Court Opinion

ID: 9379480
Source: CourtListenerOpinion
Date Created: 2023-03-15 19:02:10.752553+00
Date Added: 2024-06-11T17:16:21.960663
License: Public Domain

United States Tax Court

                         T.C. Memo. 2023-33

    ESTATE OF BERNARD J. MACELHENNY, JR., DECEASED,
     DONOR, MICHAEL P. MACELHENNY AND CATHERINE
           MACELHENNY DANN, CO-EXECUTORS,
                       Petitioners

                                  v.

            COMMISSIONER OF INTERNAL REVENUE,
                        Respondent

  ESTATE OF BERNARD J. MACELHENNY, JR., DECEASED,
 MICHAEL P. MACELHENNY AND CATHERINE MACELHENNY
                DANN, CO-EXECUTORS,
                      Petitioners

                                  v.

            COMMISSIONER OF INTERNAL REVENUE,
                        Respondent

                              —————

Docket Nos. 12981-19, 12982-19.                  Filed March 15, 2023.

                              —————

Dennis L. Perez and Lacey E. Strachan, for petitioners.

Stephen O. Abanise, Jenny R. Casey, and Kim-Khanh Nguyen, for
respondent.

       MEMORANDUM FINDINGS OF FACT AND OPINION

       KERRIGAN, Chief Judge: Respondent determined gift tax
deficiencies in the Estate of Bernard J. MacElhenny, Jr. (estate), for

                           Served 03/15/23
                                          2

[*2] 2011 and 2012 of $188,000 and $3,335,609, respectively. 1
Respondent also determined a $3,992,656 estate tax deficiency. The
parties filed Stipulations of Settled Issues, and the remaining issues for
consideration in these consolidated cases are whether (1) the estate may
properly deduct the value of two consent judgments entered against
Bernard J. MacElhenny, Jr. (decedent), and (2) decedent’s children
received taxable gifts by purchasing property at a discount.

       Unless otherwise indicated, all section references are to the
Internal Revenue Code, Title 26 U.S.C., in effect at all relevant times,
all regulation references are to the Code of Federal Regulations, Title 26
(Treas. Reg.), in effect at all relevant times, and all Rule references are
to the Tax Court Rules of Practice and Procedure. We round all
monetary amounts to the nearest dollar.

                             FINDINGS OF FACT

       Some of the facts have been stipulated, and the stipulated facts
are incorporated in our findings by this reference. 2 Decedent, a
California resident, died April 27, 2015. Decedent had two children:
Michael P. MacElhenny and Catherine MacElhenny Dann. When the
Petitions were timely filed, Mr. MacElhenny resided in Arizona and Ms.
Dann resided in California.

       Mr. MacElhenny and Ms. Dann are co-executors of the estate and
co-trustees of the MacElhenny 1999 Trust dated February 3, 1999,
whose terms were amended and restated on April 13, 2015. In addition
to those duties, Mr. MacElhenny and Ms. Dann acted as decedent’s
representatives starting on December 22, 2004, when decedent executed
a Uniform Statutory Form Power of Attorney.

       Decedent was involved in the real estate industry. He started off
selling properties but later developed them as well. Mr. MacElhenny
also worked in real estate. He started off working for New York-based
firms but later formed his own practice in Arizona under the name of
Mission Hill Management. Through this business, Mr. MacElhenny

       1A Petition was filed for redetermination of the gift tax deficiency in Docket
No. 12981-19 and for redetermination of the estate tax deficiency in Docket No. 12982-
19. The Court consolidated the cases on September 8, 2020.
       During the trial respondent offered Exhibit 54–R, an appraisal of the
       2

El Mercado property. The Court reserved ruling on the admission of Exhibit
54–R. Respondent has withdrawn the request to admit the exhibit.
                                   3

[*3] purchased   and   resold   various   residential   and   commercial
properties.

      He also helped manage decedent’s Arizona-based properties.
Decedent and Mr. MacElhenny co-managed the Arizona properties for
approximately eight years until 2010. At that time decedent decided he
wanted to take back control, and so Mr. MacElhenny stopped working
with him. Around this same time, decedent’s health began to decline.
The deterioration began with simple cognitive issues but ripened into
amnesiac dementia in addition to other health concerns.

