Chad A. and Katherine J. Lincoln - Page 4

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               In the notice of deficiency, respondent determined that                
          petitioners failed to meet the requirements for a section 1031              
          exchange and included in petitioners’ income capital gain from              
          the sale of the Pacific Grove property.  Respondent also                    
          reallocated certain interest and tax expenses attributable to the           
          Big Sur property from Schedule E (expenses of rental real estate)           
          to Schedule A (itemized deductions).                                        

          Section 1031 Exchange                                                       
               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) contains an exception to this general rule:              

                    (1) In general.--No gain or loss shall be recognized on           
               the exchange of property held for productive use in a trade            
               or business or for investment if such property is exchanged            
               solely for property of like kind which is to be held either            
               for productive use in a trade or business or for investment.           

               The purpose of section 1031 is to defer recognition of gain            
          or loss when an exchange of like-kind property takes place                  
          between a taxpayer and another party.  Coastal Terminals, Inc. v.           
          United States, 320 F.2d 333, 337 (4th Cir. 1963).  The basic                
          reason for this tax treatment is that the exchange does not                 
          materially alter the taxpayer’s economic situation, the property            
          received in the exchange being viewed as a continuation of the              
          old investment still unliquidated.  Koch v. Commissioner, 71 T.C.           

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