59 T.C. 760 (1973), 5033-68, Bolger v.

Docket Nº:5033-68, 5755-68.
Citation:59 T.C. 760
Opinion Judge:TANNENWALD, Judge:
Attorney:C.J. Queenan, Jr., D. L. Ketter, Alan H. Finegold, and Allan McClain, for the petitioners. John J. O'Toole, for the respondent.
Judge Panel:Wiles, J., agrees with this dissent. SCOTT, J., dissenting: GOFFE, J., agrees with this dissent.QUEALY, J., dissenting: GOFFE, J., agrees with this dissent.GOFFE, J., dissenting:
Case Date:March 08, 1973
Court:United States Tax Court

Page 760

59 T.C. 760 (1973)


Nos. 5033-68, 5755-68.

United States Tax Court

March 8, 1973

C.J. Queenan, Jr., D. L. Ketter, Alan H. Finegold, and Allan McClain, for the petitioners.

John J. O'Toole, for the respondent.

Corporations were organized to acquire title to properties, issue promissory notes secured by mortgages, and execute leases in order to provide maximum financing by avoiding State law restrictions on loans to individuals, to provide a mechanism for limiting the personal liability of such individuals, and to facilitate multiple-lender financing. Upon the consummation of the foregoing transactions, the corporations immediately transferred the properties to the individuals, subject to the mortgages and leases but without such individuals assuming any personal liability. Each corporation was required to be continued in existence so long as any obligation of the mortgage note remained unpaid. Held, the corporations were at all times viable entities for tax purposes and were not agents or nominees of the individuals in respect of the underlying transactions. Moline Properties v. Commissioner, 319 U.S. 436 (1943); National Carbide Corp. v. Commissioner, 336 U.S. 422 (1949). Held, further, by virtue of the transfers by the corporations to the individuals, the latter (of which petitioner was one) acquired a depreciable interest in the properties, and, in each instance, the unpaid balance of the mortgage at the time of such transfer is includable in the basis of the property for purposes of depreciation. Crane v. Commissioner, 331 U.S. 1 (1947).

Page 761


Respondent determined the following deficiencies in petitioners' income tax:

