Torres v. Comm'r of Internal Revenue
| Citation | 88 T.C. No. 40,88 T.C. 702 |
| Decision Date | 30 March 1987 |
| Docket Number | 19884-81,20469-83.,18861-80,3369-82,12683-81,3370-82,Docket Nos. 18857-80 18860-80,328-83 |
| Parties | EDWARD TORRES, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | United States Tax Court |
OPINION TEXT STARTS HERE
On November 13, 1974, Regency Associates (Regency) entered into a sale leaseback transaction involving certain computer equipment. Under the terms of the lease, Regency would receive rent which included both fixed and contingent elements. Projections of contingent rents to be received by Regency showed that Regency would recoup its investment and make a substantial profit from the transaction. Further, Regency was to receive the equipment free and clear at the end of the lease term. HELD, the transaction here in issue is not so lacking in economic substance that it can be disregarded for Federal tax purposes. HELD FURTHER, Regency held sufficient attributes of ownership with respect to the equipment to be treated as the owner of the equipment for Federal tax purposes. HELD FURTHER, Regency entered into the sale leaseback as an activity engaged in for profit within the meaning of sec. 183, I.R.C. 1954. HELD FURTHER, Regency had a short 1974 taxable year and, therefore, must apply the half-year convention of sec. 1.167(a)- 11(c)(2)(iv), Income Tax Regs., on the basis of a short taxable year. Steven S. Brown and Harvey M. Silets, for the petitioner in docket No. 18857-80.
George N. Larsen, for the petitioners in docket Nos. 18860-80, 18861-80, 3370-82, 20469-83.
Leslie S. Klinger, for the petitioners in docket No. 12683-81.Edwin H. Baker, for the petitioners in docket No. 3369-82.John M. Elias, Brian S. Masumoto, Frank M. Lavadera, and Ralph A. Eppensteiner, for the respondent.
These consolidated cases initially involved issues relating to three limited partnerships: Regency Associates, Bari Associates, and Pallas Associates. The issues relating to Pallas Associates were conceded by petitioners and the parties have agreed to be bound by our decision in Coleman v. Commissioner, docket No. 12336- 80, with respect to the issues relating to Bari Associates. Petitioner Edward Torres is the only petitioner with an interest in Regency Associates and is, therefore, the only petitioner to which the issues discussed herein relate. For purposes of convenience, we will hereafter use ‘petitioner‘ as referring only to petitioner Edward Torres.
Respondent determined the following deficiencies in petitioner's Federal income taxes:
+----------------+
¦Year¦Deficiency ¦
+----+-----------¦
¦1974¦$1,896,912 ¦
+----+-----------¦
¦1975¦2,080,447 ¦
+----------------+
The issues for decision are:
1) Whether the transaction by which Regency Associates acquired the subject property was so devoid of economic substance that the transaction should not be given effect for Federal tax purposes;
2) Whether Regency Associates acquired sufficient benefits and burdens of ownership to be considered the owner of the subject property for Federal tax purposes;
3) Whether Regency Associates entered into the subject transaction with a bona fide intent to make a profit independent of tax considerations; and
4) If any depreciation is allowable to Regency Associates for the equipment purchased in the transaction in question, whether the half- year convention of section 1.167(a)-11(c)(2)(iii), Income Tax Regs., should be applied on the basis of a short taxable year for the year in which Regency Associates first engaged in its rental activity.
Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioner resided in Las Vegas, Nevada at the time of the filing of his petition herein.
Petitioner has been in the business of owning and operating hotels for approximately 35 years, as well as investing in other business enterprises. David Hurwitz (Hurwitz), of the law firm of Marshall, Bratter, Greene, Allison & Tucker (Marshall Bratter), began representing petitioner in 1973. In May 1975, Hurwitz left Marshall Bratter to form, with several other partners, the law firm of Gordon, Hurwitz, Butowsky, Baker, Weitzen & Shalov (Gordon Hurwitz). Hurwitz continued to represent petitioner as his personal attorney after leaving Marshall Bratter.
Regency Associates (Regency) is a limited partnership which was organized under the laws of the State of Connecticut in December 1973. Hurwitz was the original general partner of Regency and C. Martin Goldenberg (Goldenberg) was the sole original limited partner. Goldenberg is an attorney licensed to practice law in the State of New York. At the time of the transaction in question, Goldenberg was associated with Marshall Bratter. Goldenberg subsequently left Marshall Bratter to join Gordon Hurwitz.
