither expert’s conclusion as to the
amount of the adjusted land rent would have changed had he
followed the formula used by the other expert. See generally
Research & Education Association, Super Review of Basic Math and
Pre-Algebra 120-123 (2010) (explaining that under the commutative
                                                   (continued...)
                                 - 86 -

Czupryna applied a 50-percent discount rate.       Neither expert

adequately explained how he ascertained the discount rate.

However, given the size of the property and the permissible

construction that could be done thereon, we conclude that the

applicable discount rate is the 50-percent rate used by Mr.

Czupryna (as opposed to the lower rate used by Mr. LaPorte).

            4.    Fair Return Rate

     The experts applied different fair annual return rates.        Mr.

LaPorte used a 7-percent rate.       Mr. Czupryna used an 8-percent

rate.     For the reasons stated in our analysis regarding the horse

barn lease, we conclude that 7 percent was a reasonable fair

annual return rate.

             5.   Inwood Annuity Factor

     The experts used different Inwood annuity factors.       Mr.

LaPorte’s Inwood annuity factor was based on a 7-percent interest

rate.     Mr. Czupryna’s Inwood annuity factor was based on an

8-percent interest rate.     Both experts used an 8-percent interest

rate to ascertain the annuity factor applicable to the horse barn

lease.     Petitioners did not offer any evidence explaining why Mr.

LaPorte used different Inwood annuity factors for the leases, and

we see no reason the rates should be different.       We hold that the

     46
      (...continued)
and associative properties of multiplication, the order in which
three numbers are multiplied does not change the product of those
numbers).
                               - 87 -

applicable Inwood annuity factor is based on an 8-percent

interest rate.

          6.     Conclusion

     The fair market value of the Aldeborgh leasehold interest as

of July 20, 2001, is $71,908 ($166,000 x .07 x (1 - .50) x

12.3766 = $71,908).

     H.   Wild Right-of-Way Relocation

     Petitioners contend that the relocation of the Wild driveway

did not have a material effect on the value of petitioners’

properties.    Respondent contends that the value of the Wild

right-of-way relocation was $3,751.47    The parties do not dispute

that TNC paid $3,751 for the relocation, and the evidence

includes an invoice substantiating that amount.

     Each party’s contention on this issue is based primarily on

the related testimony of the other party’s expert.    Mr. LaPorte

estimated that the Wild right-of-way relocation increased the

value of Sanderling by $3,751, the cost of the relocation.      Mr.

Czupryna stated in his report that the relocation was a

“housekeeping detail” and did not “measurably improve” the value

of Sanderling.    Mr. Czupryna neither adopted nor rejected Mr.

     47
      The relocation of the Wild driveway did not occur until
sometime in 2002. However, in the final agreement, TNC agreed to
relocate the Wild driveway on demand of HCAC for $1 as of the
closing date.
                              - 88 -

LaPorte’s conclusion that the fair market value of the Wild

right-of-way relocation was $3,751.

     Respondent argues that the issue is not whether the

relocation enhanced the value of Sanderling, but rather whether

petitioners (through HCAC) received anything of value from the

relocation.   Mr. Cohan testified that his family received a

benefit from the relocation of the Wild family right-of-way

because the right-of-way no longer cut across his property

(Sanderling).   In addition, Mr. Cohan testified that the

relocation improved the aesthetics of his property.   Mr. LaPorte

opined that the value received was equal to the cost of the

relocation.   Although Mr. Czupryna concluded that the relocation

did not measurably improve the value of Sanderling, he did not

opine whether the relocation of the right-of-way benefited

petitioners without regard to the value of the affected property.

     In the absence of more fully developed appraisals, we

conclude that the relocation of the Wild family right-of-way

provided a benefit to petitioners equal to the cost of the

relocation or $3,751.
                                    - 89 -

         I.   New Beach Rights

         Mr. LaPorte appraised the new beach rights that attached to

the existing properties at $125,000 per lot, and he appraised the

new beach rights that attached to the four properties at $200,000

to $250,000 per lot.       Mr. Czupryna appraised the new beach rights

that attached to the existing properties at $200,000 per lot.

         Using an income method, both experts analyzed comparable

sales of beach rights in Chilmark.           Over 100 people shared those

rights, but the comparable rights, unlike the new beach rights,

included amenities such as lifeguard services, toilets, and

cabanas.       The comparable beach rights were as follows:

                     Date of sale          Price1
                      Mar. 2001          $150,000
                      Sept. 2000          175,000
                      May 2000            225,000
     1
      One of the two appraisal reports reverses the sale prices
for the May 2000 and September 2000 sales. The specific dates of
these sales are not material to our analysis.

     Mr. LaPorte discounted to $125,000 the value of the new

beach rights that attached to the existing properties because (1)

the property owners (namely, petitioners and the Aldeborgh

children) already had personal beach rights under the 1969

agreement, (2) the new beach rights could not be transferred

separately from the lots, and (3) the properties were within

walking distance of a public beach.          Respondent asserts that Mr.

LaPorte’s use of this discount misapplies the definition of “fair

market value”.      As respondent sees it, a prudent seller would not
                               - 90 -

accept a lower price for the new beach rights just because the

buyer already had personal beach rights.   We agree.   The value of

the new beach rights must be determined without considering the

particular circumstances of a specific buyer or a specific

seller, and the views of both hypothetical persons must be taken

into account.   See Bank One Corp. v. Commissioner, 120 T.C. at

332-333.   In addition, focusing too much on the view of one of

these hypothetical persons, to the neglect of the view of the

other hypothetical person, is contrary to a determination of fair

market value.

     Mr. LaPorte took into account the personal circumstances of

the property owners in valuing the new beach rights that attached

to the existing properties.   Those new beach rights were deeded

rights that attached to and would be conveyed with petitioners’

and the Aldeborgh children’s existing properties.   We are

convinced that a hypothetical willing buyer of petitioners’ and

the Aldeborgh children’s existing properties would view the

private beach rights as a very valuable attribute of property

ownership and would pay accordingly.    We are also convinced that

no reasonable hypothetical willing buyer or seller would conclude

that access to a public beach on Martha’s Vineyard, especially

during high season, would diminish the value of the private beach

rights.    To those ends, Mr. Czupryna testified that he had valued

many beach rights on Martha’s Vineyard and that homeowners on
                               - 91 -

Martha’s Vineyard whose properties were not close to the beach

were buying beach rights to ensure themselves access to a private

beach and to raise the value of their properties.    While he

acknowledged that the new beach rights differed significantly

from the comparable beach rights in Chilmark, petitioners did not

introduce any other evidence to prove that the appraised value of

each new beach right was less than $200,000, the value determined

by Mr. Czupryna as to the new beach rights attaching to the

existing properties.   Accordingly, given our conclusion supra

that the fair market value of all the new beach rights is the

same, we conclude that the value of each new beach right was

$200,000.

IV.   Gain From the Sale of the Rights of First Refusal

      A.   Overview

      Gross income means all income from whatever source derived,

including gains derived from dealings in property.    Sec.

61(a)(3).    Gain from the sale or exchange of property must be

recognized, unless the Code provides otherwise.48    Sec. 1001(c).

Section 1001(a) defines gain from the sale or other disposition

of property as the excess of the amount realized on the sale of

      48
      Sec. 453(a) and (b), for example, generally provides that
income from an “installment sale” is taken into account under
sec. 453. Neither party claims that HCAC’s sale of the rights of
first refusal was an “installment sale”.
                                 - 92 -

property over the adjusted basis of the property sold or

exchanged.   See also sec. 1.61-6(a), Income Tax Regs.

     B.   Amount Realized

     The first step in determining gain on the sale of property

involves calculating the amount realized.   The amount realized is

the sum of any money received plus the fair market value of any

property received.   Sec. 1001(b); Chapin v. Commissioner, 12 T.C.
235, 238 (1949), affd. 180 F.2d 140 (8th Cir. 1950).     The fair

market value of property is a question of fact, and property

lacks a fair market value only in rare and extraordinary

circumstances.   Sec. 1.1001-1(a), Income Tax Regs.

     HCAC included in the amount it realized from its sale of the

rights of first refusal the values of the four properties

(inclusive of what HCAC claimed was the value of the new beach

rights that attached thereto), the cash payments for the past and

current legal fees, and the tax make-whole payment.      HCAC did not

include the value of the new beach rights that attached to the

existing properties or the value of the release of the reciprocal

right.    We decide whether the fair market values of those omitted

items were includable in the amount HCAC realized on the sale of

the rights of first refusal.49

     49
      In addition to these omitted items, HCAC excluded the
values of the horse barn lease, the Aldeborgh lease, the Wild
right-of-way relocation, the lot 29 option, and the land bank
fees paid on behalf of HCAC. Petitioners concede that the values
                                                   (continued...)
                                - 93 -

     Petitioners argue that HCAC did not realize the values of

the omitted items on its sale of the rights of first refusal.

Respondent argues to the contrary.       We agree with respondent.   If

HCAC received consideration in exchange for the rights of first

refusal, HCAC must include that consideration in calculating the

amount it realized from the sale.    Sec. 1001(b).     HCAC received

the new beach rights attaching to the existing properties and the

release of the reciprocal right as part of the consideration for

its sale of the rights of first refusal, and both items had

significant value.    Section 1001(b) requires that the values of

those items be included in HCAC’s amount realized for purposes of

calculating the gain on the sale of the rights of first refusal.

           1.   Number of New Beach Rights

     Petitioners and respondent dispute the number of new beach

rights that HCAC received from TNC as to the existing properties.

