                        T.C. Memo. 1997-477



                      UNITED STATES TAX COURT



         DAVID DOBRICH AND NAOMI DOBRICH, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 3832-95, 7382-96.        Filed October 20, 1997.



     John M. Youngquist and Donald L. Feurzeig, for petitioners.

     Daniel J. Parent, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   Respondent determined deficiencies in

petitioners' 1989 and 1990 Federal income tax in the amounts of

$1,111,292 and $1,111,320, respectively, and section 6663(a)1


     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code for the years in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
                                - 2 -


civil fraud penalties for 1989 and 1990 of $833,469 and $833,490,

respectively.   Respondent determined the income tax deficiency

and penalty in the alternative for 1989 or 1990.

     The issues for our consideration are:     (1) Whether

petitioners may defer recognition of gain from the disposition of

certain real property under section 1031, (2) if the transaction

does not qualify for section 1031 exchange, whether petitioners

are entitled to report the gain in 1990 under the installment

sale method, and (3) whether petitioners are liable for a fraud

penalty under section 6663.

                           FINDINGS OF FACT2

     At the time the petitions in this case were filed,

petitioners resided in Danville, California.     Petitioners are

married and filed joint Federal income tax returns for each of

the years in issue.

     During the years in issue, petitioners engaged in real

estate investment and received rental income from commercial and

residential real estate.    In 1977, petitioners purchased 137

acres of unimproved real property located in Antioch, California

(Antioch property), for $300,000 and thereafter spent $30,000 in

engineering and consulting fees to improve the property.     In

1988, petitioners decided to sell a portion of the Antioch


     2
       The stipulation of facts and the attached exhibits are
incorporated herein by this reference.
                                 - 3 -


property to an unrelated third party and granted an option to

purchase 117 acres of the property for $3,969,000, to expire on

August 22, 1989.   Petitioners intended to dispose of the property

in a section 1031 exchange for like-kind property to obtain

nonrecognition treatment of the gain realized.    They knew that

they had a limited time period after the sale closed to replace

the Antioch property with like-kind property and had to identify

replacement property within 45 days.

     Petitioners entered into an agreement with Clack Brothers,

Inc. (Clack Bros.), to act as an intermediary to facilitate a

like-kind exchange of the Antioch property purportedly in

accordance with section 1031 (exchange agreement).    Timothy Clack

(Mr. Clack), the president of Clack Bros., is a real estate

attorney and had represented petitioners in real estate

transactions since the 1970's. Pursuant to the exchange

agreement, petitioners assigned the right to receive the Antioch

option proceeds to Clack Bros.    On August 22, 1989, the option

holder exercised the option to purchase the Antioch property.

Petitioners transferred the title of the Antioch property to the

purchaser without Clack Bros.' acquiring legal title.    The

purchaser paid the $3,969,000 purchase price into an escrow

account by August 22, 1989.   Clack Bros. thereafter transferred

$3,862,339.65 of the proceeds into an interest-bearing trust

account in its name and used the remainder for a deposit on
                               - 4 -


replacement property chosen by petitioners.    Petitioners paid a

portion of the interest earned on the sale proceeds to Clack

Bros. as a fee and retained the remainder of the sale proceeds

interest.

     The exchange agreement provided that petitioners would be

entitled to the sales proceeds if they did not identify

replacement property within 45 days of the transfer of the

Antioch property.   If petitioners did identify replacement

property, they would have a right to the sales proceeds if they

did not acquire replacement property within 180 days of the

transfer, pursuant to the exchange agreement.    A letter attached

to the exchange agreement also informed petitioners of the 45-day

identification period.   The 45th day after the transfer was

October 6, 1989, and the 180th day was in February 1990.

     Petitioners began looking for replacement property in 1988.

They considered numerous potential replacement properties and met

with several real estate agents.   In connection with the

properties they considered, petitioners examined various

information about the properties, such as building plans, income

and expense statements, tenant lists, leases, rents, service and

maintenance contracts on the property, and warranties, in order

to analyze the investment opportunity of the properties.

Petitioners expressed an interest in a number of replacement

properties during the identification period.    They offered to
                               - 5 -


purchase several different properties, entered into purchase

agreements, and had Clack Bros. make earnest money deposits using

the sales proceeds from the Antioch property.   However,

petitioners did not acquire any of these properties.   After the

identification period had expired, petitioners continued to

search for possible replacement properties and continued to make

unsuccessful offers as late as December 1989.   In January 1990,

petitioners made offers to purchase two parcels of real property:

2001 Contra Costa Boulevard, Pleasant Hill, California, (Pleasant

Hill) and 1032 Skyland Drive, Zephyr Cove, Nevada (Skyland).

