Burbage v. Comm'r of Internal Revenue
| Citation | 82 T.C. No. 42,82 T.C. 546 |
| Decision Date | 29 March 1984 |
| Docket Number | Docket No. 9095–79. |
| Parties | JOHN HOWARD BURBAGE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | United States Tax Court |
OPINION TEXT STARTS HERE
In 1972, petitioner was the lessor of property subject to a 99-year redeemable Maryland ground rent. Held: Petitioner's retained interest in the land is “primarily a security interest” within the meaning of section 1055(c)(3) and the redeemable ground rent is treated as being in the nature of a mortgage. Held further: Petitioner omitted from his 1972 gross income an amount in excess of 25 percent of that stated in the return and assessment of the deficiency is not barred by the statute of limitations. Section 6501(e)(1).
In 1974, petitioner exchanged 1 redeemable Maryland ground rent for 18 redeemable Maryland ground rents. Held: No taxable gain or loss occurred as a result of this transaction. Held further: Payments received pursuant to a redeemable ground rent are includable as interest income.
Held further: Petitioner's Subchapter S corporation received excessive passive income during 1974. D. Paul Alagia, Jr., Richard M. Trautwein, John E. Evans, Allan B. Solomon, and William C. Willock, Jr., for the petitioner.
Scott R. Cox, for the respondent.
Respondent determined the following deficiencies in petitioner's Federal income taxes:
+--------------------+
¦Year ¦Deficiency ¦
+------+-------------¦
¦ ¦ ¦
+------+-------------¦
¦1972 ¦$51,367.27 ¦
+------+-------------¦
¦1974 ¦78,270.00 ¦
+------+-------------¦
¦1975 ¦6,205.00 ¦
+--------------------+
After concessions, the issues for decision are: (1) Whether assessment of the deficiency for petitioner's 1972 taxable year is barred by the statute of limitations; (2) Whether petitioner's 1972 transfer of real property pursuant to a 99-year redeemable ground rent lease constituted a taxable sale or exchange; (3) Whether petitioner's 1974 transfer of the right to receive payments under one redeemable ground rent lease for 18 redeemable ground rent leases was a taxable event; (4) Whether petitioner properly reported certain payments received in the 1974 exchange of ground rents; (5) Whether Jamaica Industries, Inc., a Subchapter S corporation in which petitioner is a 50 percent shareholder, received excessive passive income in 1974 which terminated its Subchapter S election pursuant to section 1372(e)(5).1
Some of the facts have been stipulated and are found accordingly.
Petitioner resided in Berlin, Maryland, when he filed his petition in this case. Throughout the years in issue, petitioner was married to Rosalind A. Burbage and he timely filed separate Federal income tax returns for 1972, 1974, and 1975 with the Internal Revenue Service Center, Philadelphia, Pennsylvania. 2
The tax deficiencies in issue result primarily from two separate business ventures in which John Howard Burbage (hereinafter petitioner) was involved during the years in issue. For the sake of clarity we have separately organized the facts pertaining to each of these ventures.
During 1969, petitioner acquired a fee simple interest in two oceanfront lots in Ocean City, Maryland (hereinafter the Burbage property) for $35,820. 3 At some undetermined point between 1969 and 1972, Larmar Corporation (hereinafter Larmar) began plans to build a 35 unit, 1.25 million dollar oceanfront condominium project called the Spinnaker Condominiums. The Burbage property was located directly between the ocean and the property on which Larmar planned to build its condominium project (hereinafter the Larmar property).
During 1972, petitioner approached Larmar and offered to sell it the Burbage property. At that time, Lamar had acquired the Larmar property and plans for the condominium project had been developed, although it is not clear whether construction on the condominiums had yet begun. Since the condominium had been advertised as an oceanfront project, Larmar recognized that acquisition or development of the Burbage property by a third party would have considerably devalued the project and may even have forced them to abandon it.
Naturally, Larmar was interested in acquiring the Burbage property, but it did not want to make an outright purchase. Instead, Larmar leased the Burbage property from petitioner under an agreement dated July 11, 1972, whose relevant terms in part provide:
SECTION 4. The term of this lease shall commence as of July 1, 1972, and unless sooner terminated (by exercise of Tenant's option of redemption pursuant to Maryland law) shall be for a period of ninety-nine (99) years, expiring June 30, 2071, without the necessity of any notice from either Landlord or Tenant to terminate the same; subject, however, to renewal forever, in accordance with Maryland law * * *.