Petitioners argue that HCAC received three such new beach rights,

while respondent argues that those new beach rights totaled

seven.    We disagree with both parties.

                 a.   Petitioners’ Position

     Petitioners argue as to the existing properties that HCAC

received only the three new beach rights that related to them

personally and that any remaining new beach rights attached to

     49
      (...continued)
of those items were includable in the amount HCAC realized on the
sale of the rights of first refusal.
                             - 94 -

properties owned by the Aldeborgh children.   Petitioners contend

that they should not have to include the value of the new beach

rights that attached to and benefited the Aldeborgh children.

They contend that the value relating to the new beach rights that

attached to the Aldeborgh children’s property should be taxable

to the Aldeborgh children and not to petitioners.   Petitioners

argue that, although the Aldeborgh children were never formal

members of HCAC, they should be recognized as “partners” for

Federal income tax purposes because they contributed capital to

and received proceeds from HCAC with regard to the rights of

first refusal.50

     In determining the amount realized on the sale of the rights

of first refusal, we must include the value of all consideration

that HCAC received in the 2001 transaction.   A review of the

final agreement confirms that all of the new beach rights,

including the rights that attached to the Aldeborgh children’s

properties, were part of the consideration HCAC received.    We

conclude, therefore, that the value of the new beach rights that

attached to the Aldeborgh children’s property must be included in

HCAC’s amount realized for purposes of determining HCAC’s gain on

the sale.

     50
      As mentioned supra p. 7, HCAC is treated as a partnership
for Federal income tax purposes. Its members, therefore, are
considered to be “partners”.
                                   - 95 -

     The question remains whether the Aldeborgh children should

be considered partners of HCAC for Federal income tax purposes,

and if they should, whether any of the gain attributable to the

new beach rights that attached to their properties as a result of

the 2001 transaction should be taxed to them.        The Code and the

regulations do not give much guidance regarding the definition of

a partner for Federal income tax purposes.        Section 761(b)

defines a “partner” as a member of a partnership.        Section

704(e)(1) provides that a person shall be recognized as a partner

if he or she owns a capital interest in a partnership in which

capital is a material income-producing factor, whether or not

such interest was derived by purchase or gift from any other

person.51       That provision is not limited to family partnerships

but extends to all partnerships.        Evans v. Commissioner, 447 F.2d
547, 550 (7th Cir. 1971), affg. 54 T.C. 40 (1970).

     The Aldeborgh children did not own a capital interest in

HCAC.        Although the record provides little detail about the

transfer to HCAC of the Aldeborgh children’s interests in the

rights of first refusal, it appears that the Aldeborgh children

assigned all of their interests in those rights to HCAC without

        51
      A capital interest in a partnership is an interest in the
assets of the partnership, which is distributable to the owner of
the capital interest upon his or her withdrawal from the
partnership or upon the partnership’s liquidation. Sec. 1.704-
1(e)(1)(v), Income Tax Regs.
                               - 96 -

seeking or receiving any consideration for the transfer.52   They

are not listed as HCAC members (or partners), and the record does

not reveal that they participated in the events leading up to the

July 20, 2001, closing.   We conclude that the Aldeborgh children

are not partners of HCAC within the meaning of section 704(e)(1).

     Petitioners argue for the first time in their reply brief

that the Aldeborgh children are partners of HCAC under the

general definition of partner in section 761(b) if acting in good

faith and with a business purpose they intended to join together

as partners of HCAC.   See Commissioner v. Culbertson, 337 U.S.
733, 742 (1949); Carriage Square, Inc. v. Commissioner, 69 T.C.
119, 128 (1977).   Petitioners elicited no testimony at trial

regarding the Aldeborgh children’s intent to carry on a business

as members of HCAC, and they introduced no other evidence that

would establish that intent.   The record also does not otherwise

include any proof that the Aldeborgh children, in good faith and

with a business purpose, intended to join HCAC as members.   We

conclude that the Aldeborgh children are not partners of HCAC for

Federal income tax purposes and that none of the new beach rights

are taxable to the Aldeborgh children as partners of HCAC.

     52
      To be sure, the Aldeborgh children’s rights of first
refusal were worth significantly less than the rights of first
refusal which the Aldeborghs and the Marshall Cohans held because
the children’s rights were only exercisable if the Aldeborghs and
the Marshall Cohans failed to exercise their rights.
                                  - 97 -

                   b.   Respondent’s Position

     Respondent argues as to the existing properties that HCAC

received seven new beach rights from TNC, and he relies on a

document titled “Easement for Beach Rights” to support his

argument.     Respondent’s reliance is misplaced.   Although the

“Easement for Beach Rights” may indicate that HCAC received seven

beach rights, the final agreement clearly states that TNC granted

HCAC six new beach rights.       Those six new beach rights consisted

of three beach rights that attached to petitioners’ three

existing properties and three new beach rights that attached to

the Aldeborgh children’s three properties.      The number of new

beach rights set forth in the final agreement is consistent with

the number of new beach rights that Mr. Czupryna valued in his

appraisal report.       Consistent with the final agreement, we find

that HCAC received from TNC in the 2001 transaction six new beach

rights attaching to the existing properties.