Petitioners acquired these properties in February 1990 using the

sales proceeds from the Antioch property.

     Petitioners purchased the Pleasant Hill property from a

partnership in which Daniel Fivey was a general partner.   The

partnership began construction of a retail shopping center on the

property in mid-1989 and completed construction in February 1990.

The Pleasant Hill property had not been listed for sale with any

real estate brokers.   Petitioner husband had previously discussed

another possible replacement property with Mr. Fivey in mid-1989.

During the course of the discussions, Mr. Fivey mentioned the

Pleasant Hill property, which was still under construction and

not available for sale.   Petitioner husband did not ask Mr. Fivey

for a tour of the property or for any information about the

property.   Petitioners did not express any interest in purchasing
                               - 6 -


Pleasant Hill, or otherwise identify Pleasant Hill as replacement

property, at that time or at any time prior to January 1990.

     On January 11, 1990, one of petitioners' real estate agents

Kevin Van Voorhis (Mr. Van Voorhis) told petitioner husband that

the Pleasant Hill property was for sale.   This was the first time

petitioners had discussed Pleasant Hill with Mr. Van Voorhis, and

petitioner husband did not indicate to Mr. Van Voorhis that he

was familiar with the property.   Mr. Van Voorhis informed

petitioner husband that Pleasant Hill could not be part of a

section 1031 exchange for the Antioch property because it was not

identified within the 45-day identification period.    On January

26, 1990, petitioners offered to purchase Pleasant Hill for

$3,100,000 and entered into a purchase contract.    Petitioners

assigned the purchase contract to Clack Bros., and the purchase

closed on February 15, 1990.   The purchase price was paid by

Clack Bros. from the Antioch sales proceeds.    Petitioners

negotiated the purchase of Pleasant Hills themselves and paid Mr.

Van Voorhis a finder's fee of $31,000.

     Petitioners also looked for residential rental property in

the Lake Tahoe, Nevada, area in 1988 and used Sandra Love (Ms.

Love) as their real estate agent.   On October 12, 1989, after the

identification period had expired, petitioners first expressed an

interest in the Skyland property to Ms. Love.    They had toured

Skyland that day with another real estate agent but wanted Ms.
                                 - 7 -


Love to handle the purchase.   The Skyland property contains a

waterfront, single-family residence.     The house was constructed

during the summer of 1989 and first advertised for sale in June

1989 while under construction.    Ms. Love had not previously

discussed the Skyland property with petitioners or shown the

property to them.   Petitioners did not indicate to Ms. Love that

they had seen the house prior to October 12, 1989.     The next day,

October 13, 1989, petitioners made a verbal offer for the Skyland

property, which they later decided to withdraw.     On October 13,

1989, Ms. Love also contacted Mr. Clack, at petitioners' request,

to identify Skyland as replacement property.

     After the initial offer, petitioners did not express any

further interest in purchasing Skyland again until January 24,

1990, when they called Ms. Love to inquire as to whether the

Skyland property was still for sale.     On January 26, 1990,

petitioners offered to purchase the Skyland property for

$1,200,000 and entered into a purchase contract.     Petitioners

assigned the purchase contract to Clack Bros., and the purchase

price was paid by Clack Bros. from the sales proceeds of the

Antioch property.   The purchase closed on February 15, 1990.

     Petitioners regularly discussed the 45-day identification

requirement with Mr. Clack and with several real estate agents

whom petitioners employed.   Mr. Clack repeatedly advised

petitioners to obtain documentation to establish that they had
                              - 8 -


identified replacement property within the 45-day period.    Mr.

Clack recommended that petitioners purchase replacement property

that had been identified during the 45-day period.   Real estate

agents also gave petitioners similar advice, including Mr. Van

Voorhis who recommended that a written identification be

furnished to Mr. Clack as the exchange intermediary.   In

September 1989, Mr. Van Voorhis offered to write a letter to Mr.

Clack that identified replacement properties that petitioners

were considering (Van Voorhis letter).   Mr. Van Voorhis asked

petitioners which properties to include in the letter and also

included properties that Mr. Van Voorhis had shown to them.