      In early 2012 decedent had a series of embolic strokes which
severely incapacitated him. At this time Mr. MacElhenny and Ms. Dann
stepped in to assist decedent. On January 31, 2012, Dr. Robert
Harbaugh signed a Capacity Declaration-Conservatorship.          Mr.
MacElhenny—acting as the primary representative—was to manage
decedent’s business affairs and Ms. Dann was to tend to decedent’s
health-related issues.

      Mr. MacElhenny was faced with many challenges when he took
over decedent’s business. The properties were inadequately managed,
and the records were not complete. Over a two-month period Mr.
MacElhenny categorized decedent’s real estate portfolio and prioritized
the tasks that needed to be accomplished. In doing so, he discovered
several short-term debts, one to Union Bank and the other to
Westamerica Bank, that needed to be addressed immediately.

I.    Union Bank Debt

      On August 7, 2003, decedent and his then business partner
Robert O’Neel formed New Healdsburg Venture, LP (New Healdsburg).
Decedent and his wholly owned entity Creekside 50 Ltd., LLC
(Creekside), were designated the limited partners while Mr. O’Neel’s
wholly owned entity, New Healdsburg Venture, LLC, was designated
the general partner. Upon formation, decedent contributed to the
partnership a parcel of vacant land in Healdsburg, California. The plan
was to construct residential units on the property and then sell or lease
them.

      In 2007 New Healdsburg borrowed approximately $11.3 million
from Tamalpais Bank, which decedent and Mr. and Mrs. O’Neel
guaranteed. In 2010 the partnership defaulted on payments and filed
for bankruptcy. This led Tamalpais Bank to file suit against the
O’Neels, decedent, and New Healdsburg. During this time Union Bank
                                   4

[*4] acquired Tamalpais Bank thereby substituting itself as plaintiff in
the state court action.

       On August 31, 2011, the parties settled the matter, stipulating a
$6,500,000 judgment in favor of Union Bank that would be stayed so
long as the borrowers paid the bank $3,500,000. The settlement
agreement required that payment be made as follows: (1) $500,000
within 45 days of the effective date, August 31, 2011; (2) $2,500,000 by
August 31, 2012; and (3) $500,000 by February 28, 2013. If the
defendants made the payments as scheduled, Union Bank agreed to
release its claim entirely. If they did not, then the judgment would be
entered against them. As further security for the settlement payment,
the agreement required decedent to pledge his interest in five
properties: four in Santa Barbara, California, and one in Tucson,
Arizona. Among the Santa Barbara assets was the El Mercado property
which is the subject of the gift tax issue here. The El Mercado property
is a 45,000-square-foot commercial development in California.

       Decedent timely made the first $500,000 payment. On May 21,
2012, Mr. MacElhenny offered $1,800,000 to settle the remainder of the
Union Bank debt. He planned to refinance the El Mercado property,
which was subject to a mortgage of $1,614,391 owed by decedent, to
make the payment. The issue that arose was that the lending
institution was willing to lend the funds only if Mr. MacElhenny agreed
to sponsor the borrowing entity. Because of decedent’s troubled
financial state, Mr. MacElhenny was unwilling to personally guarantee
any debt on behalf of decedent. Mr. MacElhenny and Ms. Dann then
considered the possibility of purchasing the El Mercado property from
decedent.

       Union Bank ultimately rejected the $1,800,000 offer and counter-
offered to settle the claim for $2,750,000. On August 29, 2012,
Mr. MacElhenny rejected that offer and made a new offer of $2,500,000.
Union Bank rejected this offer as well.        On August 31, 2012,
Mr. MacElhenny offered the bank $2,000,000 from the El Mercado
property refinancing—set to close on September 12, 2012—and $625,000
by year-end which he would personally guarantee. In exchange for the
payment, Union Bank would move to dismiss the claim. This offer was
modified one additional time to increase the guaranteed payment to
$650,000. Union Bank accepted this offer on September 7, 2012.

      Mr. MacElhenny’s efforts to refinance the El Mercado property
ultimately failed. Around this time, Mr. MacElhenny spoke with his
                                   5

[*5] personal attorney about the most viable and advantageous way to
obtain the necessary funds while not becoming an unsecured creditor of
decedent. Counsel advised that purchasing the judgment could be an
attractive alternative because it would give Mr. MacElhenny priority
over other creditors—in that he would be stepping into the shoes of
Union Bank—and could be used to offset the purchase price of any estate
assets he might wish to purchase.