            2.     Release of the Reciprocal Rights Encumbering
                   the Aldeborgh Children’s Existing Properties

     Petitioners argue that the value of the release of the

reciprocal rights that encumbered the Aldeborgh children’s

property should not be included in petitioners’ gross income.

They make the same argument that they made regarding the new

beach rights that attached to the Aldeborgh children’s

properties.      For the reasons stated with regard to the new beach

rights, we conclude that the value of the release of the
                               - 98 -

reciprocal right encumbering the Aldeborgh children’s properties

is included in HCAC’s amount realized for purposes of calculating

the gain on the disposition of the rights of first refusal.     We

conclude similarly that any gain attributable to those reciprocal

rights is taxable to the members/partners of HCAC, none of whom

were the Aldeborgh children.

     C.    Adjusted Basis

     In order to calculate the gain realized from the 2001

transaction, we must subtract HCAC’s adjusted basis in the rights

of first refusal from the amount realized by HCAC from its sale.

Section 1011(a) generally provides that a taxpayer’s adjusted

basis for determining the gain from the sale or other disposition

of property shall be its cost, adjusted to the extent provided by

section 1016.53   See also sec. 1012.   Under section 1016(a)(1),

the basis of property must be adjusted for expenditures,

receipts, losses, or other items properly chargeable to capital

account.    A taxpayer has the burden of proving the basis of

property for purposes of determining the amount of gain the

taxpayer must recognize.    O’Neill v. Commissioner, 271 F.2d 44,

50 (9th Cir. 1959), affg. T.C. Memo. 1957-193.

     53
      The special adjusted basis computation rule that applies
to bargain sales to charitable organizations is inapplicable
because HCAC was not allowed to claim a charitable contribution
deduction. See sec. 1011(b); sec. 1.1011-2(a)(1), Income Tax
Regs.
                               - 99 -

     HCAC reported on its 2001 Schedule D, Capital Gains and

Losses, that its basis in the rights of first refusal was

$825,162.   Respondent concedes that $607,15754 of the $825,162 is

included in HCAC’s basis, while petitioners concede that $26,271

is not included.55   In addition, petitioners did not introduce any

evidence substantiating the $404 in bookkeeping and accounting

expenditures, the $19,169 paid to PMBC, and the $500 paid to

Horsley & Witten, which were included in the $825,162.   We

sustain without further comment respondent’s determination that

the $404, $19,169, and the $500 are not included in HCAC’s

adjusted basis of the rights of first refusal, see id., and we

turn to decide whether the remaining items in the $825,162, each

of which was personally paid by Mr. Hughes, should be included in

HCAC’s basis.   Those remaining items are:   (1) The $35,000 paid

     54
      Respondent’s concession reflects the $566,030 of capital
expenditures paid to Nutter and the $41,127 paid to Horsley &
Witten. Respondent stipulated that if the Court holds that the
disposition of the rights of first refusal qualifies for capital
gain treatment, respondent concedes that the $41,127 paid to
Horsley & Witten is included in the adjusted basis of those
rights. It appears that there is an error in the stipulation of
facts regarding the Horsley & Witten payment. The parties
stipulated that HCAC paid $23,000 in 2000 and $17,126.96 in 2001,
yet they stipulated HCAC paid $41,127 to Horsley & Witten. We
leave it to the parties to account for this discrepancy in their
computation(s) under Rule 155.
     55
      Petitioners’ concession reflects the $6,000 paid to Nutter
for HCAC’s sec. 212 expenses, the $6,607 paid to Nutter for the
Marshall Cohans’ sec. 212 expenses, and the $13,664 paid to
Nutter for nondeductible personal expenditures.
                                   - 100 -

to Wallace & Co., (2) the $100,000 success fee paid to Nutter,

and (3) the $36,662 paid to Nutter for tax advice.56

               1.   Wallace & Co. Payment

     Petitioners argue that the Wallace & Co. payment should be

included in HCAC’s basis in the rights of first refusal.        They

contend the payment was for the Wallace letter, which Mr. Hughes

used to negotiate the amount of the escrow account covering the

tax make-whole payment.        As Mr. Hughes sees it, the Wallace

letter helped ensure that TNC placed adequate funds in escrow to

cover the tax make-whole payment.

     Respondent contends that the Wallace & Co. payment was not

entirely for the Wallace letter but was partly for consulting

work.        As respondent sees it, none of the $35,000 is deductible

because petitioners failed to establish the portion of the

$35,000 that is attributable to the Wallace letter.        Respondent

also argues that the payment, even if entirely for the Wallace

letter, is not entirely includable in HCAC’s basis in the rights

because the Wallace letter related to the values of items that

        56
      After trial, petitioners moved to reopen the record for
additional evidence. Petitioners sought to have admitted the
testimony of Mr. Hughes regarding the verification of certain
checks that he wrote. Despite several requests from respondent
before trial, petitioners refused to provide documentation to
support their claimed deduction in accordance with the Court’s
pretrial order. We therefore denied petitioners’ motion, and we
decide this issue on the record before us.
                                - 101 -

HCAC received in the 2001 transaction and not to the value of the

rights of first refusal.