Petitioners did not inform Mr. Van Voorhis that they were

interested in either the Skyland or Pleasant Hill properties in

his preparation of this letter.   The letter, dated September 18,

1989, identified 10 potential replacement properties and did not

include either the Pleasant Hill or Skyland properties.     Despite

this advice, petitioners did not identify either Pleasant Hill or

Skyland in writing or obtain other written documentation.

Moreover, petitioners did not discuss purchasing either the

Pleasant Hill or Skyland property with Mr. Clack, any of their

real estate agents, or the prior owners of the properties during

the 45-day period.

     In January 1990, petitioner husband asked Ms. Love to write

a false letter (Skyland letter) addressed to petitioners
                                 - 9 -


purporting to acknowledge that petitioners had expressed an

interest in purchasing the Skyland property to her as of

September 1989.   The letter was backdated to September 19, 1989,

on petitioner husband's request to misrepresent the time by which

Skyland was identified as replacement property.     The letter also

incorrectly stated that petitioners had made a verbal offer to

purchase the property on that date.      At petitioners' direction,

Ms. Love also changed the date of petitioners' offer for the

Skyland property from January 26, 1990, to a September date.

Petitioners and Ms. Love also re-dated the purchase contract to

September 19, 1989.   In January 1990, petitioner husband also

asked Mr. Fivey to write a similar letter to fabricate an

interest in the Pleasant Hill property during the identification

period (Pleasant Hill letter).    The letter, backdated to

September 15, 1989, purported to acknowledge petitioner husband's

interest in acquiring Pleasant Hill.

     In late October 1989, after the identification period had

expired, petitioner husband had suggested that documents be

backdated in connection with another property that petitioners

were considering but did not acquire.     Petitioners offered to

purchase this property, and the purchase offer was backdated to

be within the identification period.     On January 8, 1990,

petitioners received a sample letter from Mr. Clack that was used

to prepare the back dated Pleasant Hill and Skyland letters.       The
                                - 10 -


sample letter was dated September 5, 1989, and addressed to

petitioner husband.   Petitioners received this sample letter

before they expressed an interest in acquiring either Pleasant

Hill or Skyland to Mr. Clack.

     In January 1990, petitioner husband also wrote a letter to

Mr. Clack which purported to identify five possible replacement

properties, including the Pleasant Hill and Skyland properties.

Petitioner husband backdated the letter to September 18, 1989,

the date of the Van Voorhis letter identifying potential

replacement property.

     Petitioners reported the transfer of the Antioch property on

their 1990 tax return as a section 1031 exchange qualifying for

nonrecognition of gain and reported that they identified

replacement property on September 18, 1989.   Respondent

determined that the transaction did not qualify as a section 1031

exchange because petitioners did not timely identify the

replacement property.   Accordingly, respondent determined that

petitioners must report the gain realized on the Antioch

property.

     Petitioners' accountant relied on the false letters

solicited by petitioner husband from Ms. Love and Mr. Fivey to

prepare petitioners' 1989 and 1990 tax returns.   Petitioners

indicated to their accountant that they exchanged the Antioch

property pursuant to section 1031 and that the replacement
                              - 11 -


properties had been identified within the 45-day identification

period.   During the audit of their tax returns, petitioners'

accountant provided to respondent's revenue agent a copy of the

backdated letter that petitioner husband wrote to Mr. Clack

identifying the Pleasant Hill and Skyland properties.   Mr. Fivey

sent the Pleasant Hill letter to the revenue agent.    Pursuant to

a written plea agreement with the U.S. Department of Justice,

petitioner husband pleaded guilty to two counts of violating

section 7207 for causing the delivery of false documents to the

Internal Revenue Service (IRS).

     Petitioners extended the period of limitations to assess and

collect tax for 1989 and 1990 to December 31, 1994, pursuant to

section 6501(c)(4).   Respondent timely issued a notice of

deficiency for 1989 and issued a notice of deficiency for 1990 on

April 12, 1996.

                              OPINION

     Generally a taxpayer must recognize the entire amount of

gain or loss on the sale or exchange of property.   Sec. 1001(c).

Section 1031(a)(1) allows taxpayers to defer gain or loss from

exchanges of like-kind property held for business or investment

purposes, as distinguished from a cash sale of property followed

by a reinvestment of the proceeds in other property.    Barker v.