       On September 11, 2012, Mr. MacElhenny informed Union Bank
that he was not able to refinance the El Mercado property. He instead
proposed to personally fund the entire $2,650,000 and requested that an
assignment clause be added to the stipulation. This would state that
the bank had assigned the remainder of the judgment in exchange for
the $2,650,000 payment. On September 14, 2012, a Union Bank
representative indicated that the bank would be willing to accept this
offer. On September 20, 2012, however, Union Bank stated that it was
only willing to proceed with the transaction as originally proposed sans
the assignment provision.

       As of September 21, 2012, Union Bank had again changed its
course and agreed to include the requested assignment provision in the
settlement. Union Bank did not warrant or guarantee that the state
court would enter the assigned judgment. To reduce the risk of the state
court’s not entering the judgment, Mr. MacElhenny and Ms. Dann
sought the O’Neels’ consent to the assignment. The O’Neels ultimately
consented in consideration for a promise by Mr. MacElhenny to not
pursue the judgment against them once it had been assigned to him and
Ms. Dann.

      On September 24, 2012, Mr. MacElhenny’s partner wired the
$2,650,000 to Union Bank in purchase of the judgment. Union Bank
also assigned Mr. MacElhenny and Ms. Dann the liens that it had
obtained on the five properties that were pledged in the original
settlement agreement. Mr. MacElhenny and Ms. Dann entered into a
separate agreement whereby Ms. Dann promised to pay Mr.
MacElhenny for her half of the purchase of the judgment.

       On September 27, 2012, the parties filed the stipulation with the
Sonoma County Superior Court. The state court entered an order on the
same day recognizing Mr. MacElhenny and Ms. Dann as the real parties
in interest and substituting them in place of Union Bank as plaintiffs in
the case. On October 1, 2012, Mr. MacElhenny and Ms. Dann filed the
stipulation for entry of judgment. The state court entered the judgment
                                   6

[*6] in their favor at $6,000,000 with 10% statutory annual interest.
The order indicated that both Mr. MacElhenny and Ms. Dann would
have undivided 50% interests in the judgment amount.

II.   Westamerica Bank Debt

       The Westamerica Bank debt arose in manner similar to the Union
Bank debt. On August 1, 2003, decedent’s wholly owned entity,
Creekside, borrowed $1,365,000 from Sonoma Valley Bank.                As
consideration Creekside executed a deed of trust in favor of the bank for
a property in Glen Ellen, California. The parties to the loan transaction
twice increased the principal indebtedness, ultimately to $1,800,000.
Decedent executed a commercial guaranty as further security for the
debt. On February 23, 2006, decedent personally borrowed $1,500,000
from Sonoma Valley Bank. In 2010 Westamerica Bank acquired both
loans.

       Creekside and decedent both defaulted on their loans. This led
Westamerica Bank to record notices of default and elections to sell under
deeds of trust. On June 17, 2011, Westamerica Bank filed a complaint
in the Sonoma County Superior Court against decedent and Creekside
for the $1,365,000 loan. On October 6, 2011, Westamerica Bank filed a
second complaint in the same venue against only decedent for the
$1,500,000 loan. On March 22, 2012, the state court consolidated the
two cases.

       On August 9, 2012, the parties settled the matter by stipulating
a $1,460,104 judgment. The agreement required payment to be made
primarily via sale of the Glen Ellen property and thereafter via monthly
cash payments. If the total payment was made by July 31, 2013,
Westamerica Bank agreed to release the claim and dismiss the suit. If
it was not, then the parties agreed that the bank could have the
judgment entered and would have the option to foreclose on the Glen
Ellen property. The agreement also provided that if the judgment was
entered, Mr. MacElhenny would have the right to purchase the
judgment from Westamerica Bank for a period of five days following
entry.

      In December 2012 Mr. MacElhenny sold the Glen Ellen property,
leaving a $527,938 balance owing to the bank. Realizing that decedent
was unable to pay the balance, Mr. MacElhenny inquired about
purchasing the judgment as permitted by the settlement agreement. He
asked whether he could do so at a 10% discount. On July 18, 2013, the
                                   7

[*7] parties agreed to allow Mr. MacElhenny to purchase the bank’s
rights to the judgment for $432,000. Before filing the judgment with the
court, Westamerica Bank’s representatives asked Mr. MacElhenny’s
attorney whether the judgment should be entered for $432,000 or
something higher. The parties ultimately agreed that the sum should
be $865,517.

