valorem taxes, to an escrow agent, Francis M. Lewis (Lewis).1

Also on November 29, 1994, petitioner and Rayonier executed a "MEMORANDUM OF CONTRACT", reciting that they had as of that date entered into the timber contract (referred to in the Memorandum of Contract as a "Timber Indenture Agreement"), whereby petitioner had conveyed to Rayonier:

All merchantable pine and hardwood timber suitable for poles, sawtimber, or pulpwood, which are located within *** [the 95 acres].

And, subject to the provisions of *** [the timber contract], the right to cut and remove from the above-described lands all and singular of the said described trees and timber.

Petitioner recorded this memorandum of contract (but apparently not the timber contract) in the real property deed records of Laurens County, Georgia.

Also on November 29, 1994, petitioner and Rayonier executed a "TAX FREE EXCHANGE AGREEMENT". This agreement provides in relevant part:

WHEREAS, ** * [Rayonier] and *** [petitioner] have entered into an Agreement for the purchase of timber wherein *** [petitioner] has agreed to sell to *** [Rayonier] and * * * [Rayonier] has agreed to purchase from * * * [petitioner] certain timber growing on property of * * * [petitioner]; and

WHEREAS, * ** [Rayonier] has agreed to cooperate with * * * [petitioner] in the effectuation of a tax free exchange, pursuant to Section 1031 of the Internal Revenue Code; and

***

WHEREAS, certain property will be designated by *** [petitioner] to be acquired for the purpose of an exchange within one hundred eighty (180) days of the sale of the timber by [petitioner] to *** [Rayonier] and an escrow agent will be designated by *** [petitioner] to receive and hold the monies from the sale as allowed by Section 1031 of the Internal Revenue Code; and

NOW, THEREFORE, for and in consideration of the mutual benefits and detriments to the Parties, IT IS AGREED AS FOLLOWS:

*

1.

The Parties hereto agree that the sell [sic] of the timber by * * * [petitioner] to ** [Rayonier] is expressly conditioned upon reasonable cooperation and a tax free exchange qualifying under Section 1031 of the Internal Revenue Code, and all Parties to this Agreement agree to

1 Francis M. Lewis is an attorney licensed to practice in the State of Georgia. He performed no services for petitioner during the 2-year period preceding Nov. 29, 1994, and is not related to petitioner.

cooperate to the extent set forth herein. The acquisition by * * * [Rayonier] of the timber and the acquisition by *** [petitioner] of the property to be designated are intended to be mutually interdependent transactions for the purpose of qualifying under Section 1031 of the Internal Revenue Code.

2.

*** [Rayonier] shall upon the closing of the sale of the timber transaction between *** [Rayonier] and * * * [petitioner] pay the total purchase price due for said timber to Francis M. Lewis, Escrow Agent, and not to *** ** [petitioner].

Also on November 29, 1994, petitioner, Rayonier, and Lewis executed an escrow agreement. The agreement states that petitioner "intends for his exchange under * * * [the timber contract] to permit *** [petitioner] to report the receipt of the exchange property under the income tax deferral rules of Section 1031(a) of the Internal Revenue Code”. The escrow agreement provides that on the closing of the timber contract, Rayonier will deliver to Lewis the net purchase price ($517,076 less $12,141 ad valorem taxes) to be held in escrow and paid out as provided in the escrow agreement. The escrow agreement (wherein petitioner is referred to as seller and Rayonier is referred to as purchaser) further provides in part:

3.

Seller will designate certain real estate referred to in a Tax Free Exchange Agreement between Purchaser and Seller, which shall be acquired by Purchaser and transferred to Purchaser. The Escrow Agent agrees to apply the funds toward the purchase of the property as directed by the Purchaser.

6.

Title to the exchange property shall be acquired in the name of the Escrow Agent, as Agent for the Purchaser, and then conveyed by Escrow Agent to Seller. In the event the costs of acquiring and thereafter conveying the exchange property can be reduced by a direct transfer from the Seller [sic] of the exchange property to Seller, the Escrow Agent may arrange for a direct transfer to Seller upon receipt by Escrow Agent of a request from Seller.

7.

In no event shall Seller have use or control of the funds contained in escrow on or before termination of said escrow. Seller shall not have the right to sell, assign, transfer, encumber or in any other manner anticipate or dispose of his interest in said escrow until the same is actually paid over to and received by Seller.

Pursuant to the escrow agreement and the timber contract, on November 29, 1994, Lewis received from Rayonier net proceeds of $504,935 (the escrow funds), which he deposited

into a checking account at Farmers & Merchants Bank in Dublin, Georgia. By three separate letters, dated December 18, 1994, December 21, 1994, and January 2, 1995, petitioner identified to Lewis as replacement properties three parcels of land (the replacement properties), ownership of each of which was transferred directly to petitioner by warranty deed from the respective owners as follows:

1 The parties have stipulated that the land contained 316.82 acres, although the letter to Lewis states that the property contains 312 acres. To the extent there is a discrepancy, it is immaterial to the result reached herein.

