Bryant v. Commissioner, Docket No. 3013-85.

CourtUnited States Tax Court
Citation1989 TC Memo 527,58 TCM (CCH) 235
Docket NumberDocket No. 3013-85.
PartiesJonas R. Bryant and Carmen L. Bryant v. Commissioner.
Decision Date27 September 1989

58 T.C.M. (CCH) 235 (1989)

T.C. Memo. 1989-527.

Jonas R. Bryant and Carmen L. Bryant

Docket No. 3013-85.

United States Tax Court.

Filed September 27, 1989.

Burgess L. Doan and Marvin L. Martin, for the petitioners. Andrew M. Winkler, for the respondent.

Memorandum Findings of Fact and Opinion

WRIGHT, Judge:

By two notices of deficiency dated November 27, 1984, respondent determined the following deficiencies in petitioners' Federal income tax:

 Year Deficiency
                 Jonas R. Bryant ...... 1979 $203,492.52
                 Jonas R. and Carmen L
                 Bryant .............. 1982 9,088.00

The issues for decision are: (1) whether petitioner's1 mining activities were a sham and lacked economic substance; (2) whether certain amounts expended by petitioner in 1979 and 1982 were deductible as mine development expenditures pursuant to section 616(a)2; (3) whether petitioner was at risk under section 465 for amounts borrowed in connection with his mining investments; (4) whether petitioners were entitled to an interest deduction in 1982 for a claimed payment of interest on a promissory note; and (5) whether certain miscellaneous business expenses claimed by petitioners in 1982 were ordinary and necessary business expenses.

Findings of Fact

Some of the facts of this case have been stipulated and are so found. The stipulation of facts and first supplemental stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference.

58 TCM (CCH) 236


Petitioners resided in Bardstown, Kentucky, when they filed their petition. Petitioner holds a bachelor's degree in Ceramic Engineering from Virginia Technological University and a master's degree in Business Administration from Rutgers University. Petitioner also has earned some credit towards a Ph.D. in Business Administration from the University of Southern California. In September 1978, Hitachi Metals Corporation (Hitachi) purchased petitioner's closely held business, American Magnetics Corporation (American Magnetics). Petitioner owned 56 percent of the stock in American Magnetics; Alan Brown (Brown) and Charles Repenn (Repenn) held the remaining 44 percent. As part of the sale of American Magnetics to Hitachi, petitioner entered into a 5-year employment contract with Hitachi to manage its newly purchased plant. In 1979, petitioner requested that Hitachi shorten the length of his employment contract, which it did. Petitioner worked for Hitachi from September 1978 until mid-1980, although he stopped actively working in 1979. Petitioner's sale of his American Magnetics stock resulted in a long-term capital gain in his 1978 taxable year. In 1978, petitioner invested in a cattle feeding operation that resulted in a loss for that taxable year. In 1979, petitioner recognized a gain of $331,214 from his cattle feeding investment. Since 1982, petitioner has been employed as vice president and general manager of the ceramic operations for Crucible Materials Corporation in Elizabethtown, Kentucky.

The Austin Silver Mine

The Investment

In early 1979, petitioner's former business associate Brown went to Austin, Nevada, to investigate a silver mining investment opportunity. Brown spent a week investigating the Austin Silver Mine (Austin Mine) and interviewing William Noack (Noack), the miner in charge. Brown returned from his trip enthusiastic about the investment and brought back geological reports and other engineering data that petitioner studied. In March 1979, petitioner, along with Brown and Repenn, met with American Magnetic's former certified public accountant to discuss the financial implications of investing in the Austin Mine. Petitioner, Brown, and Repenn also reviewed the investment with American Magnetic's former attorney. Based upon Brown's enthusiastic report, his review of the data brought back by Brown, and his discussions with his C.P.A. and with his attorney, petitioner decided to invest in the Austin Mine, as did Brown and Repenn. Petitioner then requested that Robert Hughes (Hughes), who was marketing the Austin Mine investment, come to Indiana to discuss the details of the investment program with him. Hughes' presentation included a discussion of the favorable tax benefits of an investment in the Austin Mine.

