Graff v. Comm'r of Internal Revenue

• Citation: 74 T.C. 743
• Decision Date: 21 July 1980
• Docket Number: Docket No. 3958-77.
• Parties: ALVIN V. GRAFF, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: United States Tax Court

74 T.C. 743

ALVIN V. GRAFF, PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 3958-77.

United States Tax Court

Filed July 21, 1980.

P owned an apartment project constructed in accordance with Sec. 236 of the National Housing Act. Under such act, HUD made so-called interest reduction payments on P's behalf. Such payments included part of the interest on the funds borrowed to construct the project. When P was considering whether to construct the project, an official of HUD led him to believe that he would be entitled to deduct the interest payments made by HUD on his behalf, and that he would not be required to include such interest reduction payments in income Held:

1. The interest reduction payments are includable in P's gross income, and he is entitled to deduct the interest payments made by HUD on the mortgage on the project.

2. The Commissioner is not estopped from assessing and collecting a tax on the interest reduction payments as a result of the representations made by the officials of HUD.

3. All payments made by P under the mortgage on the project are not allocable to interest.

4. The minimum tax on items of tax preference is a constitutional tax on income. Robert L. Trimble, for the petitioner.

John W. Dierker and Alan C. Levine, for the respondent.

SIMPSON, Judge:

The Commissioner determined deficiencies in the petitioner's Federal income taxes of $81,931.43 for 1973 and $1,429.80 for 1974. He also determined an addition to tax of $4,096.57 for 1973 under section 6653(a) of the Internal Revenue Code of 1954,¹ but he now concedes that the petitioner is not liable for such addition to tax. After concessions by the parties, the issues for decision are: (1) Whether the interest reduction payments made on behalf of the petitioner under Section 236 of the National Housing Act are taxable to him as income, and whether the portions allocable to interest are deductible under section 163; (2) whether the Commissioner of Internal Revenue should be estopped from assessing and collecting the deficiencies arising from the taxation of such interest reduction payments because of the representations made to the petitioner by officials at HUD and FHA concerning the tax treatment of such payments; and (3) whether the minimum tax on items of tax preference under section 56 is constitutional, or in the alternative, whether such tax represents a deductible excise tax.

FINDINGS OF FACT

Some of the facts have been stipulated, and those facts are so found.

The petitioner, Alvin V. Graff, resided in Dallas, Tex., at the time he filed the petition in this case. He filed his individual Federal income tax returns for 1973 and 1974 with the Internal Revenue Service Center, Austin, Tex.

At the time of the trial in this case, the petitioner was the owner of a low and moderate income housing project in Irving, Tex., known as the Park Grove Square Apartments (the project). The project contained approximately 200 garden-type apartments and accessory buildings. The petitioner built the project under the provisions of Section 236 of the National Housing Act (Section 236), which provided for certain incentives for the builders and sponsors of low and moderate income housing projects. Such incentives included a provision under which HUD made interest reduction payments on behalf of the sponsor to reduce his cost of borrowing money for the construction of the project.

The petitioner first considered building the project after he was approached by Edward J. Dee, the director of the Dallas Office of the Federal Housing Administration (FHA), a division of the United States Department of Housing and Urban Development (HUD). HUD was the department of the Federal Government responsible for administering housing projects under Section 236. Mr. Dee told the petitioner that HUD was anxious to have a Section 236 project built in the Irving area, and he asked the petitioner to build such a project on the 400 acres of land which he owned in Irving. At first, the petitioner was hesitant to accept the proposal to build an apartment complex since he had never met Mr. Dee before and since he was unfamiliar with the Section 236 program. In addition, he had never contemplated building an apartment complex on his land.

Mr. Dee met with the petitioner several times to urge him to build such a project, and he represented that there were numerous tax advantages for the sponsor of a Section 236 project. He told the petitioner that he would be able to deduct from his taxable income the interest payments made by HUD on his behalf. Mr. Dee never mentioned to the petitioner that the amount of such payments would be includable in his gross income. He told the petitioner that the sponsors of Section 236 projects received such beneficial tax treatment because Congress intended that such tax advantages serve as an incentive for builders of low and moderate income projects.

