Arrowhead Mountain Getaway, Limited v. Commissioner
| Decision Date | 31 January 1995 |
| Docket Number | Docket No. 2237-92. |
| Citation | 69 T.C.M. 1805 |
| Parties | Arrowhead Mountain Getaway, Limited, Peggy Knox, a Partner Other Than the Tax Matters Partner v. Commissioner. |
| Court | U.S. Tax Court |
Valdean Watson, for the petitioner. Gregory A. Knox, intervenor, pro se. Thomas T. Lamons, for the respondent.
CONTENTS
[CCH Page]
FINDINGS OF FACT .................................................................. 1807
I. The Parties ............................................................... 1807
II. Initial Dealings of Mr. Knox and Partnership with the Strebels ............ 1807
III. Dealings of Mr. Knox and Partnership With Investors ....................... 1809
A. Formulation, Organization, and Promotion of Partnership ................ 1809
B. The Partnership Agreement .............................................. 1809
C. The Agreement of Purchase .............................................. 1810
D. Investors' Purchases/Use of Getaway Packages/Resort Privileges ......... 1810
IV. Partnership Operations, Changes, and Conflicts of Interest ................ 1811
A. Fees and Rental Payments to Mr. Knox and the Strebels .................. 1811
B. Amendments to Partnership Agreement .................................... 1811
C. Attempted Partnership Restructuring .................................... 1812
D. Payments to or for Benefit of Mr. Knox ................................. 1812
E. Use of Property by Mr. Knox and the Strebels ........................... 1812
F. No Rentals or Transfers of Interests by Limited Partners ............... 1812
G. "Funding" the Reserve Fund ............................................. 1812
V. Economic, Tax, and Accounting Facts ....................................... 1813
A. Partnership Income Sources ............................................. 1813
B. Partnership Deductions ................................................. 1814
C. Economic Accrual Rates ................................................. 1814
VI. Ultimate Findings of Fact ................................................. 1814
OPINION ........................................................................... 1814
Issue I: Method of Accounting .................................................. 1814
Issue II: Sham Transactions .................................................... 1816
A. Lack of Economic Substance ............................................. 1816
B. Lack of Business Purpose ............................................... 1818
C. La Verne and Ames Parallels ............................................ 1819
D. Interest Deductions Disallowed ......................................... 1820
E. Gross Rental income and Receipts ....................................... 1821
Conclusions .................................................................... 1822
Memorandum Findings of Fact and Opinion
Respondent issued notices of final partnership administrative adjustment (FPAA's) reflecting adjustments to the partnership returns of income of Arrowhead Mountain Getaway, Ltd. (the Partnership or Arrowhead), as follows:
Long-Term Short-Term Self-Employment
Ordinary Capital Capital Income
Year Income Gain Gain
1984 ................................ $792,551 -- -- --
1985 ................................ 1,041,391 -- -- --
1986 ................................ 1,056,717 ($191,117)* -- $ 9,235
1987 ................................ 1,057,316 -- ($17,252) 110,700
1988 ................................ 765,887 -- -- 52,350
* By official Tax Court Order dated June 28, 1995, and
signed by Judge Renato Beghe, the above chart was
amended to read as indicated
All the adjustments are in dispute.
Arrowhead is a California limited partnership formed on December 12, 1983. Petitioner Peggy Knox (petitioner), who is the wife of Gregory A. Knox (Mr. Knox or intervenor), the tax matters partner and nominally the sole general partner of the Partnership, filed a petition with this Court as authorized by sections 6226(b)(1) and 6231(a)(2)(B).1 We permitted Mr. Knox, as the tax matters partner, to intervene pursuant to section 6226(b)(5) and Rule 245(a) and (c).