       On August 19, 2013, the parties filed the stipulated judgment and
assignment with the Sonoma County Superior Court. The stipulation
for entry of judgment provided that the judgment would be reduced by
a $594,857 credit. This provided Mr. MacElhenny with an $865,517
judgment accruing 10% annual interest. The state court entered the
judgment on September 6, 2013. Mr. MacElhenny has not taken any
action thus far to collect on this judgment.

III.   Purchase of the El Mercado Property

      On December 22, 2004, decedent amended and restated the
MacElhenny 1999 Trust instrument (2004 restatement). At this time
the trust owned the El Mercado property. The 2004 restatement
provided that the El Mercado property would pass to Mr. MacElhenny
and Ms. Dann upon decedent’s death. The 2004 restatement also
provided that Mr. MacElhenny, Ms. Dann, and Marcella Wear (a former
employee of decedent) would become successor trustees should decedent
become unable to act.

      On October 26, 2012, the MacElhenny 1999 Trust transferred
50% interests in the El Mercado property to both Mr. MacElhenny and
Ms. Dann for a stated price of $4,750,000. The purchase agreement
provided that Mr. MacElhenny and Ms. Dann assumed an existing
$1,614,391 mortgage and received a $3,135,609 credit for the remainder.
The credit comprised (1) the $2,650,000 paid to acquire the Union Bank
judgment and (2) a $485,609 offset against the Union Bank judgment.

       Simultaneously with the sale, Mr. MacElhenny and Ms. Dann
formed El Mercado (Delaware), LLC, and contributed the El Mercado
property to it. El Mercado (Delaware), LLC, then borrowed $4,750,000
from UBS Real Estate Securities, Inc., in exchange for a security
interest in the El Mercado property. El Mercado (Delaware), LLC, used
the borrowed funds to (1) pay off the $1,614,391 mortgage encumbering
the El Mercado property and (2) repay Mr. MacElhenny’s partner the
$2,650,000 used to purchase the Union Bank judgment.
                                    8

[*8] The parties have since stipulated that each 50% interest in the El
Mercado property was worth $3,100,000 and encumbered by a $807,196
mortgage at the time of sale. On June 4, 2014, Mr. MacElhenny and Ms.
Dann filed with the state court an acknowledgment of satisfaction of
judgment indicating that the judgment should be reduced by $3,135,609.

IV.   Estate and Gift Tax Returns

      On May 23, 2016, decedent’s representatives filed Form 709,
United States Gift (and Generation-Skipping Transfer) Tax Return, for
the 2011 taxable year. They did not file a Form 709 for the 2012 taxable
year. Respondent increased the estate’s adjusted taxable gifts by
$3,497,609.

      On July 22, 2016, the executors of decedent’s estate filed Form
706, United States Estate (and Generation-Skipping Transfer) Tax
Return. They claimed a $3,638,083 deduction attributable to the
remaining value of the Union Bank judgment. They also claimed a
$1,007,320 deduction attributable to the Westamerica Bank judgment.
Respondent disallowed both deductions.

                              OPINION

       Generally, the Commissioner’s determinations set forth in a
notice of deficiency are presumed correct, and taxpayers bear the burden
of showing the determinations are erroneous. Rule 142(a); Welch
v. Helvering, 290 U.S. 111, 115 (1933). Section 7491(a) provides an
exception that shifts the burden of proof to the Commissioner as to any
factual issue relevant to the taxpayer’s tax liability if the taxpayer
introduces credible evidence with respect to the issue and meets certain
other conditions. See § 7491(a)(2).

       Respondent determined that petitioners were not permitted to
deduct the value of the consent judgments from the value of the gross
estate. Respondent also determined that Mr. MacElhenny and Ms.
Dann received taxable gifts when the MacElhenny 1999 Trust
transferred to them interests in the El Mercado property. Petitioners
have not produced credible evidence within the meaning of section
7491(a). The burden of proof has therefore not shifted, and so
petitioners must show that respondent’s determinations are incorrect.
                                      9

[*9] I.        The Deductibility of the Consent Judgments

      Respondent asserts that the Union Bank and Westamerica Bank
judgments are not deductible by the estate because they involve family
members and therefore are not bona fide claims. Petitioners disagree,
arguing that the claims are bona fide debts and may properly be
deducted from the value of the gross estate.

          A.    Applicable Statute

       Pursuant to section 2001(a) tax may be imposed on the transfer
of the taxable estate of every decedent who is a citizen or resident of the
United States. A decedent’s taxable estate is the value of the decedent’s
gross estate reduced by certain deductions. § 2051. Section 2053(a)(3)
provides that “claims against the estate” may be deducted from the
value of the gross estate. When such claims are “founded on a promise
or agreement,” they are “limited to the extent that they were contracted
bona fide and for an adequate and full consideration in money or
money’s worth.” § 2053(c)(1)(A).

       The regulations provide that for a claim arising out of contracts
or torts to be deductible, the requirements of both Treasury Regulation
§§ 20.2053-4 and 20.2053-1 must be followed. Treas. Reg. § 20.2053-
4(a)(1). This means that the claims must (1) “represent a personal
obligation of the decedent existing at the time” of death; (2) be
“enforceable against the decedent’s estate (and . . . not unenforceable
when paid)”; and (3) have been actually paid by the estate or be
“ascertainable with reasonable certainty and will be paid.” Treas. Reg.
§§ 20.2053-4(a)(1), 20.2053-1(d)(4). No deduction is permitted “to the
extent [the claim] is founded on a transfer that is essentially donative
in character (a mere cloak for a gift or bequest).” Treas. Reg. § 20.2053-
1(b)(2)(i).

       “Transactions within a family group are subject to special
scrutiny . . . .” Harwood v. Commissioner, 82 T.C. 239, 259 (1984), aff’d
without published opinion, 786 F.2d 1174 (9th Cir. 1986); see also United
States v. Allison, 587 F. Supp. 3d 1015, 1030 (E.D. Cal. 2022) (“[I]ntra-
family agreements are scrutinized closely by courts due to their
potential for abuse.”). The regulations provide various factors for
analyzing whether intrafamily claims are bona fide:

                 (A) The transaction underlying the claim or expense
          occurs in the ordinary course of business, is negotiated at
          arm’s length, and is free from donative intent.
                                     10

[*10]          (B) The nature of the claim or expense is not related
        to an expectation or claim of inheritance.
               (C) The claim or expense originates pursuant to an
        agreement between the decedent and the family member,
        related entity, or beneficiary, and the agreement is
        substantiated with contemporaneous evidence.
               (D) Performance by the claimant is pursuant to the
        terms of an agreement between the decedent and the
        family member, related entity, or beneficiary and the
        performance and the agreement can be substantiated.
               (E) All amounts paid in satisfaction or settlement of
        a claim or expense are reported by each party for Federal
        income and employment tax purposes, to the extent
        appropriate, in a manner that is consistent with the
        reported nature of the claim or expense.

Treas. Reg. § 20.2053-1(b)(2)(ii).

        B.    Analysis

      The estate seeks to deduct the Union Bank and Westamerica
Bank judgments as claims against the estate pursuant to section
2053(a)(3). Because these judgments arose out of breach of contract
claims—decedent’s failure to repay the funds lent by the banks—the
requirements in both Treasury Regulation §§ 20.2053-4 and 20.2053-1
must be satisfied for the claims to be deductible. Principally the claims
must represent bona fide debts of the estate.

       A claim founded on a promise or agreement is deductible only to
the extent that the claim is “contracted bona fide and for an adequate
and full consideration in money or money’s worth.” §2053(c)(1)(A); see
Taft v. Commissioner, 304 U.S. 351, 356 (1938). The purpose of section
2053 is to prevent deductions under the guise of claims that are either
gifts or testamentary dispositions. Estate of Pollard v. Commissioner,
52 T.C. 741, 744 (1969). A deduction is not permissible to the extent
that it is founded on a transfer that is donative in character. Estate of
Huntington v. Commissioner, 16 F.3d 462, 468 (1st Cir. 1994), aff’g 100
T.C. 313 (1993).

      Respondent asserts that the Union Bank and Westamerica Bank
judgments are not bona fide claims against the estate. Respondent’s
primary argument is that Mr. MacElhenny and Ms. Dann satisfied the
debts once they transferred money to the banks in exchange for the
                                   11

[*11] purported assignments. Respondent further contends that upon
decedent’s death, the debts were no longer his personal obligations and
therefore were not deductible by the estate. We agree. Because the
claims and assignments of claims involve family members, we analyze
their validity with a heightened level of scrutiny. See Harwood, 82 T.C.
at 259. Petitioners have not satisfied their burden of proving that the
debts were still decedent’s personal obligations at his death. They
cannot meet that burden because they satisfied the debts before
decedent died.

