Holladay v. Comm'r of Internal Revenue , Docket No. 6781-75.

Decision Date25 June 1979
Docket NumberDocket No. 6781-75.
Citation72 T.C. 571
PartiesDURAND A. HOLLADAY and BLANCHE F. HOLLADAY, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

Petitioner formed a joint venture with Babcock Co. to complete development of an apartment complex. Babcock Co. previously had obtained the land and begun construction. Petitioner agreed to provide an equity contribution of $750,000 and loans up to $1 million. Each party agreed to share equally the burden of providing whatever additional financing might be necessary. With regard to equity cash distributions, the parties agreed to split the first $100,000, to distribute the next $150,000 to Babcock Co., and thereafter to share equally. Notwithstanding this nearly equal division of economic benefits, the parties agreed to allocate all losses as computed for tax purposes to petitioner for the years 1970 through 1974, inclusive. In accordance with the agreement, petitioner reported losses for Federal income tax purposes totaling $2,340,209 for the years 1970 through 1973. Held, the allocation of 100 percent of the losses to petitioner is not a bona fide allocation for Federal tax purposes since the allocation does not correspond to the actual basis upon which the parties agreed to share the economic profits and bear the economic losses of the joint venture. W. Reeder Glass and Andrew H. Weinstein, for the petitioners.

Thomas R. Ascher, for the respondent.

DAWSON, Judge:

Respondent determined deficiencies in the Federal income taxes of petitioners as follows:

+--------------------+
                ¦Year  ¦Deficiency   ¦
                +------+-------------¦
                ¦      ¦             ¦
                +------+-------------¦
                ¦1968  ¦$38,914      ¦
                +------+-------------¦
                ¦1969  ¦97,519       ¦
                +------+-------------¦
                ¦1970  ¦11,403       ¦
                +------+-------------¦
                ¦1971  ¦120,154      ¦
                +------+-------------¦
                ¦1972  ¦260,727      ¦
                +------+-------------¦
                ¦1973  ¦126,690      ¦
                +--------------------+
                

After concessions by respondent, the sole issue1 for our decision is whether the allocation to petitioner of all the taxable losses of the Kings Creek Joint Venture for the taxable years 1970 through 1973 is a bona fide allocation within the meaning of section 704.2

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.

Durand A. Holladay and Blanche F. Holladay, husband and wife, resided in Coral Gables, Fla., at the time their petition was filed in this case. Petitioners filed joint Federal income tax returns for 1968 through 1973 with the Internal Revenue Service Center, Chamblee, Ga. Blanche F. Holladay is a party to this action solely because she signed the joint return in question. Consequently, any reference to petitioner relates to Durand A. Holladay.

The development of the Kings Creek Apartments project originated before any involvement by petitioner. Charles I. Babcock, Jr. (hereinafter Babcock), during the years in question, was a developer and builder of housing. On October 18, 1968, Babcock purchased 17 1/2 acres of undeveloped land (hereinafter the Kings Creek land) in southwest Dade County for the site of the construction of the Kings Creek Apartments. Babcock financed 90 percent of the $599,000 purchase price with purchase money mortgages and promissory notes. On the same day, Babcock transferred the Kings Creek land to Babcock Co., his personal investment company, and received in return the 10-percent downpayment and expenses that he had incurred to purchase the property. After capitalizing interest, real estate taxes, and other expenses, the total acquisition cost of the Kings Creek land was $631,533.55.

Babcock Co. prepared plans to have the Kings Creek Apartments built in three phases of 200 units each by In the latter part of 1969, Babcock Builders, Inc. In the latter part of 1969, Babcock Builders, Inc., prepared the Kings Creek land for construction of the apartments by installing sewer and water lines, driveways, electric utilities, and streets at a cost of approximately $202,000. The buildings were constructed in accordance with the following schedule:

+--------------------------------------------+
                ¦Building No. 1 (102 units) [phase I]        ¦
                +--------------------------------------------¦
                ¦  ¦                      ¦                  ¦
                +--+----------------------+------------------¦
                ¦1.¦Permit                ¦November 25, 1969 ¦
                +--+----------------------+------------------¦
                ¦2.¦Plans                 ¦September 26, 1969¦
                +--+----------------------+------------------¦
                ¦3.¦Construction began    ¦December 1969     ¦
                +--+----------------------+------------------¦
                ¦4.¦Construction completed¦July 1970         ¦
                +--+----------------------+------------------¦
                ¦5.¦Rental income began   ¦August 1970       ¦
                +--+----------------------+------------------¦
                ¦6.¦Depreciation began    ¦July 1, 1970      ¦
                +--------------------------------------------+
                
                Building No. 2 (96 units) [phase I]  
                1. Construction began     May 1970
                2. Construction completed January 1971
                3. Depreciation began     February 1, 1971
                
                Building No. 3 (clubhouse) [phase I]  
                1. Construction began     June 1970
                2. Construction completed January 1971
                3. Depreciation began     January 1, 1971
                
                Building No. 4 (204 units) [phase II]  
                1. Permit                 June 18, 1970
                2. Construction began     July 1970
                3. Construction completed May 1971
                4. Depreciation began     June 1, 1971
                
                Building No. 5 (198 units) [phase III]  
                1. Permit                 June 18, 1970
                2. Construction began     December 1970
                3. Construction completed August 1971
                4. Depreciation began     September 1, 1971
                
                Cabana and pool [phase III]  
                1. Construction began     August 1971
                2. Construction completed October 1971
                3. Depreciation began     November 1, 1971
                

To finance the above construction, Babcock initially relied on short-term institutional financing. His long range objectives were to build the apartment project, to recover the equity that Babcock Co. had invested in the project, to earn construction and management fees, and to retain an ownership interest in the project. To attain these objectives, Babcock wished to finance the project in accordance with what he characterized as a classic builder/investor deal. Babcock hoped to provide building and management expertise, but to have most of the equity financing provided by a third party investor. Additional funds were to be obtained by institutional debt financing.