Petitioner became the sole general partner of Regency pursuant to an amendment to the partnership agreement dated November 11, 1974. By the same amendment, four limited partners were added to Regency: (1) Rick Ovadia Torres Trust (ROT Trust), (2) Brad Edward Torres Trust (BET Trust), (3) Dara Grace Torres Trust (DGT Trust), and (4) Lara Allegra Torres Trust (LAT Trust). Petitioner was trustee of each of the four trusts. Under the terms of the amendment to the partnership agreement, profits would be allocated 50 percent to the general partner and 50 percent to the limited partners in proportion to their respective capital contributions, and losses would be allocated 99 percent to the general partner and one percent to the limited partners in proportion to their respective capital contributions. With the addition of petitioner as general partner and the four trusts as limited partners, Hurwitz became a limited partner of Regency with a nominal interest and Goldenberg remained a limited partner, also with a nominal interest.2
Petitioner's contribution to the partnership capital was $657,500, while the contribution of each of the four trusts was $164,375. The capital contributions of petitioner and the four trusts were borrowed from the Valley Bank of Nevada (Valley Bank). The capital was borrowed pursuant to demand notes in the names of petitioner, RAT Trust, BET Trust, DGT Trust, and LAT Trust, dated November 13, 1974. The interest rate on each of the notes was one percent over the prime rate charged by the Bank of America and the demand date on each of the notes was June 30, 1977. The loans to each of the four trusts were guaranteed by petitioner. The beneficiaries of the four trusts are petitioner's children.
Regency's 1974 partnership return shows that at the beginning of 1974 Regency had no assets and no liabilities. The return shows that at the end of 1974, Regency's only assets were the equipment it acquired in the transaction here in issue and $200 in ‘capital contribution receivables‘ from Hurwitz and Goldenberg, and that Regency's only liability was that which it incurred upon entering the transaction here in issue. Since its inception, Regency has been involved in no commercial activity other than its involvement with the transaction which is the subject of this case.
Copylease Corporation of America (Copylease) was, in 1974, a wholly owned subsidiary of Alanthus Corporation (Alanthus). Alan Shalov was chairman, president and chief executive officer of Alanthus in 1974. When it acquired Copylease in 1973, Alanthus was principally engaged in the business of third party leasing of IBM mainframe computers. Alanthus had historically involved itself in ‘agency leasing transactions,‘3 i.e., transactions in which it arranged and administered equipment leases for outside investors. However, in 1972, Alanthus announced a program by which it intended to de-emphasize its agency leasing program.
During the fiscal year ended August 31, 1974, Alanthus received $2,916,000 from sale leaseback transactions with third party investors on equipment with an undepreciated cost of $31,806,000 when sold. Alanthus continued to carry the equipment and related balances on its accounts.
Copylease was principally engaged in leasing Xerox and IBM photocopying equipment to end-users. Copylease would purchase equipment from the manufacturer only after a lease commitment had been obtained from an end-user. Copylease would typically lease the photocopiers to end-users on relatively short-term leases which averaged 26 months.
A standard end-user lease between Copylease and a third party lessee of a Xerox 7000 would be for a period of three years, at a rental rate of $1,250 per month, plus an excess copy charge of $0.005 per copy for each copy in excess of the base volume of 40,000 copies. Under the terms of such a lease, Copylease was to enter into a Full Service Maintenance Agreement with Xerox, at its own cost, to provide for Xerox to maintain the leased equipment. Copylease assumed all responsibility for loss or damage to equipment installed on the lessee's premises, except for loss or damage caused by the negligent or purposeful acts of the lessee, its agents, or employees. Copylease's initial service contracts with Xerox ran on average for five years and three months from the date of installation of each piece of equipment.
Copylease would attempt to re-lease its equipment until its investment was recovered and it had earned at least its desired return on investment. As of August 31, 1974, the aggregate purchase price of IBM and Xerox equipment that Copylease had under lease, including equipment not yet installed, was $12,536,957. Copylease had earned rentals of $3,179,045 on such equipment, and another $10,088,574 of rentals (based on the minimum monthly rental) were payable after that date, assuming no early terminations by the lessees. If all lessees who had early termination rights exercised them at the earliest opportunity, Copylease would have been entitled to receive, after August 31, 1974, at least $7,876,709, based upon minimum monthly rental and...
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