Year Deficiency
1963 $13,153.44
1964 $22,596.75
1965 $30,512.00
1966 $90,186.00
Certain concessions having been made, the only issue remaining for our consideration is whether petitioners are entitled to deductions for depreciation on account of certain real and personal property under the circumstances set forth herein. A decision with respect to this issue governs the allowability of rental and interest expenses and the investment credits claimed by petitioners. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation and exhibits attached thereto are incorporated herein by this reference. David F. Bolger (hereinafter referred to as the petitioner) and Barbara A. Bolger are husband and wife whose legal residence was Ridgewood, N.J., at the time the petitions herein were filed. Joint returns for the years in question were filed with the district director of internal revenue for the Manhattan District, New York. Petitioner Barbara A. Bolger is a party herein solely because she filed joint returns with her husband for the years in question. During the years in question, petitioner was actively engaged in real estate investment and finance. As a result of his experience, he became familiar with the intricacies of various real estate transactions, one form of which is the subject herein. Petitioner's modus operandi was generally the same for all 10 transactions challenged by respondent. Typically, petitioner would form a financing corporation with an initial capitalization of $1,000. The shareholders consisted of those individuals who would ultimately receive title to the property, as explained infra. Petitioner would then arrange to have the corporation purchase a building which some other manufacturing or commercial concern (hereinafter referred to as the user) desired to lease; on occasion, the seller was the user itself. Then within several days, and, more often, on the same day, all of the following transactions would take place: (1) The seller would convey the property to the financing corporation; (2) the financing corporation would enter into a lease with the user; and (3) the financing corporation would then sell its own negotiable interest-bearing corporate notes in an amount equal to the purchase price to an institutional lender (or lenders, as the case might be) pursuant to a note purchase agreement (as the document was usually called), which would provide that the notes be secured by Page 762 a first mortgage (which sometimes took the form of a deed of trust), and by an assignment of the lease. The mortgage notes provided for payment to be made over a period equal to or less than the primary term of the lease and the financing corporation was also obligated to pay for all of the lender's out-of-pocket expenses, including legal fees. The mortgage was a lengthy, detailed document covering almost every conceivable contingency. It spelled out in great detail the terms of payment and right of prepayment, the rights of the parties in case of default, and the responsibilities and limitations of the financing corporation under the agreement. More specifically, the corporation promised to maintain its existence and to refrain from any business activity whatsoever except that which arose out of the ownership and leasing of the property. Payments by the lessee were to be made directly to the mortgagee (or trustee) in satisfaction of payments on the secured notes. Moneys received under the lease were to be first applied to payment on the mortgage notes with the remainder to be paid over to the financing corporation. Provision was made as to the circumstances under which the corporation could sell or transfer the property, the transferee being required to assume all obligations under the mortgage and lease except that the transferee assumed no personal financial obligation for the payment of principal and interest or any other monetary judgment, liability on such assumption being limited to the property transferred. The transferee was also required to compel the financing corporation to maintain its existence, prevent it from engaging in any business other than that arising out of the property and lease thereon, cause such corporation to maintain books available for inspection by the mortgagee, and prevent any merger or consolidation by such corporation with any other corporation. The lease was for a primary term at least equal to, and, on occasion, in excess of, the period of the mortgage note. Provision was also made for payment by the lessee of all taxes, insurance, repairs, etc., and all costs of acquisition save the purchase price incurred by the lessor- i.e., it was a net lease. The lessee's right and interest in the property, easements, or appurtenances were subordinated to the mortgage. Payments under the lease were to continue even if the building was destroyed; the lessee had the right to purchase the property in such event for a price set in accordance with a schedule attached to the lease which approximated the amount required from the lessor to prepay the note. Refusal to accept the offer of purchase would result in the termination of the lease. The lessee further agreed to indemnify the lessor from any liability resulting from any occurrence on the premises or because of the work being done on the premises by the lessee. The lessee was permitted to sublease the premises or any portion thereof, and he was permitted to assign his interest in the lease, providing Page 763 the sublessee or assignee promised to comply with the terms of the mortgage and the lease and further providing the lessee remain personally liable for the performance of all its obligations under the lease. Upon the completion of the foregoing, the financing corporation would convey the property to its shareholders for ‘ One dollar and other valuable consideration,‘ subject to the lease and the mortgage and without any cash payment or promise thereof by the transferee. Concurrently, the transferee would execute an assumption agreement in favor of the financing corporation, promising to assume all of the financing corporation's obligations under the lease and the mortgage but limited as aforesaid. The particulars of the various transactions, insofar as they are material to the within case, are summarized in the following chart and the qualifications thereafter set forth:
Property and Nature of Purchase Financing Lessee base Lease renewal Annual
(financing improvement price term term rental
corporation) (years)
Colton, Cal. Bank bldg- $250,835 $250,000- American 26 3 successive ,048.45
(Stonbernardino secured National 10-year
Properties, by 5% terms at
Inc.) mortgage $5,000
notes annually
Silver Spring, Warehouse- 215,000 $215,000- Beckman 28 4 successive 14,835.00
Md. (Instrument secured Properties, 5-year
Properties, by 5.25% Inc. terms at
Inc.) secured $5,375
notes annually
Kinney Shoe Stores__- 1,355,500 $1,355,500- Kinney 25 3 successive 93,528.00
(Janess secured Shoe 5-year
Properties, by 5% Affiliates terms at
Inc) mortgage $37,413
notes annually
Muskegon, Bank 1,650,000 $1,650,000- National 30 5 successive 107,055.00
Mich. bldg. secured Lumberman's 5-year
(Georgiana by 5.25% Bank terms at
Properties, mortgage reduced
Inc.) notes rent at %
of cost
San Antonio, Warehouse 370,000 $370,000- Shop-Rite 20 4 successive 36,340.00
Texas secured Foods, 5-year
(Andrean by 5.20% Inc. terms at
Properties, secured reduced
Inc.) notes rent at %
of cost
Rockford, III. Factory 935,000 $935,000- National 25 4 successive 65,544.00

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