     We hold that petitioners have failed to prove that the

Wallace & Co. payment is included in HCAC’s adjusted basis in the

rights of first refusal.     Despite several requests from

respondent before and during trial, petitioners did not provide

any evidence to prove that the Wallace & Co. payment is included

in the rights’ adjusted basis, and they did not call Mr. Wallace

as a witness to testify as to the services he rendered in

consideration for the payment.     In addition, HCAC obtained the

Wallace letter to estimate the tax make-whole payment, and the

letter reflects Mr. Wallace’s opinion on the value of the

consideration that HCAC and petitioners were to receive from TNC,

not his opinion on the value of the rights of first refusal.       We

sustain respondent’s determination on this issue.

          2.   Success Fee

     Mr. Hughes paid a $100,000 “success fee” to Nutter.     The

amount of this “fee” was not set until after the consummation of

the 2001 transaction.   Petitioners assert that the success fee

represents a contingency fee for the successful disposition of

the rights of first refusal to TNC and for the protection of that

right in the Wallace litigation.     However, they did not introduce

any evidence from which we can determine the appropriate

treatment of the success fee.     Consequently, on the record before
                                - 102 -

us, we cannot conclude that the success fee payment is properly

included in HCAC’s adjusted basis in the rights of first refusal.

We therefore sustain respondent’s determination on this issue.

See O’Neill v. Commissioner, 271 F.2d at 50.

            3.   Tax Advice

       Mr. Hughes paid $36,662 to Nutter for tax advice.

Petitioners argue that this payment related to Mr. Fryzel’s and

Mr. Gleason’s work during the negotiations and closing of the

final agreement.    Respondent contends that the payment was a

deductible expense under section 212(3) because it related to

reporting the 2001 transaction on HCAC’s and petitioners’ Federal

income tax returns and thus does not increase HCAC’s adjusted

basis.    Section 212(3) lets individuals deduct all ordinary and

necessary expenses paid or incurred during the taxable year in

connection with the determination, collection, or refund of any

tax.    Any payments deductible under section 212(3) do not

increase a taxpayer’s adjusted basis in property.    See sec.

1.1016-2(a), Income Tax Regs.

       We conclude that the $36,000 payment was for Mr. Fryzel’s

advice concerning HCAC’s and petitioners’ reporting of the 2001

transaction for Federal income tax purposes.    Mr. Fryzel

testified that he advised HCAC on whether to include in income

the value of the new beach rights and the release of the

reciprocal right.    In addition, Mr. Ridgeway sent Mr. Hughes a
                                 - 103 -

letter stating that on the basis of advice from Mr. Fryzel,

certain enhancements were excluded in calculating petitioners’

reporting positions.     Ms. McMorrow also sent a December 10, 2001,

email to Mr. Ridgeway and Mr. Fryzel regarding HCAC’s tax

liability with an attached chart of petitioners’ reporting

positions.

     Petitioners had detailed invoices from Nutter regarding the

tax advice payment, but they did not introduce those invoices

during trial.    The evidence in the record regarding the Nutter

payment is not sufficient to satisfy petitioners’ burden of proof

on this issue.    We are unable to determine what part, if any, of

the tax advice payment related to advice other than in connection

with determining HCAC’s or petitioners’ Federal income tax

liability.    We sustain respondent’s determination on this issue.

See O’Neill v. Commissioner, supra at 50.

V.   Character of Gain

      The parties dispute whether HCAC’s gain on the sale of the

rights of first refusal is taxable as a long-term capital gain or

as ordinary income.      Petitioners argue that the gain is taxable

as a capital gain because HCAC’s disposition of the rights was a

sale or exchange of a capital asset within the meaning of section

1222(3).     Respondent argues that the disposition was not a sale

or exchange because the rights were personal and nontransferable

under the terms of the 1969 agreement.     In addition, respondent
                                - 104 -

asserts, the rights of first refusal were not sold or exchanged;

HCAC canceled or terminated those rights, or they simply ceased

to exist.     Respondent does not dispute that the rights of first

refusal were capital assets.     We agree with petitioners on this

point.

     HCAC’s gain on its disposition of the rights of first

refusal is taxable as a long-term capital gain if the disposition

was the sale or exchange of a capital asset held for more than 1

year.     See sec. 1222(3); see also Dobson v. Commissioner, 321
U.S. 231, 231-232 (1944).     The Code does not define the term

“sale or exchange” for purposes of section 1222(3).     However,

courts have generally defined the term “sale” by its ordinary

meaning to denote a transfer of property for a fixed amount in

money or its equivalent.     Helvering v. William Flaccus Oak

Leather Co., 313 U.S. 247, 249 (1941); Ray v. Commissioner, 18
T.C. 439, 441 (1952), affd. 210 F.2d 390 (5th Cir. 1954).       The

term “exchange” is construed similarly, except that an exchange

reflects the fact that no price is set for the property

exchanged.     Gruver v. Commissioner, 142 F.2d 363, 365-366 (4th

Cir. 1944), affg. 1 T.C. 1204 (1943).