       The claims at issue arose in a commercial lending arrangement:
the predecessors to Union Bank and Westamerica Bank lent decedent
and his business partners money for their real estate enterprise. After
they defaulted on the debts, the lenders sued for breach of contract,
among other causes. At that time the claims represented personal
obligations of decedent. But once decedent—represented by Mr.
MacElhenny and Ms. Dann—settled the debts with the banks, he was
no longer personally obligated to make payments towards the
judgments. The parties’ decision to assign the judgments to Mr.
MacElhenny and Ms. Dann did not change this result. The assignments
were not made in the ordinary course of business and were not
negotiated at arm’s length.

       The banks wanted the borrowed funds to be repaid. And after
significant negotiations, they both accepted a discounted sum in
satisfaction of their claims against decedent. While settling the claim
via cash payment was an ordinary business transaction, the assignment
was not.

      In Union Bank’s case it initially rejected Mr. MacElhenny’s offer
to purchase the judgment, preferring instead to release the claim
against decedent for an agreed sum of money. Although Union Bank
ultimately agreed to assign the claim, it refused to warrant or otherwise
represent that the state court would enter the assigned judgment.

      With respect to Westamerica Bank, the bank asked Mr.
MacElhenny whether it should enter the judgment for the amount of the
settlement payment, $432,000, or a higher amount. A payment of
$432,000 would have satisfied decedent’s liability. Since Westamerica
Bank assigned the debt to Mr. MacElhenny and Ms. Dann, a higher
amount was not of consequence to Westamerica Bank. As in the case of
Union Bank, Westamerica Bank was not requiring an assignment.
                                  12

[*12] Petitioners assert that because the Sonoma County Superior
Court entered the assigned judgments, we should find that they are
bona fide. We disagree. See Treas. Reg. § 20.2053-1(b)(3)(i) (“[A] final
judicial decision . . . may be relied upon to establish the amount of a
claim or expense that is otherwise deductible under section 2053 and
these regulations provided that the court actually passes upon the facts
on which deductibility depends.” (Emphasis supplied)). The state court
did not consider whether the claims continued to be decedent’s personal
obligations after payments were made to the banks. It therefore did not
pass upon the facts on which deductibility depends. For that reason we
are not inclined to rely upon the entries as evidence that the assigned
claims were bona fide. We conclude that neither assignment was an
ordinary course of business transaction.

        There is no evidence to support petitioners’ contention that the
assignments were negotiated at arm’s length. Mr. MacElhenny was on
both sides of the transactions. He agreed on decedent’s behalf to have
the judgments entered against decedent and in his and Ms. Dann’s
favor. There is no record of consent by decedent for maintenance of the
liabilities after payment. True, Mr. MacElhenny held decedent’s power
of attorney and so had the authority to make these decisions on
decedent’s behalf. It is also true that Mr. MacElhenny employed
multiple attorneys to represent the competing interests involved. But
we do not see any evidence that these individuals actually negotiated
amongst themselves.

      We note that the consent judgments entered against decedent did
not resolve a dispute between decedent and his children.
Mr. MacElhenny contends that he did not want to take over his father’s
debts. At the time of the assignments for both claims, agreement had
been reached regarding settling the debts with the banks. When an
agreement was reached with Union Bank, Mr. MacElhenny’s plan to
refinance the El Mercado property and transfer ownership was in the
works. The El Mercado property was transferred one month after the
assignment of the Union Bank claim, and Mr. MacElhenny and Ms.
Dann were repaid one month later. Thus, although Mr. MacElhenny
did eventually become a creditor of decedent, he and Ms. Dann were
repaid in short order.

       The motivation for the assignments was donative, and
structuring the transactions in this manner served only as a cloak for a
gift from decedent to his children. At the time of the settlement
negotiations of the claims, Mr. MacElhenny and Ms. Dann were acting
                                         13

[*13] under decedent’s power of attorney. 3 This made them interested
in both settling the debt on decedent’s behalf and trying to preserve it
for their own benefit. Had decedent still been competent, it is difficult
to imagine that he would have agreed to pay off the banks yet not have
the claims dismissed or at least reduced by the payments. If anything,
this seems to have been only a manner of creating a debt in favor of
decedent’s children which they could use to offset the purchase price of
estate assets. It also created a significant deduction against the value
of the gross estate which would as well serve to enhance Mr.
MacElhenny and Ms. Dann’s inheritance.