* * *
SECTION 6. * * * If Tenant shall violate any covenant, including the covenant to pay rent [$10,800 in semiannual installments of $5,400 each, in arrears], made by it in this Lease Agreement and shall fail to comply or in good faith commence compliance with said covenant within ninety (90) days after being sent written notice of such violation by Landlord, Landlord may, at his option, re-enter the premises and declare this lease and the tenancy hereby created terminated; * * * subject, however, to the provisions of Maryland law respecting the perpetual renewal of ninety-nine (99) year ground rent leases (and it is hereby covenanted and agreed by and between the parties that this Lease is a Maryland ground rent lease for ninety-nine (99) years renewable forever).
SECTION 7. * * * Furthermore, Tenant shall have and is hereby given the unqualified right, at its option, of subletting the demised premises, or any part thereof, or of any improvements thereon, provided that Tenant shall remain liable hereunder.
* * *
SECTION 9. It is covenanted and agreed that the capitalized value of this Lease is One Hundred Eighty Thousand Dollars ($180,000). * * *
On the same date that petitioner leased the Burbage property to Larmar, Larmar subleased the Burbage property, plus the adjacent Larmar property to Larmar Associates, which latter transfer was pursuant to a redeemable ground rent agreement. Subsequent to this sublease and lease, Larmar Associates erected the 35 unit Spinnaker Condominium building on the Larmar property.
On his 1972 Federal income tax return, petitioner reported no income from the lease of the Burbage property to Larmar, although he reported total gross income of $267,340.05 and taxable income of $131,556.63.
On March 14, 1974, petitioner entered into a tripartite exchange agreement with Larmar and Larmar Associates. Under the exchange agreement, Larmar Associates agreed to create, prior to July 1, 1974, Maryland ground rents on each of the 35 units in the Spinnaker Condominium (hereinafter unit ground rents). Promptly after the creation of these unit ground rents, Larmar Associates agreed to convey to Larmar 18 unit ground rents having an aggregate capitalized value of $180,000 and total annual payments due thereunder of $10,800. Larmar accepted these 18 unit ground rents in partial redemption of the Larmar property pursuant to its redeemable ground rent agreement with Larmar Associates. Immediately thereafter Larmar conveyed to petitioner the 18 unit ground rents “in complete redemption and satisfaction of and in exchange for the Burbage Ground Rent.” Petitioner, in turn, delivered to Larmar a deed in fee simple to the Burbage property which extinguished the original ground rent between petitioner and Larmar and petitioner's reversionary interest in the Burbage property.
Following this exchange, Larmar owned the Burbage property in fee simple, Larmar Associates apparently owned the Larmar property,4 and petitioner owned 18 unit ground rents in the Spinnaker Condominiums. Petitioner had to look to each of the condominium owners separately for payment of the aggregate annual ground rents of $10,800. In the event one of the condominium owners defaulted on his rental payments to petitioner, petitioner could reenter the premises, subject however to any incumbrances placed on the property by the lessee. As of the date of the trial herein, petitioner had received all of the ground rent payments from the condominium owners, although he was sometimes forced to contact the condominium owners to collect the amounts due.
Because the condominiums had not been completed on the date that the tripartite exchange was executed, Larmar guaranteed the aggregate $10,800 payments due under the 18 unit ground rents until such time as each of the units was sold and the first purchaser became liable to petitioner for the annual ground rent. Pursuant to this guarantee agreement, Larmar paid petitioner $15,357 in 1974 and $5,400 in 1975.5
On his 1974 and 1975 Federal income tax returns, petitioner reported the $15,357 and $5,400, respectively, as the sale proceeds of capital assets held for more than six months.6 He claimed a cost basis of $543 in 1974 and $191 in 1975, the derivation of which amounts was unexplained at trial or on brief. From these calculations, petitioner reported long-term capital gain of $14,814 in 1974 and $5,209 in 1975.
During March 1969, Jamaica Industries, Inc. (hereinafter Jamaica) was organized under the laws of Maryland and it properly elected to be taxed as an electing small business corporation pursuant to the provisions of Subchapter S 7 with a fiscal year ending October 31. Throughout the years in issue, petitioner was a 50 percent shareholder in Jamaica. The remaining 50 percent of Jamaica's shares were owned by Lee W. Bolte (hereinafter Bolte), an attorney practicing in Maryland. Throughout the years in issue, Jamaica's principal activity consisted of lending money and engaging in real estate transactions.
Petitioner and Bolte equally but informally...
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