        Respondent’s arguments rest on his proposed finding that

HCAC terminated the rights of first refusal as opposed to

transferring those rights to TNC.     Respondent supports his

argument with another proposed finding that HCAC could not have
                                - 105 -

sold or exchanged the rights of first refusal because they were

personal and nontransferable.    The record, however, does not

support either proposed finding, and we decline to make either.

To the contrary, the record establishes, and we find, that HCAC

sold the rights to TNC in consideration for money and property,

and TNC in turn terminated the rights, after receiving their

passage, incident to its purchase of the farm from the Wallace

family.   We read nothing in the 1969 agreement that provides (nor

do we find) that the rights, while “personal”, could not be

transferred to HCAC or to TNC under the facts herein.    In fact,

respondent’s argument is contrary to the parties’ stipulation No.

17 and to respondent’s determination in the notices of

deficiency.   The stipulation states that the rights of first

refusal “were assigned to HCAC in December of 1995.”    The notices

state that HCAC “conveyed” the rights of first refusal to TNC.57

     Respondent also argues that HCAC could not have sold the

rights of first refusal because those rights “vanished” with the

2001 transaction incident to the Wallace family’s sale of the

     57
      Moreover, regardless of whether the rights of first
refusal were transferable, we find that the rights were in fact
transferred first to HCAC and later to TNC, and that the later
transfer was apparently done with the knowledge and consent of
all persons with an interest in those rights. Respondent also
argues that the substance of the transaction compels a holding
for him. We disagree. The mere fact that the rights of first
refusal may have had to be terminated for the 2001 transaction to
occur does not necessarily mean that HCAC had to be the one who
terminated those rights.
                               - 106 -

encumbered land.   Respondent relies primarily upon Nahey v.

Commissioner, 111 T.C. 256 (1998), affd. 196 F.3d 866 (7th Cir.

1999), to support this argument.58   Respondent’s reliance on Nahey

is misplaced.

       In Nahey v. Commissioner, supra at 265, we concluded that

proceeds from the payment of the settlement of a lawsuit were

taxable as ordinary income because the settlement was not a sale

or exchange under section 1222.    We noted that the rights in the

lawsuit “vanished both in form and substance” on receipt of the

payment and that the payor did not receive any property or

property rights which could later be transferred.    Id. at 264-

266.    We analogized the payment to an extinguishment of a debt.

Id.

       In contrast to the facts of Nahey, HCAC’s sale of the rights

of first refusal was not an extinguishment of a claim; the owner

of the encumbered land continued to have rights in the property.

The release gave the owner of the encumbered land the right to

       58
      Respondent also relies on other cases, each of which is
factually distinguishable from this case. For example,
respondent cites Wolff v. Commissioner, 148 F.3d 186, 188-189 (2d
Cir. 1998), revg. Estate of Israel v. Commissioner, 108 T.C. 208
(1997), where the court held that there was no sale or exchange
under sec. 1222 on the cancellation of forward contracts because
on cancellation, the contract (the underlying asset) ceased to
exist and all rights and obligations with respect to that
contract were released. Here, the underlying asset (the
encumbered land) did not cease to exist on the release of the
rights, and the owner of the encumbered land continued to have
rights in the property.
                                - 107 -

immediately sell the property without having to offer it first to

the Marshall Cohans and the Aldeborgh families for the price

stated in the 1969 agreement.    Additionally, the underlying asset

here (the encumbered land) did not cease to exist as did the

lawsuit in Nahey.

     Congress enacted the capital gain provisions to relieve

taxpayers of the heavy tax burden that resulted from situations

like this one where a capital asset has appreciated over time.

See Corn Prods. Ref. Co. v. Commissioner, 350 U.S. 46, 52 (1955)

(stating that capital gains treatment was intended “‘to relieve

the taxpayer from * * * excessive tax burdens on gains resulting

from a conversion of capital investments, and to remove the

deterrent effect of those burdens on such conversions.’” (quoting

Burnet v. Harmel, 287 U.S. 103, 106 (1932))).   The Marshall

Cohans and the Aldeborgh families held the rights of first

refusal for more than 30 years, and during that time the value of

the rights fluctuated with the value of the encumbered land.    The

appreciation did not result from ordinary income type activities

but from the market value of the encumbered land.   See Michot v.

Commissioner, T.C. Memo. 1982-128.

     We hold that HCAC’s sale of the rights of first refusal is a

sale or exchange of a capital asset under section 1222(3) and

that the resulting gain is taxed as a long-term capital gain.
                              - 108 -

VI.   Accuracy-Related Penalties

      A.   Overview

      Respondent contends that petitioners are liable for the

section 6662(a) penalties on alternative grounds:   (1) The

underpayments were attributable to negligence or disregard of

rules or regulations within the meaning of section 6662(b)(1), or

(2) there were substantial understatements of income tax within

the meaning of section 6662(b)(2).   Petitioners contend that they

are not liable for the section 6662(a) penalties because (1) they

were not negligent, (2) there are no substantial understatements

of income tax, and (3) in any event, they qualify for relief from

the penalties under section 6664(c)(1).

