212 Corp. v. Comm'r of Internal Revenue
| Decision Date | 31 August 1978 |
| Docket Number | Docket Nos. 8683-74,8684-74. |
| Citation | 70 T.C. 788 |
| Parties | 212 CORPORATION, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENTESTATE of ARTHUR F. SCHULTZ, DECEASED, ROBERT C. SCHULTZ and HAROLD H. SCHULTZ, EXECUTORS, and MADELINE M. SCHULTZ, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
(1) H and W transferred appreciated real property to a corporation in exchange for an annuity. Held, the recoverable “investment in the contract,” as defined in sec. 72(c), I.R.C. 1954, is the fair market value of the property transferred; the fair market value of such property determined.
(2) Held, the gain resulting from the transfer of such properties is taxable to the transferors in the year of the exchange. Estate of Bell v. Commissioner, 60 T.C. 469 (1973), followed.
(3) Held, the bases and useful lives of the properties transferred determined for purposes of computing allowable depreciation. Joseph Getz and Robert N. Spaeder, for the petitioners.
Stephen R. Takeuchi, for the respondent.
The Commissioner determined the following deficiencies in the petitioners' Federal income taxes:
By an amendment to his answer, the Commissioner claimed increased deficiencies as follows:
In his amendment to the answer in docket No. 8684-74, the Commissioner claimed, in the alternative, increased deficiencies of $13,062.26 for 1968 and $3,637.36 for 1969.
The issues for decision are: (1) The amount to be treated as the investment in the contract by the individual petitioners in determining the taxability under section 72, I.R.C. 1954,1 of an annuity received by them in exchange for certain property; (2) the manner of reporting the gain realized by the individual petitioners on the transfer of such property; and (3) the cost basis and useful lives of the properties received by the corporate petitioner for the purpose of computing its depreciation deductions.
Some of the facts have been stipulated, and those facts are so found.
The petitioner in docket No. 8683-74 is 212 Corporation (212 Corp.), which had its principal place of business in Erie, Pa., at the time it filed its petition in this case. It filed its corporate Federal income tax returns for 1968 and 1969 with the Philadelphia Service Center.
The petition in docket No. 8684-74 was filed by Arthur F. Schultz and Madeline M. Schultz, his wife, who, on the date of the filing of such petition, resided in Erie, Pa. They filed their joint Federal income tax returns for 1968 and 1969 with the Philadelphia Service Center. After the filing of the petition, Mr. Schultz died; Robert C. Schultz and Harold H. Schultz were appointed executors of his estate, and the estate was substituted as a party in this case.
Prior to June 30, 1968, Arthur and Madeline Schultz owned the property commonly known as 212 East 18th Street, Erie, Pa. (the 18th Street property), consisting of several parcels of land, a building, and a fenced parking area. They also owned the property known as 3831 West 12th Street, Erie, Pa. (the 12th Street property), consisting of a lot and building. As of June 30, 1968, their adjusted basis in such properties was $82,520.57. By an “Agreement of Sale and Annuity Contract” dated June 30, 1968, Mr. and Mrs. Schultz agreed to transfer such properties to the 212 Corp. in exchange for such corporation's promise to pay to them jointly, or to the survivor of them, the sum of $18,243.74 per year. Mr. Schultz was born on April 3, 1895, and Mrs. Schultz was born on August 20, 1895; for actuarial purposes, both were 73 years of age on July 1, 1968.
On July 1, 1968, Mr. and Mrs. Schultz conveyed the properties to 212 Corp. On the same date, 212 Corp. leased the properties to the Arthur F. Schultz Co. (Schultz Co.). The lease for the 18th Street property was for a term of 5 years, commencing on July 1, 1968, at a yearly rental of $25,500, payable in installments of $2,125 per month. The lease for the 12th Street property also was for a period of 5 years, commencing July 1, 1968, at an annual rental of $2,400, payable in monthly installments of $200. Schultz Co. was granted three independent 5-year options to renew each lease at the expiration of the preceding term. Under the terms of both leases, Schultz Co. was responsible for all maintenance and repairs, both interior and exterior.