On March 27, 1979, petitioner executed the following documents in connection with his subscription to the Austin Silver Program:

1. Appointment of Agent and Authorization to Negotiate — Petitioner appointed The Equitable Corporation (Equitable) as his agent to negotiate with Argus Resources, Inc. (Argus), the mineral claim owner, for silver recovery rights and to obtain mineral lease approval to remove 83,600 troy ounces from silver-bearing ore material in the leased property. Petitioner also authorized Equitable to arrange for an independent miner to develop the mine property in preparation for being mined and to mine, mill, and refine petitioner's ore. Equitable was to contract with the independent miner for $380,000 of development work.
2. Mineral Claim Lease — between Argus, as lessor, and petitioner, as lessee/miner, for "sufficient silver-bearing material to produce by good mining methods 83,600 troy ounces of .999 silver on the 29 patented mining claims of the Kilborn and Patriot Groups, Lander County, Reese River Mining District, Austin, Nevada." The lease was in consideration of "one dollar and other valuable consideration * * *." The lease was to terminate after the time necessary to mine and mill (as amended on October 8, 1981) the specified silver or 5 years, whichever occurred sooner. The lease provided for petitioner to pay Argus a royalty of 5 percent "of the market price recovered silver `at site' after first deducting taxes due the State of Nevada or Lander County, Nevada."
3. $285,000 Promissory Note — from petitioner, as payor, to Equitable, as payee. The note provided for payments of $95,000 each on June 1, 1980, 1981 and 1982, with interest at the prime rate as established by Chase Manhattan Bank, N.Y., New York plus one-quarter (¼) percent. The note also provided that all payments were to be applied against interest first, with the balance, if any, applied against principal.
4. Subscription Form — instructing Equitable, as petitioner's agent, to deliver the $95,000 in cash and the $285,000 note to an independent miner for the development of petitioner's mining property. This form provided a commission fee of 2 percent of the market value of silver, when produced.
5. Mining Contract — between petitioner, as lessee, and Manhattan Consolidated Gold Mines, Inc. (Manhattan), as miner. The contract authorized Manhattan to perform
58 TCM (CCH) 237
$380,000 in development work and to remove 83,600 troy ounces of silver for petitioner.

On March 27, 1979, a note was executed by Hughes as president for Equitable to Manhattan for $285,000. The note provided for three payments of $95,000 on March 27, 1980, March 27, 1981, and March 27, 1982, with interest at the prime rate plus 1/8 percent as established by Chase Manhattan Bank, New York. The note was marked "Paid 12-7-79" over the signature stamp of Noack.

Petitioner made the following payments to Equitable in connection with his Austin Mine investment:

 Date of
                 Check Amount Description
                 3/27/79 $95,000.00 Silver mine
                 development work
                 12/30/80 61,152.05 One half silver
                 development note &amp
                 12/29/82 10,000.00 interest for Austin
                 12/27/83 19,300.00 interest on Austin
                 Silver notes

On October 22, 1985, petitioner executed a new promissory note to Equitable for $237,500. The note provided for interest of 8 percent per annum and a due date of October 22, 1995. The note further provided that it was secured by a mortgage. The mortgage, also dated October 22, 1985, was between petitioner, as mortgagor, and Equitable, as mortgagee. The mortgage conveyed an interest in petitioner's Bardstown, Kentucky, residence to Equitable as security for the payment of petitioner's note. The mortgage was notarized on November 15, 1985. The copy received by Equitable reflected that the mortgage had been recorded in the Nelson County, Kentucky courthouse. Petitioners jointly owned their residence, which was appraised at $232,500 on November 14, 1985.

Description and Background of the Leased Mineral Claim

The ore blocks leased by petitioner were located west of the Hillside Shaft on the Panamint Vein system. High grade silver was first discovered in the Austin area in the early 1860's. Miners sunk the Hillside Shaft at that time, and the area was heavily mined until the 1880's. The methods used by miners in the 1800's were very expensive compared to methods currently used. Accordingly, only high grade silver ore was mined and milled. Generally, those miners only considered ore containing in excess of 50 ounces of silver per ton to be worth mining. In 1946, the Nevada Equity Mining Company was formed to explore the claims around the Austin area, including the Hillside Shaft, which was cleaned out and rehabilitated. The next major development work was performed by Argus.

By letter dated December 7, 1979, Equitable obtained an accounting from Argus detailing the following development work undertaken and completed on petitioner's behalf:

Description Cost
                Site Preparation:
                 Hillside Shaft .......... $ 25,000
                 New York Shaft .......... 7,000
                 $ 32,000
                Headframe Base:
                 Hillside ................. 10,000
                 New York ................. 5,000
                Decline Shaft:
                 Hillside 95 ft. @ $3,000/ft. 285,000
                 New York 10 ft. @
                 $3,000/ft................. 30,000
                 Hillside ................... 3,000
                 New York ................... 2,000
                Metallurgy ................... 2,300
                De-Water Shaft ............... 10,700

Manhattan Consolidated Gold Mines, Inc., also disbursed $557,193 during 1980 for the development of the Austin Mine. On January 6, 1981, Argus spun off...

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