2925 Briarpark, Ltd. v. C.I.R., 97-60850

• Decision Date: 06 January 1999
• Docket Number: No. 97-60850,97-60850
• Parties: -312, 99-1 USTC P 50,209 2925 BRIARPARK, LTD., James C. Motley, Tax Matters Partner, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 313

163 F.3d 313

83 A.F.T.R.2d 99-312, 99-1 USTC P 50,209

2925 BRIARPARK, LTD., James C. Motley, Tax Matters Partner Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 97-60850.

United States Court of Appeals Fifth Circuit.

Jan. 6, 1999.

Alan Lee Tinsley, Madisonville, TX, Charles Benjamin Koerth, Allie & Thurmond, Houston, TX, for Petitioners-Appellants.

Patricia McDonald Bowman, U.S. Dept. of Justice, Tax Div., Charles Casazza, Clerk, U.S. Tax Court, Washington, DC, Stuart L. Brown, Chief Counsel, IRS, Loretta Argrett, Asst. Atty. Gen., Teresa Ellen McLaughlin, U.S. Dept. of Justice, Tax Div., App. Section, Washington, DC, for Respondent-Appellee.

Appeal from the Decision of the United States Tax Court.

Before REYNALDO G. GARZA, STEWART and PARKER, Circuit Judges.

PER CURIAM:

I. FACTUAL AND PROCEDURAL BACKGROUND

In 1981, Briarpark was organized as a Texas limited partnership ("the partnership"). James C. Motley ("Motley") was a general partner. During 1983 and 1984, the partnership acquired a three-acre parcel of land at 2925 Briarpark Road, Houston, Texas ("the property") and constructed a 12-story office building on it. On September 27, 1983, the partnership borrowed $21,600,000 from InterFirst Bank Houston, N.A. ("InterFirst") to finance the acquisition of the property and the construction of the building. Motley personally guaranteed the principal, interest, penalties and fees on the loan.

By December 31, 1986, the outstanding principal and accrued interest due on the loan was $24,700,000. On May 28, 1987, the partnership and InterFirst modified and extended the original loan pursuant to a modified loan agreement. At the time, InterFirst estimated that the fair market value of the property was approximately $17,000,000. The original loan was converted from a recourse to a nonrecourse obligation, and accrued but unpaid interest in the amount of $3,100,000 was capitalized. Motley's personal obligation under his guarantee was limited to $5,000,000. Also on May 28, 1987, Briarpark obtained a $1,500,000 loan for tenant improvements ("build-out loan") on a nonrecourse basis.

By January 21, 1988, First Republic Bank Houston, N.A. ("First Republic") became the successor in interest to InterFirst. The Federal Deposit Insurance Corporation, as receiver for First Republic, assigned the modified loan and the built-out loan to NCNB Texas National Bank ("NCNB").

During March of 1989, Briarpark submitted an application to NCNB seeking to modify the loans to allow a cash sale of the building. In the summer of 1988, at the suggestion of the bank, Motley placed the building on the market, and in March of 1989, he brought to the bank several similar proposals for the sale of the property. At that time, the bank considered as available options: (1) liquidation in the event of a default (but at that time there was no default); (2) refinancing (which was not an "easily obtained alternative at the level of the debt"); and (3) a sale/settlement, the loan officer expressing the view that "the bank will realize the highest value if the building is sold in 1989." In NCNB's view, the best proposal was a $12,700,000 cash sale offer.

As of July 1989, Briarpark was in default on the loans. On July 21, 1989, the partnership signed a sale agreement to sell the property to Dan Associates. The gross purchase price for the property was $12,200,000. Dan Associates conditioned the purchase of the property upon the partnership's arranging the satisfaction or removal of the encumbrances for consideration paid to NCNB not in excess of $11,490,000. On July 31, 1989, NCNB agreed to release its liens to allow the sale of the property to Dan Associates for $12,200,000, with the proceeds being assigned to NCNB.

On October 5, 1989, Briarpark and Dan Associates amended the sale agreement, reducing the gross sale price to $11,600,000. Under the amended agreement, Briarpark was required to arrange for the satisfaction of the loans and removal of the encumbrances for consideration not exceeding $11,036,000 plus a $175,000 payment by Motley in settlement of his guarantee.

On October 11, 1989, Motley's liabilities exceeded his assets by $13,497,675. On October 16, 1989, NCNB agreed to allow the cash sale of the property for $11,600,000 and to settle with Motley on his guarantee for $175,000.

