Dunlap v. Comm'r of Internal Revenue
| Decision Date | 24 September 1980 |
| Docket Number | 5351-77,9438-77.,2414-77,7858-76,Docket Nos. 6726-76,2779-77 |
| Citation | 74 T.C. 1377 |
| Parties | PAUL D. DUNLAP and SHIRLEY A. DUNLAP, et al.,1 PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioner Dunlap, together with one Weil, were officers and shareholders of petitioner Hawkeye Bancorporation. Hawkeye wished to acquire the stock of Jasper Bank but required prior Federal Reserve Board (F.R.B.) approval, and the Jasper stockholders were unwilling to wait. Accordingly, Dunlap and Weil purchased the Jasper stock, most of it under an installment payment agreement, for a total price of $4,072,190, with Dunlap taking an 83.6-percent interest and concurrently with the purchase of the bulk of the stock, agreed with Hawkeye to resell all the stock to Hawkeye for $4,150,000 if and when F.R.B. approval was received. Hawkeye immediately paid $4,150,000 to Dunlap and Weil. Dunlap and Weil used the money to buy $4,150,000 of Hawkeye 53;4-percent notes. Two years later, the F.R.B. rejected the proposal as an indirect unprecleared acquisition of Jasper by Hawkeye. Accordingly, on July 1, 1971, the parties recast the deal. Dunlap and Weil repaid Hawkeye the $4,150,000 by canceling the 53;4-percent notes and agreed that, subject to and following F.R.B. approval, they would sell their Jasper stock to Hawkeye for a price equal to the sum of (a) cash of $2,283,994, (b) $1,866,006 in installment notes bearing 91;2-percent interest from July 1, 1971, until paid, and (c) reimbursement of the sellers' interest and cost of carrying their Jasper shares pending the closing. $2,283,994 and $1,866,006 total $4,150,000, but at F.R.B. insistance, the cash part of the agreed price was reduced to reduce the $4,150,000 figure to $4,072,190. It was also agreed that if the F.R.B. failed to approve the sale, Dunlap and Weil would pay Hawkeye an amount ($681,507) equal to Jasper's earnings for the period Aug. 1, 1969, through June 30, 1971. The F.R.B. approved the sale, and it was closed on July 12, 1972. At that time, Hawkeye delivered to the sellers (a) cash of $2,206,184, (b) 91;2-percent notes for $1,866,006 ($4,072,190 less $2,206,184), (c) $177,271 preissue interest on the notes from July 1, 1971, through June 30, 1972, and (d) $149,864 reimbursement of the sellers' interest and costs of carrying the Jasper stock.
Held, Hawkeye had no income, and Dunlap no deduction, with respect to the $681,507 of Jasper earnings which would have been payable had the F.R.B. rejected the sale. Held, further, on the facts, the $177,271 preissue “interest” on Hawkeye's notes was not intended to be part of the purchase price of the stock but was interest, deductible to Hawkeye and 83.6 percent thereof includable as ordinary income to Dunlap. Monon Railroad v. Commissioner, 55 T.C. 345 (1970), followed. Held, further, on the facts, the $149,864 reimbursement for the sellers' carrying costs was intended as, and for tax purposes is, part of the purchase price, to be capitalized by Hawkeye and being part of the sellers' capital gain.
Hawkeye incurred certain capitalizable costs in 1971, 1972, and 1973 in acquiring controlling interests in other corporations. Held, the portion of Hawkeye's outlays which must be so capitalized is determined on the facts.
Hawkeye paid $35,000 apiece for a series of 10 consecutive 1-year options to purchase an office building. The option price was not to be applied against the purchase price in the event of exercise. Held, the price paid for the option which lapsed in 1973 is deductible in that year.
Dunlap was a 30-percent tenant-in-common in improved property leased on a “fully net” basis for 25 years at a rental of $761,507 per year, renewable for up to 30 more years at $264,000 per year. The tenants-in-common invested $387,000 for their equity in the property and took title subject to nonrecourse financing, secured by the property and the lease, for the $8,413,000 remainder of the $8,800,000 cost. The trust deed debt required $759,107 debt service per year and would be fully amortized after 25 years. Held: On the facts, respondent has failed to meet his burden of proof under his amended answer to the contrary, and Dunlap, therefore, was for tax purposes an owner of the property and could deduct depreciation on the improvements. Despite the absence of significant cash flow for 25 years, substantial economic benefits were foreseeable from the equity buildup during the loan amortization period, the lease rental thereafter (in the event of renewal) would be attractive in relation to the original investment, and the reversion could have considerable value. Frank Lyon Co. v. United States, 435 U.S. 561 (1978), followed. Hilton v. Commissioner, 74 T.C. 305 (1980), distinguished. Held, further, the useful life of the improvements is 35 years. Kent O. Littlejohn and Michael L. Sullivan, for the petitioners.