Respondent determined that all transactions in which the Partnership purported to engage, both with James K. and Pamela H. Strebel (the Strebels) and with the limited partners, were shams that are to be disregarded for tax purposes. Respondent therefore disallowed all the Partnership's claimed deductions, including purported interest accruals, and claimed capital gains.2 Respondent also determined, in the alternative, that the Partnership's method of accounting materially distorts income, and that the distortion provides an independent ground for disallowing all interest deductions claimed by the Partnership. For the reasons that follow, we uphold in full the adjustments resulting from respondent's determinations, excluding from gross income, however, the amounts of gross rents and gross receipts received from the limited partners and reported by the Partnership.
Some of the facts in this case have been stipulated and are so found. By this reference, we incorporate the first and second stipulations of facts, supplemental stipulation of facts, and attached exhibits.
When the petition was filed, petitioner and intervenor resided in — and the Partnership had its mailing address at — Redlands, California.
Mr. Knox received a J.D. degree from Brigham Young University in 1977. He thereafter became a financial planner and salesman of financial products, but has never been licensed to practice law in any jurisdiction. While employed by an insurance company, he first encountered a tax shelter program in the form of a computer sale/leaseback program. He was also a salesman for the Kilburn Vacation Homeshares and Admiral Beach Hotel resort timeshare programs.3 He thereafter began to formulate the Arrowhead program, which he characterized as his own program to provide a "reasonably-priced time share vacation to middle-class investors with some tax benefits."
In 1983, Mr. Knox moved to Lake Arrowhead, California, to find a house he could use to put his program into effect. In the second half of 1983, when the Strebels heard that Mr. Knox was looking for such a house, they let him know that they had a house for sale. The house owned by the Strebels was located at 1359 Portillo Lane, Lake Arrowhead, California (the Arrowhead property), and they were using it as their residence in 1983. As of December 1983, the fair market value of the Arrowhead property as a residence was less than $150,000.
Mr. Knox visited the Arrowhead property and decided that it was suitable for his purposes. He then informed the Strebels that he was willing to buy the property only on terms that he had already arrived at. These terms included dividing the property into 52 "time share weeks", to be sold to a partnership for $6,000 each. The downpayment for each timeshare week was to be $1,500, with payment of the remaining $4,500 deferred for 40 years under a "zero coupon bond" formula, with interest compounding at 13.6 percent annually, payable currently only in certain circumstances. Mr. Knox believed the Arrowhead property to be worth about $2,500 per timeshare week, or $130,000, as a residence.
On December 31, 1983, the Partnership (see infra pp. 10-14) and the Strebels entered into their first Property Interest Purchase Agreement, which had been prepared by Mr. Knox. Under that agreement, the Strebels purported to divide their fee interest (subject to their liability under a mortgage loan dated September 7, 1979, in the original principal amount of $66,000 in favor of the Bank of America, which the Partnership took subject to) in the Arrowhead property into 10 units, and to sell units to the Partnership for $31,200 per unit. Each unit represented 5.2 weeks of occupancy per year. Pursuant to the agreement, the Strebels agreed to "create ten undivided fractional interests in common tenancy in the real property". The interests sold by the Strebels to the Partnership were "undivided interests as tenant-in-common" in the real property and improvements in question. Under the agreement, of the $31,200 purchase price for each one-tenth undivided interest in the property (representing 5.2 weeks of occupancy), $7,800 was a downpayment, which could be paid "in cash or other valuable property." The balance of principal plus accrued interest was to be due and payable on December 31 of the 40th year after the year of purchase.4
The Partnership agreed to pay the Strebels a purchase price of $6,000 per week of ownership, which is equivalent to a purchase price of $31,200 per unit, or $312,000 for all 10 units. Of the $6,000 purchase price, $1,500 was a downpayment, and the remainder of $4,500 was deferred principal. The Strebels agreed that they would have no recourse for payment of principal or interest against any partner of the Partnership. It was an express condition of the Strebels' obligation to perform that the Partnership would establish a reserve fund for payment of the principal due: the fund would have to equal $4,186 per property interest, be established by December 31, 1988, and grow at such a rate that it would equal $358,8005 on December 31, 2023. If the Partnership failed to perform its...
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