On November 3, 1989, Briarpark, Motley, Dan Associates, and NCNB entered into a conditional release agreement. NCNB agreed to release the property from all liens and security interests upon satisfaction of the following conditions: (1) the sale of the property to Dan Associates for a minimum gross sales price of $11,600,000; (2) the assignment of the greater of the net sale proceeds or $11,036,000 sale proceeds to the bank, to be applied against the partnership's cash notes; (3) the transfer of the partnership's cash reserves to the bank; and (4) Motley's payment of $175,000 to the bank.

On December 27, 1989, the outstanding balances of the modified and the build-out loan were $24,562,763 and $1,019,418, respectively. Briarpark sold the property to Dan Associates for $11,600,000. Briarpark incurred selling expenses of $554,901. Dan Associates paid the net sales proceeds of $10,936,532 to NCNB. The adjusted basis of the property was $11,105,733.

Also on December 27, 1989, NCNB released the liens against the property and released Motley from his guarantee of the modified loan, in return for his payment of $175,000 in cash. The partnership transferred its cash reserves of $177,495 to NCNB. As of December 31, 1989, Briarpark had no assets and ceased business operations.

On its income tax return for 1989, Briarpark reported cancellation of indebtedness income for $14,468,154 as a result of the November 3, 1989, conditional release agreement. The reported amount was calculated as follows:

Modified loan balance $24,562,763

Build-out loan balance 1,019,418

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Total loan Balance $25,582,181

Less sale proceed from Dan Associates 10,936,532>

Less cash reserves paid to NCNB 177,495>

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Net cancellation of indebtedness income $14,468,154

The partnership also reported a net loss on the sale of the property in the amount of $61,245.

Upon audit, the Commissioner determined that the property incorrectly reported discharge of indebtedness income under I.R.C. § 61(a)(12) on its return. The Commissioner asserts that the partnership realized a gain from dealings in property under I.R.C. § 61(a)(3) because the amount of the discharged debt that had encumbered the property was includable in the amount realized. The Internal Revenue Service mailed to the partnership a Notice of Final Partnership Administrative Adjustment ("FPAA") proposing adjustments to the partnership's return to reflect realized gain from the sale of $13,920,936, rather than the reported loss of $61,245 and to eliminate the reported cancellation of indebtedness income. ¹ Pursuant to the parties' stipulation, the Commissioner calculated the partnership's capital gain as follows:

The Tax Court agreed with the Commissioner that the partnership had realized gains from dealings in property under I.R.C. § 61(a)(3) rather than discharge of indebtedness income under § 61(a)(12). The court noted that, for purposes of §§ 61(a)(3) and 1001(b), "the amount realized from a sale or other disposition of property includes the amount of liabilities from which the transferor is discharged as a result of the sale or disposition." The court found that the sale of the property and the assignment of sale proceeds and transfer of the partnership's cash reserves to NCNB "has the same practical effect as several other transactions which have been held to be a 'sale or exchange.' " According to the court, the transaction at issue "is the functional equivalent of a foreclosure, reconveyance in lieu of foreclosure, abandonment, or repossession" because "the mortgagor in each case is relieved of debt encumbering property and also is relieved of the obligation to pay taxes and assessments against the property."

The court rejected the partnership's argument that NCNB should be regarded as having forgiven, independently of the sale, the excess of the $25,582,181 debt over the $11,114,027 in cash received. Thus, the court disagreed with the partnership's assertion that amount realized on the sale of the property to Dan Associates was only $10,936,532, or less than the partnership's adjusted basis in the property. Far from being "two independent events," as the partnership argued, the court found the record to be "replete with evidence" that the sale and the loan discharges were the "result of a single transaction involving the sale of encumbered property." The court reasoned as follows:

NCNB conditioned the discharge of the loans upon the sale of the property, and Dan Associates conditioned the purchase upon that discharge. At the end of the day, NCNB had proceeds from the sale, Dan Associates had the property, and Briarpark was relieved of the entire balance of the loans. In the foregoing context, the arrangements among NCNB, Dan Associates, and Briarpark embodied a single transaction to sell the property securing the loans.

This appeal followed.

II. STANDARD OF REVIEW

The Tax Court's fact findings are reviewed for clear error because they were based on documentary evidence presented to the court. See Pacific Employers Ins. Co. v. M/V Gloria, 767 F.2d 229, 235 (5th Cir.1985)(citing Anderson v. Bessemer City, 470 U.S. 564, 574, 105 S.Ct. 1504, 84 L.Ed.2d 518 (1985)). A finding is clearly erroneous when the reviewing court, upon reviewing all of the evidence, is left with a firm conviction that a mistake has been committed. Daniels Towing Service, Inc. v. Nat Harrison Associates, Inc., 432 F.2d 103, 105 (5th Cir.1970)(citing McAllister v. United States, 348 U.S. 19, 20, 75 S.Ct. 6, 99 L.Ed. 20 (1954)). In reviewing the Tax Court's characterization of the...