Robert L. Archambault, for the respondent.
Respondent determined the following income tax deficiencies and additions to tax:
+-----------------------------------------------------------------------------+
¦ ¦ ¦ ¦ ¦Sec. 6653(b) 2 ¦
+--------------------------+------------+------+------------+-----------------¦
¦Petitioners ¦Docket No. ¦Year ¦Deficiency ¦addition to tax ¦
+--------------------------+------------+------+------------+-----------------¦
¦ ¦ ¦ ¦ ¦ ¦
+--------------------------+------------+------+------------+-----------------¦
¦Paul D. Dunlap and Shirley¦2779-77 ¦1971 ¦$125,780 ¦$62,890 ¦
¦A. Dunlap ¦ ¦ ¦ ¦ ¦
+--------------------------+------------+------+------------+-----------------¦
¦ ¦6726-76 ¦1972 ¦289,709 ¦144,855 ¦
+--------------------------+------------+------+------------+-----------------¦
¦ ¦5351-77 ¦1973 ¦40,914 ¦20,457 ¦
+--------------------------+------------+------+------------+-----------------¦
¦Hawkeye Bancorporation ¦2414-77 ¦1971 ¦16,513 ¦--- ¦
+--------------------------+------------+------+------------+-----------------¦
¦ ¦7858-76 ¦1972 ¦523,915 ¦--- ¦
+--------------------------+------------+------+------------+-----------------¦
¦ ¦9438-77 ¦1973 ¦340,775 ¦--- ¦
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2. All statutory references are to the Internal Revenue Code of 1954 as in effect during the years in issue.
In his amended answer in docket No. 5351-77 (Paul D. Dunlap and Shirley A. Dunlap), respondent asserts that the deficiency should be increased by $49,313 for a total deficiency of $90,227. In his amended answer in docket No. 2414-77 (Hawkeye Bancorporation), respondent asserts that the deficiency should be increased by $327,123 for a total deficiency of $343,636.
Due to concessions by the parties,3 the issues remaining are:
(1) Whether Hawkeye Bancorporation realized $681,507 in unreported taxable interest income in 1971 or 1972; if so, then whether Paul D. and Shirley A. Dunlap are entitled to a $568,904 interest expense deduction for 1972.
(2) Whether payments of $148,199 and $125,286 received by Paul D. and Shirley A. Dunlap from Hawkeye Bancorporation in 1972 in connection with the sale of Jasper County Savings Bank stock constitute ordinary or capital gain income. If we determine that these payments constitute ordinary income to Paul D. and Shirley A. Dunlap, then we must determine whether Hawkeye Bancorporation is entitled to expense deductions of $177,271 and $149,864 in 1972 relative to payments made in connection with the Jasper County Savings Bank stock acquisition.
(3) Whether $29,671, $348,622, and $131,114 paid by Hawkeye Bancorporation in 1971, 1972, and 1973, respectively, represent currently deductible business expenses or capital expenditures made to acquire the controlling interests of other corporations.
(4) Whether Hawkeye Bancorporation's option to purchase the Stephens Building expired or lapsed during 1973 thereby entitling Hawkeye Bancorporation to a $35,000 loss deduction.
(5) Whether petitioner Paul D. Dunlap had sufficient investment interest in the buildings, site improvements, and equipment comprising a Safeway Stores, Inc., facility in El Paso, Tex., to entitle him to deduct depreciation expense. If so, then we must determine the useful life of the buildings.
Some of the facts have been stipulated and are found accordingly.
At the time of filing their petitions, petitioners Paul D. and Shirley A. Dunlap were residents of Des Moines, Iowa. When we hereafter refer to Dunlap, we will be referring to Paul.
Hawkeye Bancorporation (Hawkeye), a corporation organized under the laws of Iowa, had its principal place of business in Des Moines, Iowa, at the time it filed its petitions. Hawkeye is a bank holding company registered under the Bank Holding Company Act of 1956. As of December 31, 1973, Hawkeye owned a controlling shareholder interest in 13 commercial banks located in Iowa. For Federal tax purposes, Hawkeye employs the accrual method of accounting on a calendar year basis. During the years in issue, Hawkeye filed consolidated returns with its subsidiary constituent banks.
Dunlap is the founder and president of Hawkeye. During the years in issue, Dunlap was also a shareholder and a director of Hawkeye. Hawkeye is owned by approximately 4,500 shareholders.
Prior to July 1, 1969, Dunlap, as president of Hawkeye, was approached by a representative of a group of controlling shareholders of Jasper County Savings Bank (Jasper) who inquired whether Hawkeye was interested in purchasing the Jasper...
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