The replacement properties are all within 30 miles of the 95 acres. When petitioner acquired these replacement properties, they all contained standing timber that accounted for a significant part of their value.

The purchase of these three replacement properties exhausted all but $205.45 of the escrow funds. By check dated May 9, 1995, Lewis paid petitioner the $205.45 bal

ance.

Petitioners are cash basis taxpayers. On their joint 1994 Federal income tax return, filed on or about April 15, 1995, they characterized the subject transaction as a like-kind exchange of "Timber" for "Timber and Land", giving rise to $496,076 realized gain, all of which they treated as deferred gain pursuant to section 1031.

In the notice of deficiency, dated December 4, 1997, respondent determined that petitioners realized gain of $489,935, instead of $496,076, from their 1994 timber sale.2 The notice of deficiency states that "the realized gain from the sale of the timber is to be fully recognized [in 1994] because it has not been established that the requirements of section 1031 of the Internal Revenue Code have been met."

2 The parties have stipulated that petitioner's basis in the timber conveyed to Rayonier was $3,200. On brief, respondent contends that after subtracting this basis, the amount of petitioners' realized gain is $486,735.

A. The Parties' Contentions

OPINION

1. The Like-Kind Exchange Requirement

Petitioners argue that to continue petitioner's timber investment, he exchanged standing timber for standing timber that necessarily had to have land attached. Petitioners argue that under applicable Georgia law, both the relinquished property and property and the replacement property are characterized as real property interests, and that under Commissioner v. Crichton, 122 F.2d 181 (5th Cir. 1941), affg. 42 B.T.A. 490 (1940), the subject transaction qualifies as a tax-deferred like-kind exchange within the meaning of section 1031.

Respondent argues that under Georgia law, the 2-year timber cutting contract was personal property and thus not of like kind to the replacement real property. In addition, relying on Oregon Lumber Co. v. Commissioner, 20 T.C. 192 (1953), respondent argues that regardless of how the property interests may be characterized under State law, the property relinquished and the properties received differ so intrinsically that they are not of like kind within the meaning of section 1031.3

2. Petitioners' Alternative Argument: Lack of Actual or Constructive Receipt in 1994

On brief, petitioners raise an alternative argument that regardless of whether the subject transaction qualifies as a like-kind exchange, respondent has erroneously determined that they realized income from the transaction in 1994. Relying on section 1.1031(k)-1(g)(3) and (j), Income Tax Regs., petitioners argue that they realized no gain in 1994 because they had no actual or constructive receipt of property in 1994.

3 Respondent does not dispute that petitioners have met all other requirements for a nontaxable exchange of property held for productive use in a trade or business or for investment within the meaning of sec. 1031. In particular, respondent does not dispute that petitioner's transaction with Rayonier constituted an “exchange" within the meaning of sec. 1031 or that petitioners have satisfied the requirements of sec. 1031(a)(3), which in the case of a nonsimultaneous exchange generally requires that the replacement property be identified no more than 45 days after, and the exchange be completed no more than 180 days after, the transfer of the relinquished property.

Respondent contends that petitioners have improperly raised this issue for the first time on brief. Respondent alleges, and petitioners do not dispute, that the 3-year limitations period for respondent to assess tax for taxable year 1995 ran shortly after the trial date of this case and shortly before the date respondent received a copy of petitioners' brief. Respondent contends that because of this circumstance, he is "especially prejudiced" by petitioners' delay in raising their alternative arguments.

In a memorandum filed with the Court in response to respondent's arguments on reply brief, petitioners argue that they raised what they characterize as the "receipt issue" frequently before and during trial. In their memorandum, petitioners catalog various references in their petition, their trial memorandum, the parties' stipulations of facts, and statements at trial to arguments or facts or circumstances in support of arguments that in 1994 petitioner never received or had access to or control over any moneys incident to the exchange in question.

B. Lack of Prejudice to Respondent in Addressing Actual or Constructive Receipt

A party may rely on a theory only if it provides the opposing party fair warning so that the opposing party is not prejudiced in its ability to prepare its case. See Pagel, Inc. v. Commissioner, 91 T.C. 200, 211 (1988), affd. 905 F.2d 1190 (8th Cir. 1990). Accordingly, a party may not raise an issue for the first time on brief where surprise and prejudice are found to exist. See Seligman v. Commissioner, 84 T.C. 191, 198-199 (1985), affd. 796 F.2d 116 (5th Cir. 1986). The general rule against raising new issues on brief is not absolute, being "founded upon the exercise of judicial discretion in determining whether considerations of surprise and prejudice require that a party be protected from having to face a belated confrontation which precludes or limits that party's opportunity to present pertinent evidence." Ware v. Commissioner, 92 T.C. 1267, 1268 (1989), affd. 906 F.2d 62 (2d Cir. 1990).

Respondent does not contend that he has been prejudiced in developing or presenting evidence regarding petitioners' alternative argument. In respondent's reply brief, respond