Accordingly, Babcock prepared an economic analysis for a proposed joint venture limited partnership to develop the Kings Creek Apartments. The analysis estimated costs, revenues, and return on investment for a proposed joint venture to develop the project. The advantages of tax losses generated during the early years were noted in the economic analysis. Babcock used the analysis in several unsuccessful attempts to obtain mortgage financing from major insurance companies and equity financing from private individuals. In February 1970, Babcock submitted the economic analysis to petitioner.

Petitioner is an attorney and a graduate of both Georgia Tech., where he studied engineering, and the University of Miami Law School. From 1949 until 1962, petitioner was engaged in the active practice of law in Miami, Fla. In 1962, he and three other individuals were instrumental in forming Continental Mortgage Investors, one of the first real estate investment trusts. From 1962 until 1967, petitioner was associated with Continental Mortgage Investors as legal counsel. In 1967, the petitioner terminated his practice of law and became the president of Continental Advisors (originally named Mortgage Consultants), which was the investment adviser, loan manager, and financial recordkeeper for Continental Mortgage Investors. In 1969 and 1970, the petitioner became the senior executive of Continental Advisors. The petitioner drew a salary of approximately $50,000 per year from Continental Advisors.

By 1970, Continental Mortgage Investors had accumulated a loan portfolio of approximately $300 million. Some of the mortgage loans placed by Continental Mortgage Investors were for the construction of apartment projects similar to the Kings Creek Apartments. As a result, petitioner was very knowledgeable and experienced in financing this type of construction project.

As adviser to Continental Mortgage Investors, Continental Advisors received a gross fee based upon the size of the investment portfolio held by Continental Mortgage Investors. The petitioner's wholly owned small business corporation, Dumare Enterprises, Inc., held a 20-percent interest in Continental Advisors, which interest was its most valuable asset and major source of income. In this regard, from 1969 until 1973, the petitioner received from Dumare Enterprises, Inc., substantial distributions of income. These distributions were as follows:

+-----------------+
                ¦Year  ¦Amount    ¦
                +------+----------¦
                ¦      ¦          ¦
                +------+----------¦
                ¦1969  ¦$340,141  ¦
                +------+----------¦
                ¦1970  ¦676,360   ¦
                +------+----------¦
                ¦1971  ¦709,289   ¦
                +------+----------¦
                ¦1972  ¦1,024,879 ¦
                +------+----------¦
                ¦1973  ¦201,802   ¦
                +-----------------+
                

The petitioner was also instrumental in the formation of Diversified Mortgage Investors, a real estate investment trust, which in 1969 had a loan portfolio of approximately $150 million. Moreover, the petitioner was president of Diversified Advisors, which was the adviser to Diversified Mortgage Investors. Petitioner was also the managing trustee of Diversified Mortgage Investors.

Petitioner studied the economic analysis and verified Babcock's business reputation by calling a number of his friends. Petitioner then physically reviewed the project, visited certain other management projects nearby, and interviewed their managers to discover information about occupancy levels and rents. For further advice, petitioner...

To continue reading

Request your trial
13 cases
  • Davis v. Comm'r of Internal Revenue, Docket Nos. 6540-77
    • United States
    • United States Tax Court
    • July 31, 1980
    ...for coal mined under the Palmer Bros., Early, and Trader leases. See Boynton v. Commissioner, 72 T.C. 1147 (1979); Holladay v. Commissioner, 72 T.C. 571 (1979); Kresser v. Commissioner, supra. Section 704(b)(2), as interpreted by the regulations, requires every special allocation to have “ ......
  • Reynolds v. Commissioner, Docket No. 8087-84.
    • United States
    • United States Tax Court
    • May 26, 1987
    ...Dec. 40,096, 80 T.C. 843, 857-858 (1983) (Doctrine of economic substance applies independently of sec. 704(b)); Holladay v. Commissioner Dec. 36,143, 72 T.C. 571, 586-588 (1979), affd. 81-2 USTC ¶ 9559 649 F.2d 1176 (5th Cir. 1981) 16 We are confirmed in approaching the issue in this manner......
  • Pearlstein v. Commissioner, Docket No. 5551-81
    • United States
    • United States Tax Court
    • November 16, 1989
    ...Commissioner Dec. 36,338, 72 T.C. 1147, 1157-1160 (1979), affd. 81-2 USTC ¶ 9560 649 F.2d 1168 (5th Cir. 1981); Holladay v. Commissioner Dec. 36,143, 72 T.C. 571, 585-587 (1979), affd. 81-2 USTC ¶ 9559 649 F.2d 1176 (5th Cir. 1981); H. Rept. No. 1337, 83d Cong., 2d Sess. A223 (1954); S. Rep......
  • Cirelli v. Comm'r of Internal Revenue
    • United States
    • United States Tax Court
    • February 28, 1984
    ...Commissioner, 80 T.C. 843, 857–858 (1983) (doctrine of economic substance applies independently of section 704(b)); Holladay v. Commissioner, 72 T.C. 571, 586–588 (1979), affd. 649 F.2d 1176 (5th Cir. 1981) (same).20 Whether a “partner” owns “a capital interest in a partnership” (the phrase......
  • Request a trial to view additional results

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT