64 T.C. 752 (1975), 2126-73, Estate of Franklin v. Commissioner of Internal Revenue
|Citation:||64 T.C. 752|
|Opinion Judge:||FEATHERSTON, Judge:|
|Party Name:||ESTATE OF CHARLES T. FRANKLIN, DECEASED, SOUTHERN CALIFORNIA FIRST NATIONAL BANK, TRUST DEPARTMENT, EXECUTOR, AND MARGARET A. FRANKLIN, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT|
|Attorney:||Charles A. Pinney, Jr., Robert P. Simpson, William M. Schindler, and Richard L. Kintz, for the petitioners. Robert E. Casey, for the respondent.|
|Case Date:||July 30, 1975|
|Court:||United States Tax Court|
The owner of certain motel property entered into several agreements purporting to sell such property to a limited partnership, of which the deceased taxpayer was a member, and to lease the property back from the partnership. Thereafter, the taxpayers claimed as loss deductions their distributive share of the excess of the interest on the purchase price stated in the sales agreement plus depreciation deductions on the property over the rent specified in the lease. Held, the partnership obligations defined in the aforesaid agreements are not sufficiently definite and unconditional to constitute indebtedness on which interest is allowable as a deduction under sec. 163(a), I.R.C. 1954, or cost basis for depreciation deduction purposes under sec. 167(g), I.R.C. 1954.
Respondent determined the following deficiencies in Federal income tax due from the Estate of Charles T. Franklin, deceased, and Mrs. Margaret A. Franklin, petitioners:
Certain concessions having been made, only one issue remains for our resolution: Are petitioners entitled to deductions for their distributive share of the losses reported by a limited partnership which entered into a contract with respect to the acquisition of a motel and related property? The answer depends on whether the obligations undertaken by the partnership were sufficiently definite and unqualified to constitute ‘ indebtedness' within the meaning of section 163(a) and cost basis for depreciation purposes as provided by section 167(g). Page 753 FINDINGS OF FACT Charles T. Franklin (hereinafter referred to as decedent) died on August 28, 1971. Southern California First National Bank, executor of his estate, maintained its principal place of business in San Diego, Calif., at the time the petition was filed. Petitioner Margaret A. Franklin is the surviving spouse of decedent, and she was a legal resident of La Mesa, Calif., at the time the petition was filed. Decedent and his wife filed a timely joint Federal income tax return for 1968 with the District Director of Internal Revenue, Los Angeles, Calif., and for 1969 with the Internal Revenue Service Center in Ogden, Utah. Twenty-fourth Property Associates (hereinafter the partnership or Twenty-Fourth) is a limited partnership formed on November 25, 1968, pursuant to the California Uniform Limited Partnership Act. The partnership was composed of one general partner, Jack R. Young & Associates (hereinafter JRYA), a California corporation, and eight limited partners. Decedent was one of these limited partners, who included seven medical doctors and one dentist. The formation of Twenty-Fourth was evidenced by two documents, an ‘ Agreement of Limited Partnership’ (hereinafter the agreement) and a ‘ Certificate of Limited Partnership of Twenty-Fourth Property Associates.’ The latter document was recorded with the appropriate office of the State of California. Both documents provided for the amendment of any provision by a majority vote of the limited partners. The agreement recites that the purpose of the partnership was to acquire from Wayne L. and Joan E. Romney (hereinafter the Romneys or Wayne L. Romney singularly as Romney) real property, improvements, and certain personal property known as the Thunderbird Inn (sometimes referred to as the motel or property) in Williams, Ariz., and to lease the property back to the sellers or their nominee. The agreement provides that six of the limited partners would contribute $10,000 each to the limited partnership, to be credited to their respective capital accounts, and a like amount towards the capital account of the general partner, JRYA. Two of the limited partners contributed $7,500 each to the partnership's capital and a similar amount to the capital account of JRYA. According to the agreement, contributions by the limited Page 754 partners towards the capital account of JRYA, amounting to a total of $75,000 (which JRYA withdrew before the end of 1968), were compensation for services to be rendered by JRYA to the partnership during its life. The other $75,000 was paid to the Romneys as prepaid interest pursuant to a ‘ Sales Agreement,‘ described later herein. The agreement also provides that the life of the partnership shall be 25 years with earlier termination under circumstances enumerated in the agreement. upon early termination of the partnership, nowhere does the agreement provide for a refund of any portion of the account constituting prepaid management expenses. Of the $75,000 withdrawn by JRYA from its capital account, $18,750 was paid by JRYA as commissions or finder's fees to the salesmen who arranged for the contributions of the limited partners, and approximately $50,000 was allocated by JRYA to services performed during the first year of the partnership. The amount left was to cover services to be performed over the remaining life of the partnership. These duties could include preparation of the partnership tax returns, any negotiations leading to a renewal of leases with respect to the acquired property or the refinancing of any mortgages, or any other disposition of the property owned by the partnership. During a period extending from February through August 1968, the Romneys had purchased the stock of two corporations, Thunderbird Inn, Inc., and Thunderbird Hotels, Inc. The total purchase price for the stock of the corporations was approximately $800,000. The assets of Thunderbird Inn, Inc., included a 96-unit motel and related property, a restaurant, and approximately 17 acres of unimproved land adjacent to the motel property. The assets of Thunderbird Hotels, Inc., comprised a cocktail lounge on the motel property and the liquor license for the lounge. Thunderbird Inn, Inc., was dissolved by the Romneys on September 1, 1968, and the Romneys acquired all of its assets. Thunderbird Hotels, Inc., was not dissolved. JRYA, on behalf of Twenty-fourth, executed a ‘ Sales Agreement’ with the Romneys, dated November 15, 1968. The sales agreement recites that: ‘ Seller (the Romneys) has this date sold to Buyer (the partnership) and Buyer has purchased from Seller’ the real property, together with the improvements and personal Page 755 property, known as the Thunderbird Inn. According to the sales agreement, the conveyed property included all personal property located on the premises except the liquor license and certain inventory. The sales agreement did not cover the 17 acres adjacent to the motel. In negotiating the sales agreement for the Thunderbird Inn, Romney and Jack R. Young, representative of JRYA (hereinafter Young), utilized an appraisal report, prepared in May 1968 at Romney's request, by Ralph W. Jenkins, who died several years prior to the trial. Young never had an independent appraisal made for the benefit of JRYA. Young was not personally familiar with the property which he purported to purchase on behalf of Twenty-Fourth. He did not visit the property, but a Mr. Darling, then president of JRYA, who was not a real estate appraiser, visited the motel and gave Young a general report on its condition. Young did not make an effort to determine the age of the property improvements which are the subject of the sales agreement. The total sales price stated in the sales agreement was $1,224,000, plus interest on the unpaid balance at the rate of 7 1/2 percent per annum, payable in monthly installments of principal and interest of $9,045.36 for a period of approximately 10 years. The sales agreement also recites that a payment, described as prepaid interest and in the amount of $75,000, as mentioned in our earlier discussion of the partnership agreement, was payable upon the signing of the agreement, and this payment was made. At the time of the execution of the sales agreement, there was a first mortgage on the property in the approximate amount of $235,000, and a second mortgage in the approximate amount of $550,000 was in the process of being placed on the property. These encumbrances remain the sole obligation of the Romneys under the sales agreement until the end of the 10-year period, at which time, if the transaction is completed, Twenty-Fourth is to assume them. At the expiration on January 15, 1979, of the 10-year period, a payment equal to the ‘ Seller's equity’ will be due. The sales agreement defines ‘ Seller's equity’ as the difference between the outstanding encumbrances and the principal balance due and owing under the terms of that agreement. At the time of the Page 756 execution of the sales agreement, it was estimated that at the end of the 10 years, the unpaid principal balance would equal approximately $975,000. The sales agreement further provides:
Buyer is purchasing the property described in Exhibit ‘ A’ together with the improvements situated thereon and the furnishings and fixtures located therein, subject to the existing indebtedness thereon, and is not assuming any of said indebtedness, and BuyerS liability and obligation hereunder shall be limited to its investment in the property in accordance with the terms and provisions of this Agreement, and there shall be no personal liability on the...
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