Commissioner, 74 T.C. 555, 561 (1980).   Section 1031(a)(3)

governs nonsimultaneous like-kind exchanges.   To qualify as a
                                - 12 -


nonsimultaneous like-kind exchange, the taxpayer must identify

replacement property to be received in the exchange within 45

days after the date the taxpayer transfers the property

relinquished in the exchange.    Sec. 1031(a)(3)(A).   In this case,

the 45-day period ended on October 6, 1989.

     The parties dispute whether petitioners timely identified

either the Pleasant Hill or Skyland properties as replacement

properties.   Petitioners contend that they discussed Pleasant

Hill and Skyland with each other during the identification

period.   Petitioners further allege that they drove by the

properties while under construction and that petitioner husband

toured the construction site and inquired about building plans

with construction workers.   Petitioners concede that they never

indicated that they were interested in acquiring Pleasant Hill or

Skyland to the prior owners of either property, their exchange

intermediary/attorney, Mr. Clack, or any of their numerous real

estate agents.   Petitioners contend that identification of

replacement property to each other was sufficient to meet the

identification requirement of section 1031(a)(3)(A).    Respondent

contends that petitioners did not consider purchasing Pleasant

Hill or Skyland during the identification period, and even if

they did, petitioners did not adequately identify either

property.

     Section 1031(a)(3) provides:
                                - 13 -


For purposes of this subsection, any property received by the
taxpayer shall be treated as property which is not like-kind
property if--

         (A) such property is not identified as property to
     be received in the exchange on or before the day which
     is 45 days after the date on which the taxpayer
     transfers the property relinquished in the exchange, or

         (B) such property is received after the earlier of--

             (i) the day which is 180 days after the date on
     which the taxpayer transfers the property relinquished
   in the exchange, or

             (ii) the due date (determined with regard to
 extension) for the transferor's return of the tax
imposed by this chapter for the taxable year in which
the transfer of the relinquished property occurs.

The Secretary issued regulations under section 1031 after the

years in issue which require taxpayers to identify replacement

property in a written document signed by the taxpayer and sent to

either (1) the person obligated to transfer the replacement

property or (2) any person involved in the exchange (e.g., a

party, an intermediary, or an escrow agent) other than the

taxpayer or a disqualified person (the taxpayer's agent or a

related party).   Sec. 1.1031(k)-1(c)(2), Income Tax Regs.   The

regulations apply to transfers of property made on or after June

10, 1991, or in limited cases, transfers made on or after May 16,

1990.   Sec. 1.1031(k)-1(o), Income Tax Regs.

     As the regulations do not apply in this case, petitioners

contend that during the years in issue, the proper method of

identification was ambiguous.    They argue that section
                               - 14 -


1031(a)(3)(A) does not expressly require written identification

or specify to whom identification must be made.    Petitioners also

argue that the legislative history for section 1031(a)(3) does

not clarify the required method of identifying replacement

property.   The conference report provides

               The conference agreement follows the
            Senate amendment except that transferors are
            permitted 45 days after the transfer to
            designate the property to be received * * *.
            The conferees note that the designation
            requirement in the conference agreement may
            be met by designating the property to be
            received in the contract between the parties.
            It is anticipated that the designation
            requirement will be satisfied if the contract
            between the parties specifies a limited
            number of properties that may be transferred
            and the particular property to be transferred
            will be determined by contingencies beyond
            the control of both parties. * * * [H. Conf.
            Rept. 98-861, at 866 (1984), 1984-3 C.B.
            (Vol. 2) 1, 120.]

Congress' primary concern in amending section 1031(a)(3) was to

prevent long periods of delay between the exchange of properties,

as occurred in Starker v. United States, 602 F.2d 1341 (9th Cir.

1979).   H. Conf. Rept. 98-861, supra, 1984-3 C.B. at 120.

Congress added the 45- and 180-day requirements for like-kind

exchanges to address this concern.

     It is not necessary for us to decide whether identification

must be in writing.    Rather, we must decide whether the steps

taken by petitioners were sufficient.    Petitioners have no

credible evidence that they had considered Pleasant Hill or
                                - 15 -


Skyland as replacement properties during the identification

period.   During that period, petitioners did not inform anyone,

either verbally or in writing, that they were interested in

either property.   Petitioners first expressed an interest in

acquiring Pleasant Hill in January 1990 when the property was

brought to their attention by Mr. Van Voorhis.      Petitioner

husband may have briefly discussed Pleasant Hill with Mr. Fivey

during the identification period.    However, petitioner husband

concedes that he did not indicate to Mr. Fivey any intention to

acquire Pleasant Hill as replacement property until after the

identification period had expired.       Petitioners first indicated

their interest in the Skyland property on October 12, 1989.