       In any event, we do not think that the estate would be entitled to
deduct the claims because it did not itself pay any money towards them.
Mr. MacElhenny and Ms. Dann did when they were assigned the
judgments. For the Union Bank debt Mr. MacElhenny and Ms. Dann
borrowed money from Mr. MacElhenny’s partner. For the Westamerica
Bank debt they allegedly borrowed money from their mother. In either
case, petitioners do not contend that the estate is out any money because
of the claims. They instead assert that the estate will satisfy the
amounts remaining owed once these cases are resolved. Given that
Mr. MacElhenny and Ms. Dann have not taken any actions to collect
thus far—and likely will not because they are on both sides of the
claims—we do not think that there is any reasonable certainty of
payment, and so the claims would not be deductible anyway. See Treas.
Reg. § 20.2053-1(d)(4)(i).

       All of these facts lead us to the conclusion that the debts in these
cases—the ones incurred by decedent—were extinguished when
Mr. MacElhenny and Ms. Dann paid the $2,650,000 and $432,000 to
Union Bank and Westamerica Bank, respectively. Since the claims were
no longer decedent’s personal obligations, we agree with respondent that
the estate improperly deducted them.

II.    The Sale of the El Mercado Property to Mr. MacElhenny and
       Ms. Dann

      On October 26, 2012, Mr. MacElhenny and Ms. Dann, as trustees
of decedent’s revocable trust, transferred the El Mercado property
subject to a mortgage of $1,614,391 to themselves as joint owners. Then

        3 On December 22, 2004, decedent appointed Mr. MacElhenny—or

alternatively if he could not act, Ms. Dann—as his representative to act for him with
respect to the grant of powers given in the Uniform Statutory Form Power of Attorney.
                                    14

[*14] they transferred the property to El Mercado (Delaware), LLC, of
which they were equal owners. The transfer was structured as a sale
with a price of $4,750,000. Mr. MacElhenny and Ms. Dann paid
$1,614,391 to discharge decedent’s existing mortgage, paid $2,650,000
to Union Bank in settlement of decedent’s liability as a guarantor, and
reduced the outstanding amount of the Union Bank judgment by
$485,609. Respondent contends the amount of consideration is limited
to the $1,614,391 paid to satisfy the existing mortgage plus the
$2,650,000 paid to Union Bank. Respondent says this resulted in Mr.
MacElhenny’s and Ms. Dann’s each receiving a $967,805 taxable gift.
We agree.

       Section 2501 provides for the imposition of tax on gifts made by
individuals. Pursuant to section 2512(a), “[i]f the gift is made in
property, the value thereof at the date of the gift shall be considered the
amount of the gift.” Section 2512(b) provides:

      Where property is transferred for less than an adequate
      and full consideration in money or money’s worth, then the
      amount by which the value of the property exceeded the
      value of the consideration shall be deemed a gift, and shall
      be included in computing the amount of gifts made during
      the calendar year.

       The regulations provide that the gift tax is not confined only to
transfers which accord with the common law concept of gifts. Treas.
Reg. § 25.2512-8. The regulation “embrace[s] as well sales, exchanges,
and other dispositions of property for a consideration to the extent that
the value of the property transferred by the donor exceeds the value in
money or money’s worth of the consideration given therefor.” Id. That
said, transfers “made in the ordinary course of business (a transaction
which is bona fide, at arm’s length, and free from any donative intent),
will be considered as made for an adequate and full consideration in
money or money’s worth.” Id. We review intrafamily transfers with a
heightened level of scrutiny. See Harwood, 82 T.C. at 259.

        Since we conclude that the Union Bank claim was not a bona fide
liability, a reduction in the judgment amount cannot replenish or
augment the donor’s taxable estate. The reduction in debt is therefore
not consideration in money and or money’s worth for decedent’s gift of
El Mercado to his children. On that basis, we sustain respondent’s
finding that Mr. MacElhenny and Ms. Dann received taxable gifts of
$967,805 each.
                                   15

[*15] III.   Conclusion

       We conclude that petitioners have failed to carry their burden of
proof as to the deductibility of the judgments rendered against decedent.
They may not reduce the value of the gross estate by the value of the
claims. On the basis of that finding we also hold that they received
taxable gifts in their discounted purchase of the El Mercado property.

       To reflect the foregoing,

       Decisions will be entered under Rule 155.