Prior to and during 1968, Schultz Co. was wholly owned by Mr. Schultz, who was the president and principal operating executive of Schultz Co. during such period. Schultz Co. was incorporated in 1946 and, since at least the 1960's, has been engaged in the business of retail sales of appliances and furniture and commercial sales of supplies and equipment to restaurants, hotels, and the like. From 1946 to 1970, the principal business office, warehouse, and largest retail outlet of Schultz Co. was located at the 18th Street property. From 1954 to 1972, one of the retail appliance store outlets was located at the 12th Street property. Prior to 1968, Schultz Co. had leased the properties from Mr. and Mrs. Schultz. Schultz Co. paid a gross yearly rental of $25,500 for the 18th Street property and a gross yearly rental of $2,400 for the 12th Street property under the terms of its leases with Mr. and Mrs. Schultz. However, under the terms of such leases, the lessor was responsible for repairs and maintenance.
The 212 Corp. was formed in 1968 and was owned by Robert C. Schultz (Robert) and Harold H. Schultz (Harold), the sons of Mr. and Mrs. Schultz, and Jerome H. Blakeslee (Jerome), who was the son-in-law of Mr. and Mrs. Schultz. The first meeting of 212 Corp. was held on July 15, 1968. At such meeting, Robert was elected president, Jerome was elected vice president, and Harold was elected secretary and treasurer of the corporation. Also at such meeting, the purchase of the 18th Street and 12th Street properties from Mr. and Mrs. Schultz was approved. It was agreed to pay for such properties with a joint survivor annuity payable to Mr. and Mrs. Schultz. The leases to the Schultz Co. also were approved. In 1968 and 1969, the three owners of 212 Corp. were the officers of the corporation, but received no compensation. There were no other employees.
The same attorney and the same certified public accountant had represented Mr. and Mrs. Schultz from at least 1960 through 1968. That attorney and CPA represented both Mr. and Mrs. Schultz and 212 Corp. in the negotiations relating to and consummation of: the transfer of the properties from Mr. and Mrs. Schultz to 212 Corp. by deed dated July 1, 1968; the lease agreement between 212 Corp. as lessor and Schultz Co. as lessee; and the annuity contract between 212 Corp. and Mr. and Mrs. Schultz. That attorney and CPA also represented Robert, Harold, and Jerome in the formation and incorporation of 212 Corp.
The transactions involved in this case were all part of a plan proposed by the CPA in order to effect income and estate tax plans for Mr. and Mrs. Schultz. The original plan submitted by the CPA to Mr. Schultz, on January 16, 1968, proposed a transfer of only the 18th Street property for a consideration of $200,000. Mr. Schultz had in mind a price of $200,000 for the property because he had received an offer to purchase such property at such price from the Prudential Insurance Co. in 1952.
In 1952, the area surrounding the 18th Street property was a good business neighborhood. However, from 1952 through 1968, such neighborhood had declined drastically and had become a ghetto area, making it necessary to institute certain security measures to protect both the customers of Schultz Co. and the property itself. Yet, despite the neighborhood, Schultz Co. was able to continue to operate successfully at such location. Moreover, in 1968, there were plans to restore and rehabilitate the area under the model cities plan. The building at 18th Street was four stories high. It was constructed in 1903; it had originally been used for manufacturing, but had been converted by Schultz Co. to a combination warehouse and commercial and retail outlet. The building had been well maintained and was in good condition.
The discussions leading to the transfer of the properties began in March of 1968, when Mr. Schultz met with Robert, Harold, and Jerome. At such meeting, he stated that he was thinking of selling the 18th Street property and asked the others if they were interested in buying it. Mr. Schultz stated that he had a plan whereby the property would be transferred to a separate corporation to be owned by Robert, Harold, and Jerome. According to the plan, Schultz Co. would rent the property from such corporation, and the corporation would use the rentals to pay Mr. Schultz for the property and to pay taxes and insurance. However, at such time, Mr. Schultz did not give the others a copy of the plan proposed by his CPA.2 Mr. Schultz told Robert, Harold, and Jerome that if they were interested in purchasing the property, they should meet with his attorney, who would explain the details of the plan.
Early in April 1968, Robert, Harold, and Jerome met with the attorney, who outlined to them the details of the plan. They were interested in the plan, but believed that the 12th Street property also should be conveyed to them, so that Schultz Co. would be renting from one landlord. They were particularly...
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