Petitioners claim that they drove by the house with a real estate

agent in the summer of 1989 while it was under construction.

They did not express an interest in purchasing Skyland at that

time.   They also contend that they drove by both properties by

themselves on several occasions and that petitioner husband

viewed the construction site.

     However, there is no evidence, other than their testimony,

that petitioners considered purchasing these properties or

expressed an interest in the properties during the identification

period.   Throughout the end of 1989, petitioners made a number of

offers and entered into purchase contracts on other properties as

replacements for the Antioch property, including an offer in
                               - 16 -


December 1989.   Petitioners claim that by October 6, 1989, they

had decided to purchase Pleasant Hill and Skyland.   However, they

rely solely on their own testimony in that regard.   Apart from

their testimony there is no evidence that they saw the Skyland

property before October 12, 1989 or the Pleasant Hill property

before January of 1990.   Even if they had seen either property on

the dates alleged, that would likely not be sufficient to meet

the identification requirement.

     Although petitioners are not specifically educated in tax

matters, they are sophisticated real estate investors.

Petitioners repeatedly discussed the identification requirement

with their advisers and were advised as to the adequate measures

of identification.   We find that petitioners understood the

importance of timely identification.    Indeed, they asked Ms. Love

to identify Skyland to Mr. Clack when they made a verbal offer.

Nevertheless, they never disclosed their alleged interest in the

Pleasant Hill or Skyland properties during the identification

period to anyone, not to Mr. Clack, their real estate agents, or

the prior owners.    Petitioners failed to mention either property

to Mr. Van Voorhis in September 1989 when Mr. Van Voorhis

prepared an identification letter to Mr. Clack.   Moreover,

petitioner husband did not indicate any prior interest in

Pleasant Hill and acted as if he were unfamiliar with the

property when Mr. Van Voorhis first approached him about it.    As
                               - 17 -


petitioners knew and understood the need to timely identify

replacement property, it is highly improbable that petitioners

would have kept any actual interest in these properties to

themselves.    Under these circumstances, we find to be untrue

petitioners' testimony that their decisions to acquire Pleasant

Hill and Skyland as replacement property were made during the

identification period.   As further evidence of the incredible

nature of his testimony, petitioner husband repeatedly testified

that he was not familiar with the 45-day identification

requirement.   Yet, Mr. Clack and several real estate agents

testified that they regularly discussed the requirement with

petitioners and that petitioner husband appeared to understand

it.

      We find that petitioners did not take any steps to identify

Pleasant Hill or Skyland as replacement property during the

identification period.   Moreover, if taxpayers were permitted to

identify replacement property between themselves without

notifying an unrelated party or another party to the exchange,

the identification requirement would be meaningless.    Designation

between married taxpayers would also create problems with the

limitation on the number of properties permitted to be identified

and would essentially be the equivalent of permitting taxpayers

to identify an unlimited number of replacement properties.     See

St. Laurent v. Commissioner, T.C. Memo. 1996-150.    We conclude
                              - 18 -


that petitioners did not identify the Pleasant Hill or Skyland

properties as replacement property within the time period

required by section 1031(a)(3)(A).     Accordingly, the gain

realized from the sale of the Antioch property is recognizable.

     In the notices of deficiency, respondent determined the gain

realized on the sale of the Antioch property without regard to

petitioners' basis in the property.     Section 1001 provides that

the gain from the sale of property is the excess of the amount

realized over the adjusted basis.    The adjusted basis of property

is its basis (cost) as determined under section 1011 and as

adjusted by section 1016.   Sec. 1012.    The basis is adjusted for

the costs of improvements and betterments made to the property.

Sec. 1016(a)(1); sec. 1.1016-2(a), Income Tax Regs.

     Petitioners paid $300,000 for 137 acres of the Antioch

property and sold 117 acres of the property in the transaction at

issue in this case.   Petitioners' original basis in the 117

acres, based on the $300,000 purchase price, is $256,204, as

conceded by respondent.   Petitioners also expended approximately

$30,000 in engineering and consulting costs to improve the 137

acres of the Antioch property.   We find that petitioners' basis

in the 117 acres of the Antioch property is $281,825, and their

gain realized is $3,687,175 ($3,969,000-$281,825).

Installment Method

     Petitioners argue that they are entitled to report any gain

that they must recognize from the sale of the Antioch property in
                              - 19 -


1990 under the installment method of section 453.   Section 453

permits taxpayers to report gain from the sale of property in the

year payment is received.   Payment includes amounts either

actually or constructively received by the taxpayer.    Sec.

15A.453-1(b)(3)(i), Temporary Income Tax Regs., 46 Fed. Reg.

10710 (Feb. 4, 1981).   Taxpayers are not entitled to report gain

under the installment method if they directly or indirectly

control the sales proceeds or receive the economic benefit

therefrom.   Roberts v. Commissioner, 643 F.2d 654, 656 (9th Cir.

1981) (citing Rushing v. Commissioner, 441 F.2d 593, 598 (5th

Cir. 1971), affg. 52 T.C. 888 (1969)), affg. 71 T.C. 311 (1978);

Estate of Silverman v. Commissioner, 98 T.C. 54, 64 (1992).

     Respondent contends that petitioners are not entitled to use

the installment sale method because petitioners constructively

received the sales proceeds and received economic benefits from

the proceeds in 1989.   Respondent argues that petitioners

obtained control over the sales proceeds when they were deposited

into the Clack Bros.' trust account.   The funds were used to make

earnest money deposits on replacement properties that petitioners

wanted to acquire, and petitioners negotiated the purchase price

on the properties.   Based on these facts, respondent contends

that petitioners directed how and when the sale proceeds were

spent and, thus, had control over the sales proceeds.

     Respondent argues that a seller cannot defer gain

recognition under the installment method by placing the purchase
                                - 20 -


price with a third party for payment to the seller in a later

year.     Respondent relies on a line of cases, including Griffith

v. Commissioner, 73 T.C. 933 (1980); Pozzi v. Commissioner, 49

T.C. 119 (1967); and Oden v. Commissioner, 56 T.C. 569 (1971),

among others, which found that the seller no longer looked to the

buyer for payment and expected to collect the sales proceeds from

a third-party source, such as an escrow account.    Petitioners,

however, argue that the cases cited by respondent did not involve

circumstances where substantial restrictions existed on the

seller's right to the third-party funds.    Money deposited in an

escrow account by a buyer is not deemed to be constructively

received by the seller if the seller's right to receive the funds

is subject to substantial limitations or restrictions.     Stiles v.

Commissioner, 69 T.C. 558, 563 (1978); Champy v. Commissioner,

T.C. Memo. 1994-355; see sec. 1.451-2, Income Tax Regs.

        Here, the exchange agreement provides that petitioners were

to transfer the Antioch property to Clack Bros. in exchange for

property to be identified by petitioners.    To accomplish this,

petitioners were to transfer title and assign the proceeds from

the option agreement on the Antioch property to Clack Bros.

Under the agreement, Clack Bros. would have became the seller;

however, petitioners did not follow the agreement in that they

retained title and transferred it directly to the purchaser.

Clack Bros. did receive the sales proceeds and deposited them

into the trust account.     Although the exchange agreement provided
                              - 21 -


that petitioners were not entitled to exercise control over the

sales proceeds and Clack Bros. was obligated to use the sales

proceeds to acquire replacement property designated by

petitioners, we do not find the agreement with Clack Bros. to be

a sufficient basis for finding a restriction on petitioners'

ability to use the proceeds of sale.

     Petitioners, as a guise, named 10 properties within the 45-

day period with no apparent intention to use them as replacement

properties.   When the replacement properties suitable to

petitioners were designated (after the 45-day period),

petitioners, with Clack's cooperation and participation,

backdated documents to make it appear that the properties had

been timely identified.   In this setting, we hold that

petitioners have failed to show that any restriction on their

ability to use the proceeds was sufficient to avoid constructive

receipt in 1989.   Accordingly, petitioners are not entitled to

installment reporting into the 1990 taxable year.

Fraud Penalty

     Section 6663(a) imposes a penalty equal to 75 percent of any

underpayment that is due to fraud.     Fraud is defined as an

intentional wrongdoing designed to evade tax believed to be

owing.   Edelson v. Commissioner, 829 F.2d 828, 833 (9th Cir.

1987), affg. T.C. Memo. 1986-223; Bradford v. Commissioner, 796

F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo. 1984-601.

Respondent has the burden of proving fraud by clear and
                              - 22 -


convincing evidence.   Sec. 7454(a); Rule 142(b).3    To satisfy

this burden, respondent must prove that petitioners intended to

evade taxes known to be owing by conduct intended to conceal,

mislead, or otherwise prevent the collection of taxes.      Rowlee v.

Commissioner, 80 T.C. 1111, 1123 (1983).

     The existence of fraud is a question of fact to be resolved

upon consideration of the entire record.   DiLeo v. Commissioner,

96 T.C. 858, 874 (1991), affd. 959 F.2d 16 (2d Cir. 1992); Estate

of Pittard v. Commissioner, 69 T.C. 391 (1977).      Fraud is never

presumed and must be established by independent evidence that

establishes fraudulent intent.   Edelson v. Commissioner, supra;

Beaver v. Commissioner, 55 T.C. 85, 92 (1970).    Fraud may be

proven by circumstantial evidence because direct evidence of the

taxpayer's fraudulent intent is seldom available.      Spies v.

United States, 317 U.S. 492 (1943); Rowlee v. Commissioner,

supra; Gajewski v. Commissioner, 67 T.C. 181, 199 (1976), affd.

without published opinion 578 F.2d 1383 (8th Cir. 1978).     The


     3
       Petitioners had raised the defense that the period for
assessment had expired when respondent issued the notice of
deficiency for the 1990 year. The 1990 year comes into play in
the context of this case if petitioners are entitled to
installment sale treatment. In that event respondent would also
have the burden of proving that an exception to the general
period of limitations applies. Stratton v. Commissioner, 54 T.C.
255, 289 (1970). That question is mooted by our holding that
petitioners are not entitled to installment reporting. Even if
petitioners had been successful on the installment reporting
issue, respondent has carried the burden of showing a fraudulent
return, and, therefore, the period for assessment would not have
expired prior to issuance of the deficiency notice. Sec.
6501(c)(1).
                              - 23 -


taxpayer's entire course of conduct may establish the requisite

fraudulent intent.   Stone v. Commissioner, 56 T.C. 213, 223-224

(1971); Otsuki v. Commissioner, 53 T.C. 96, 105-106 (1969).

     Courts have developed several indicia of fraud, or "badges

of fraud", which include:   (1) Understatement of income, (2)

inadequate books and records, (3) failure to file tax returns,

(4) implausible or inconsistent explanations of behavior, (5)

concealment of assets, (6) failure to cooperate with tax

authorities, (7) filing false Forms W-4, (8) failure to make

estimated tax payments, (9) dealing in cash, (10) engaging in

illegal activity, and (11) attempting to conceal illegal

activity.   Douge v. Commissioner, 899 F.2d 164, 168 (2d Cir.

1990); Bradford v. Commissioner, supra at 307; Recklitis v.

Commissioner, 91 T.C. 874, 910 (1988).    This list is

nonexclusive.   Miller v. Commissioner, 94 T.C. 316, 334 (1990).

     The strongest evidence of fraud in this case consists of the

false documents that petitioner husband prepared and solicited to

make it appear that petitioners expressed an interest in the

Pleasant Hill and Skyland properties within the identification

period.   Submitting false documents to the IRS is an indication

of fraud.   Stephenson v. Commissioner, 79 T.C. 995, 1007 (1982),

affd. 748 F.2d 331 (6th Cir. 1984); Association Cable TV, Inc. v.

Commissioner, T.C. Memo. 1995-596.

     Petitioners contend that their attorney Mr. Clack advised

them to obtain the false documents.    Petitioners maintain that
                              - 24 -


they relied on Mr. Clack's advice and that they did not know that

written identification was required and did not realize the

significance of the false, backdated letters.     We believe,

however, that petitioner husband initiated the idea of backdating

documents and falsifying identification and, more importantly,

that petitioners knew their misrepresentations were fraudulent.

     Mr. Clack maintains that it was petitioner husband's idea to

falsify documents.   In late October 1989, petitioner husband

suggested backdating and falsifying a purchase offer and contract

for another property not ultimately purchased by petitioners in

order to fraudulently obtain section 1031 tax deferral.     Mr.