      B.   In General

      Section 6662(a) and (b)(1) authorizes the Commissioner to

impose an accuracy-related penalty equal to 20 percent of the

portion of an underpayment attributable to negligence or to

disregard of rules or regulations.   In this context, negligence

is defined as any failure to make a reasonable attempt to comply

with the provisions of the Code.   Sec. 6662(c); see also Neely v.

Commissioner, 85 T.C. 934, 947 (1985) (negligence is lack of due

care or failure to do what a reasonable prudent person would do

under the circumstances).   Negligence is strongly indicated where

a taxpayer fails to make a reasonable attempt to ascertain the

correctness of a deduction, credit, or exclusion on a return that
                                - 109 -

would seem to a reasonable and prudent person to be “too good to

be true” under the circumstances.    Sec. 1.6662-3(b)(1)(ii),

Income Tax Regs.

     The Commissioner also is authorized to impose an accuracy-

related penalty equal to 20 percent of the portion of an

underpayment attributable to a substantial understatement of

income tax.   Sec. 6662(a) and (b)(2).    A substantial

understatement of income tax with respect to an individual

taxpayer exists if, for any taxable year, the amount of the

understatement for the taxable year exceeds the greater of 10

percent of the tax required to be shown on the return for the

taxable year or $5,000.   Sec. 6662(d)(1)(A).

     Section 6664(c)(1) sets forth an exception to the imposition

of a section 6662(a) penalty.    It provides that generally “No

penalty shall be imposed under * * * [section 6662] with respect

to any portion of an underpayment if it is shown that there was a

reasonable cause for such portion and that the taxpayer acted in

good faith with respect to such portion.”     Whether a taxpayer had

reasonable cause for, and acted in good faith with respect to,

part or all of an underpayment is determined on a case-by-case

basis, taking into account all pertinent facts and circumstances.

Sec. 1.6664-4(b)(1), Income Tax Regs.     The most important factor

is the extent of the taxpayer’s effort to assess the proper tax

liability.    Id.
                               - 110 -

     C.    Respondent’s Initial Burden of Production

     Although an individual taxpayer bears the burden of proving

that he or she is not liable for a section 6662(a) penalty

determined by the Commissioner, Pahl v. Commissioner, 150 F.3d
1124, 1131 (9th Cir. 1998), affg. T.C. Memo. 1996-176, the

Commissioner has the initial burden of producing evidence to

support the applicability of such a penalty, sec. 7491(c).      To

meet this burden, the Commissioner must come forward with

sufficient evidence to show that it is appropriate to impose the

penalty.    See Higbee v. Commissioner, 116 T.C. 438, 446-447

(2001).    If the Commissioner satisfies his burden of production,

the burden of producing evidence shifts to the taxpayer, who must

demonstrate by a preponderance of the evidence that he or she is

not liable for the penalty either because the penalty does not

apply or because the taxpayer qualifies for relief under section

6664(c).

     Respondent introduced evidence showing that HCAC,

petitioners, and their counsel knew about the various items of

consideration that HCAC received in the 2001 transaction and that

HCAC, petitioners, and their counsel were well aware of the total

consideration received when the bargain sale gift agreement and

gift letter were being negotiated and finalized.       Respondent also

introduced evidence showing that HCAC, petitioners, and their

counsel knew or should have known that HCAC’s 2001 income tax
                              - 111 -

return did not accurately report the amount realized from the

2001 transaction and that HCAC, the Hugheses, and the Marshall

Cohans claimed charitable contribution deductions that were

artificially inflated in amount through the exclusion of some of

the consideration that HCAC received in the 2001 transaction.

Respondent also demonstrated that there were underpayments

attributable to substantial understatements of income tax on

petitioners’ 2001 returns.   We conclude that respondent

introduced sufficient evidence to satisfy his burden of

production under section 7491(c).

     D.   Analysis

     We now turn to examine whether petitioners have proven that

they are not liable for the section 6662(a) penalties.      Because

respondent has met his burden of production, petitioners must

come forward with sufficient evidence to persuade the Court that

respondent’s determination is incorrect.    See Higbee v.

Commissioner, supra at 446-447.     Petitioners contend that section

6664(c) relieves them from the section 6662(a) penalties because

they had reasonable cause for the underpayments of tax and acted

in good faith with respect to the underpayments.    Petitioners

contend more specifically that:   (1) Mr. Hughes reasonably relied

in good faith on the advice of independent professional advisers,

Mr. Fryzel and Mr. Ridgeway, regarding the proper reporting of

the 2001 transaction, and (2) the Marshall Cohans and the
                                - 112 -

Aldeborghs reasonably relied in good faith on the Schedules K-1

issued to them by HCAC for the reporting of the 2001 transaction.