After Congress enacted the Section 236 program, officials of HUD from Washington (including the Under Secretary of the department) conducted regional meetings to explain the tax incentives available to builders and sponsors of such projects. Mr. Dee and his fellow administrative officers at the Dallas office of FHA were advised at such regional meetings that the interest payments by HUD on behalf of a sponsor of a Section 236 project were deductible by the sponsor without a corresponding inclusion of such amount in his income. Mr. Dee and Jake H. Waddle, the Deputy Director of the FHA Office in Dallas at that time, conducted meetings in many cities in Texas to explain the Section 236 program to potential sponsors. At such meetings, both men represented that a sponsor of such a project would receive the benefit of the interest deductions without a corresponding inclusion in his income.

In 1969, the petitioner filed an application to sponsor a Section 236 project. He later hired John Huddleston, who had worked for HUD and FHA as an appraiser from 1961 to 1968, to assist him in evaluating the Section 236 project. When the petitioner and Mr. Huddleston inquired once again about the tax treatment of the interest payments by HUD, they were again assured that the official position of HUD and FHA was that such payments would be fully deductible by the petitioner and that such payments would not be includable in his income. Consequently, the petitioner agreed to build the Section 236 project on his property. He agreed to undertake the project in part because of the tax benefits he expected to receive. However, the petitioner never consulted a tax attorney regarding the tax consequences of the Section 236 program.

On or about May 18, 1970, FHA issued a commitment to the Housing America Mortgage Co., Inc. (Housing America), as mortgagee, for insurance advances under Section 236 in the principal amount not to exceed $2,910,600. Such commitment was for the petitioner's Section 236 project, and his name appeared on the document as the sponsor of the project and as the proposed mortgagor. On or about May 25, 1970, Housing America assigned the commitment to Farm and Home Savings Association (Farm and Home), a Missouri corporation having an office and place of business in Dallas. On June 1, 1970, Farm and Home loaned the $2,910,600 to the petitioner at interest of 81;2 percent per year. Such loan was evidenced by a promissory note and secured by a deed of trust on the project. Farm and Home then became the mortgagee of record. The petitioner's name appeared as the maker of the promissory note and as the grantor of the deed of trust which secured the project as collateral for the mortgage.

On or about June 1, 1970, the petitioner entered into a regulatory agreement with HUD in which he agreed to make all payments due under the note and mortgage to Farm and Home, and HUD agreed to make a portion of those payments to Farm and Home on behalf of the petitioner in accordance with such regulatory agreement, Section 236, and the Federal regulations promulgated thereunder. During 1971, Farm and Home transferred the note and deed of trust for the petitioner's project to the Federal National Mortgage Association [FNMA].

During 1973, the total payments on the mortgage on the petitioner's project were $270,394.91, which consisted of $11,106.19 payment of principal, $244,943.09 payment of interest, and $14,345.63 as premium for mortgage insurance. Of such total, HUD paid $179,868.71, and the petitioner paid $90,526.20. During 1974, the total payments on the mortgage on the petitioner's project were $270,191.21, which consisted of $12,087.88 payment of principal, $243,820.99 payment of interest, and $14,282.34 as premium for mortgage insurance. Of such total, HUD paid $179,805.42, and the petitioner paid $90,385.79.

On his individual Federal income tax return for 1973, the petitioner deducted $130,638.43 as interest paid with respect to his Section 236 project during such year. On his return for 1974, he deducted $121,910.50 as interest paid with respect to such project during that year. Subsequently, his returns for such years were audited by the Internal Revenue Service, and he was informed that the deductions for the interest payments which were made by HUD were being disallowed. The petitioner called Mr. Dee to clarify what he had been told regarding the interest deduction before he undertook the project. Mr. Dee wrote to the petitioner in December 1976 and reiterated that, as the Section 236 program had been explained to him, sponsors of such projects would be allowed a deduction for interest payments made by HUD on their behalf. Mr. Dee wrote to the petitioner again in October 1977 and stated that he never told the petitioner that there would be a corresponding inclusion in his income for the amount of the interest payment deducted under a Section 236 project. Mr. Dee stated:

As I explained to you in our recent telephone conversation, and as I attempted to explain in my letter to...