Clack denies that he advised petitioners to falsify documents to

establish timely identification but admits that he assisted

petitioners in perpetuating this fraud.     Mr. Clack provided a

backdated sample letter that petitioners used in soliciting the

Pleasant Hill and Skyland letters.     Mr. Clack contends that he

believed that petitioners in fact had expressed an interest in

the Pleasant Hill and Skyland properties during September to Ms.

Love and Mr. Fivey and that he did not know that the letters were

false (other than being improperly backdated).     Petitioners

received the sample letter from Mr. Clack before they expressed

interest in acquiring Pleasant Hill or Skyland.     Most likely,

petitioners obtained the letter because they intended to create a

false impression that they had timely identified whatever

property they acquired.
                               - 25 -


     Petitioners had repeated discussions with their real estate

agents and Mr. Clack about the identification requirement and the

need to adequately identify replacement property.    Mr. Clack

advised petitioners of the need to acquire property that had been

identified during the 45-day period.    Mr. Van Voorhis and other

real estate agents counseled petitioners to have written

documentation of their identification.    When Mr. Van Voorhis

first showed Pleasant Hill to petitioners, he informed them that

it could not qualify as replacement property because it was not

timely identified.   A letter attached to the exchange agreement

clearly informed petitioners of the need to identify property

within 45 days of the sale of the Antioch property.

     We find in this setting petitioners cannot rely on Mr.

Clack's advice as an excuse for their fraudulent conduct.       They

knew their actions were fraudulent because of the repeated advice

they received.   Petitioners were not misled into committing fraud

by their attorney, as they contend.     See Medieval Attractions

N.V. v. Commissioner, T.C. Memo. 1996-455.     We consider it

probative that petitioner husband pleaded guilty to submitting

false documents to respondent's revenue agent in violation of

section 7207.    Although this conviction does not alone establish

fraudulent intent to evade taxes, it is evidence of petitioner

husband's intent and propensity to defraud.     Petzoldt v.

Commissioner, 92 T.C. 661, 701-702 (1989); Alvarez v.

Commissioner, T.C. Memo. 1995-414.
                                - 26 -


     Petitioners are highly successful, effective, and

sophisticated real estate investors.     They knew that they had not

timely identified Pleasant Hill or Skyland as replacement

property and that the transaction did not qualify as a section

1031 exchange.    Petitioners reported the transaction as a section

1031 exchange and knowingly and deceptively deferred tax on over

$3.5 million in taxable gain.    Petitioners willfully took steps

to disguise the taxable sale as a section 1031 exchange.

Petitioner husband knowingly solicited fabricated letters from

Mr. Fivey and Ms. Love.   He also knowingly intended to commit

fraud when he backdated a letter to Mr. Clack in which petitioner

husband purported to identify Pleasant Hill and Skyland.    It is

likely that petitioner husband intended this letter to replace

the Van Voorhis letter which identified 10 replacement

properties, not including either Pleasant Hill or Skyland.

Petitioners were involved in the preparation of these false

documents and presented them to their accountant and to the IRS

as part of their tax returns and in support of their reporting

during the audit.

     Petitioners argue the false documents were not fraudulent

because written identification was not required under section

1031(a)(3)(A) and the regulations thereunder during the years in

issue.   This case involved more than fabricated written

identification.   We have found that petitioners did not show any

interest in the Pleasant Hill property or the Skyland property
                                - 27 -


within the identification period, and we do not believe their

self-serving and uncorroborated testimony that, during the

identification period, they discussed these properties with each

other and decided to buy them.

     Although they knew that they had not identified Pleasant

Hill or Skyland even verbally, petitioners misrepresented to the

IRS that they had in fact identified the replacement property and

reported the transaction as a section 1031 exchange.      Petitioners

knew that they would owe a substantial amount of tax if they did

not timely identify replacement property.       The law is clear with

respect to this issue.   Petitioners fabricated timely

identification and obtained false documents to substantiate their

claim.   Petitioners knew that the letters were false and that

their tax returns were false.    The false letters, even if not

required for adequate identification, are evidence of fraud.      See

Association Cable TV, Inc. v. Commissioner, T.C. Memo. 1995-596.

     Petitioners' conduct presents clear and convincing evidence

of their intent to defraud.   Accordingly, petitioners are liable

for a section 6663 fraud penalty for 1989.

     To reflect the foregoing,

                                      Decisions will be entered

                                 under Rule 155 in docket No. 3832-

                                 95 and for petitioners in docket

                                 No. 7382-96.
