## Facts

- William P. Adams, a California taxpayer, bought a San Francisco house in 1963, lived there until 1979, then continuously rented it through 2003 while making improvements.
- In June 2004, Adams sold the San Francisco rental house and, using a qualified intermediary, acquired a replacement house in Eureka, California, intending a like-kind exchange under I.R.C. § 1031.
- The Eureka house was in poor condition; Adams’s adult son (“Bill”) and Bill’s family performed substantial repairs and improvements to make it habitable.
- From July–September 2004, Bill’s family lived in the Eureka house rent-free while working roughly 60 hours per week on renovations; Adams treated the services as consideration in lieu of cash rent.
- Beginning October 2004, Bill paid $1,200 per month in rent (below market), while continuing to renovate, repair, and maintain the property through early 2008.
- On his 2004 return, Adams reported no gain on the San Francisco sale, treating the exchange as fully qualifying under § 1031.
- The IRS issued a notice of deficiency for 2004, asserting the exchange failed § 1031 (replacement property allegedly held for personal reasons), disputing rental and business items, and asserting additions to tax under §§ 6651(a)(1), 6651(a)(2), and 6654(a).
- Adams petitioned the Tax Court for redetermination.

## Issues

1. Whether the June 2004 disposition of the San Francisco rental house and acquisition of the Eureka house qualified for nonrecognition as a like-kind exchange under I.R.C. § 1031.
2. What amount of rental income and rental deductions Adams had for 2004.
3. What amount of deductible expenses Adams substantiated for his electrical-safety consulting business for 2004.
4. Whether Adams was liable for additions to tax under §§ 6651(a)(1), 6651(a)(2), and 6654(a).

## Decision

- The court held the transaction qualified for § 1031 nonrecognition because Adams intended, at the time of exchange, to hold the Eureka house for rental/investment purposes.
- The court found Adams received $7,200 of rental income in 2004 and allowed $1,054 of related rental deductions.
- The court allowed $4,416.07 of deductions for Adams’s electrical-safety consulting business, yielding $6,458.93 of taxable income from that activity.
- The court sustained additions to tax under §§ 6651(a)(1) and 6651(a)(2).
- The court sustained the § 6654(a) estimated-tax addition unless Rule 155 computations showed an exception under § 6654(e)(1).

## Legal Principles

- For § 1031, the “held for productive use in a trade or business or for investment” requirement for replacement property turns on the taxpayer’s intent at the time of the exchange, evaluated from objective evidence.
- Related-party rental and below-market cash rent do not, by themselves, convert replacement property into personal-use property; non-cash consideration (such as substantial renovation services) may be treated as part of the rental arrangement when it reflects fair rental value.
- Deductions for rental and business expenses are allowed only to the extent substantiated and shown to be allowable under the Internal Revenue Code (including ordinary and necessary business expense rules).
- Additions to tax under §§ 6651(a)(1) and 6651(a)(2) apply absent proof of reasonable cause and lack of willful neglect.
- The § 6654(a) estimated-tax addition is generally mandatory unless a statutory exception applies (including the possible exception under § 6654(e)(1)).

## Conclusion

The Tax Court concluded Adams’s exchange qualified under § 1031 because the replacement property was held for rental/investment use notwithstanding related-party occupancy and reduced cash rent offset by renovation services, but it still imposed most asserted additions to tax and adjusted rental and business items based on substantiation.


Adams v. Commissioner, T.C. Memo. 2013-7 (2013)