Petitioners have the burden of proving reasonable cause and good

faith.   Id.

     A taxpayer’s reasonable reliance in good faith on the advice

of an independent professional adviser as to the tax treatment of

an item can constitute reasonable cause under certain

circumstances.     See United States v. Boyle, 469 U.S. 241, 250

(1985); sec. 1.6664-4(b)(1), Income Tax Regs.    The taxpayer must

show that (1) the adviser was a competent professional who had

sufficient expertise to justify the taxpayer’s reliance on him or

her, (2) the taxpayer provided necessary and accurate information

to the adviser, and (3) the taxpayer actually relied in good

faith on the adviser’s judgment.    See Neonatology Associates,

P.A. v. Commissioner, 115 T.C. at 98-99; Sklar, Greenstein &

Scheer, P.C. v. Commissioner, 113 T.C. 135, 144-145 (1999).

     We conclude that petitioners acted with reasonable cause and

in good faith as to the underpayments attributable to (1) the

omission of the values of the new beach rights and the release of

the reciprocal right from HCAC’s amount realized on the sale of

the rights of first refusal and (2) the undervaluation of the

four properties.    Petitioners introduced both documentary and

testimonial evidence establishing HCAC’s reliance on Mr. Fryzel’s

advice regarding whether the new beach rights and the release of
                               - 113 -

the reciprocal right should be included in the amount realized

and HCAC’s reliance on Mr. LaPorte’s appraisals of the four

properties.   Both Mr. Fryzel and Mr. LaPorte were experienced

professionals who had sufficient expertise to justify the

reliance placed upon them.   The evidence establishes that HCAC

provided Mr. Fryzel and Mr. LaPorte with necessary and accurate

information regarding the 2001 transaction and that HCAC and

petitioners reasonably relied on those professionals’ advice in

reporting the 2001 transaction.   Thus, petitioners are not liable

for the section 6662(a) penalties on the underpayments

attributable to those items.

     However, we reach a different conclusion with respect to the

remaining portions of the underpayments.    Petitioners have not

established that they acted with reasonable cause and in good

faith with respect to the remaining underreporting of gain on the

sale of the rights of first refusal.     Petitioners also have not

established that the Hugheses and the Marshall Cohans acted with

reasonable cause and in good faith with respect to the charitable

contribution deductions.   To both ends, petitioners have not

introduced any credible evidence indicating that they sought

professional advice regarding the substantiation of the

charitable contribution deductions or the treatment of the horse

barn lease, Aldeborgh lease, lot 29 option, Wild right-of-way

relocation, and land bank fees.   Petitioners knew they received
                               - 114 -

those items; however, they failed to seek professional advice

regarding whether those specific items should have been included

in the gift letter and in HCAC’s income on the sale of the

rights.   Instead, petitioners blindly relied on the gift letter

from TNC despite their knowledge that TNC had a financial stake

in the reporting of the 2001 transaction.59     The record also

contains no evidence that HCAC or petitioners sought professional

advice regarding the items erroneously included in the basis of

the rights of first refusal.

     We also disagree with petitioners’ argument that the

Marshall Cohans and the Aldeborghs acted with reasonable cause

and in good faith by relying on the Schedules K-1 issued by HCAC.

A taxpayer may not rely on the information on an information

return (e.g., a Schedule K-1) if the taxpayer knows, or has

reason to know, that the information is incorrect.      Sec. 1.6664-

4(b)(1), Income Tax Regs.   The Marshall Cohans and the Aldeborghs

knew or should have known, through their agent Mr. Hughes, that

they were receiving the benefit of omitting items from the amount

realized on the sale of the rights.      In addition, the Marshall

Cohans knew that they were receiving the benefit of omission of

the Wild right-of-way relocation from the gift letter.      Despite

     59
      Petitioners, on the other hand, lacked any financial stake
in the accuracy of the reporting of the 2001 transaction, because
TNC and HCAC had agreed that TNC would pay any tax, penalties, or
interest petitioners owed as to the transaction.
                                - 115 -

their knowledge, there is no credible evidence in the record that

they sought the advice of a tax professional regarding the proper

treatment of those items.     We have no basis for deciding that the

Marshall Cohans and the Aldeborghs acted with reasonable cause

and in good faith in relying on the Schedules K-1 under these

circumstances.

       Consequently, we sustain respondent’s determination of

negligence penalties under section 6662(a) and (b)(1) with regard

to petitioners’ underpayments attributable to the denial of the

charitable contribution deductions and the underreporting of gain

on the sale of the rights of first refusal relating to the

omission of the horse barn lease, the Aldeborgh lease, the lot 29

option, the Wild right-of-way relocation, and the land bank fees

from the amount realized on the sale and the overstatement of the

rights’ adjusted basis.

VII.    Remaining Arguments

       We have considered all arguments made by the parties, and to

the extent not discussed above, we reject those arguments as

irrelevant, moot, or without merit.

       To reflect the foregoing,

                                           Decisions will be

                                      entered under Rule 155.