Casebeer v. C.I.R., 123087 FEDTAX, 32928-83

Docket Nº:32928-83
Opinion Judge:HAMBLEN, JUDGE:
Attorney:Thomas F. Topel, Kenneth L. Cutler, J. Marquis Eastwood, and Maureen H. Parkinson, for the petitioners. Randy G. Durfee and Joel A. Lopata, for the respondent.
Case Date:December 30, 1987
Court:United States Tax Court

54 T.C.M. (CCH) 1432




No. 32928-83

United States Tax Court

December 30, 1987

Thomas F. Topel, Kenneth L. Cutler, J. Marquis Eastwood, and Maureen H. Parkinson, for the petitioners.

Randy G. Durfee and Joel A. Lopata, for the respondent.



Respondent determined deficiencies in petitioners' [1] Federal income tax as follows:

Year Deficiency
1978 $11,939.00
1979 14,433.00
1980 8,546.00
The primary issues for our determination are whether the ownership interest acquired by petitioner in a sale and leaseback transaction was supported by economic substance and whether petitioner acquired the benefits and burdens of any such ownership. Subsidiary issues for our determination are (1) whether the ownership interest acquired, if any, was a present depreciable interest; (2)whether petitioner was at risk for certain borrowed amounts pursuant to section 465; [2] (3) whether petitioner was entitled to depreciate certain computer equipment pursuant to the half-year convention method of depreciation in the taxable year 1978; and, (4) whether petitioner is liable for additional interest pursuant to section 6621(c). [3] FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. petitioners resided in the State of Montana at the time their petition herein was filed. Petitioner is a physician licensed to practice Medicine and Surgery in the State of Montana. Petitioner has specialized his practice in opthalmology. During the taxable years 1978 and 1979, petitioner was a self-employed ophthalmologist conducting business in the name of Casebeer Eye Clinic. Petitioner's investment experience is primarily limited to the purchase and rental of apartment and commercial buildings used in the medical profession. In a transaction that is the subject of this case, petitioner purchased from Finalco, Incorporated (‘ Finalco‘ ) certain used peripheral computer equipment [4] manufactured by International Business Machines Corporation (‘ IBM ‘ ) and, in a simultaneous transaction, leased such equipment back to Finalco. [5] FINALCO Finalco is the principal subsidiary of Finalco Group, Inc., formerly Financial Analytics Corporation, a publicly-held corporation, the stock of which is traded over-the-counter and reported in NASDAQ quotations. The principal offices of Finalco and Finalco Group, Inc., are located in McLean, Virginia. During the years in issue, Finalco was a closely-held company. During the years in issue, Finalco typically engaged in leasing transactions involving electronic data processing equipment in which Finalco negotiated and entered into a lease with an end-user, purchased the equipment, financed the purchase with a lending institution, and resold the equipment in a sale and leaseback transaction with an independent third party. The resale of the equipment provided Finalco with much of the capital necessary to generate additional lease transactions. In addition to generating transactions through its own marketing programs, Finalco also acquired equipment subject to existing end-user leases from other leasing companies. During its fiscal year ending June 30, 1979, Finalco entered into lease transactions of approximately $129,000,000 based on the original cost of equipment. John Olmstead (‘ Olmstead ‘ ) served as president of Finalco during the years in issue. ACQUISITION OF EQUIPMENT BY FINALCO By a Purchase Agreement (‘ the Comdisco Purchase Agreement‘ ) with a closing date of September 29, 1978, Finalco acquired certain used IBM computer equipment from Comdisco, Inc. (‘ Comdisco‘ ), through Bluewood Corporation (‘ Bluewood‘ ), a Finalco subsidiary formed for the purpose of purchasing computer equipment for Finalco. Included as a portion of the Comdisco Purchase Agreement were certain magnetic tape units and a tape control unit with a fair market value of $157,923 (the ‘ Equipment‘ ). Comdisco, a publicly-held Delaware Corporation, is unrelated to Finalco and is a competing equipment leasing company that buys and sells new and used IBM computer equipment and arranges leases of such equipment. During the years in issue, Comdisco had no shareholders, officers, directors, or employees in common with Finalco. The Comdisco Purchase Agreement stated the fair market value of all equipment sold to Bluewood to be $2,776,500, however, the negotiated purchase price paid by Bluewood was stated as $2,070,545.81 payable as follows:
Promissory Note $ 276,650.00
Rental Proceeds 1,793,895.81
Total $2,070,545.81
Title to the Equipment was transferred from Comdisco to Bluewood, and then to Finalco, subject to an existing bank lien placed by Continental Illinois National Bank and Trust Company (the ‘ Bank‘ ), which provided Comdisco with acquisition financing. Title to all the equipment was transferred to Bluewood also subject to the recourse promissory note in the amount of $276,650 issued by Finalco in favor of Comdisco, and the lease to Beneficial Merchandise Data processing Corporation (the ‘ End User‘ ). The lease to the End User (‘ End User Lease‘ ) was a typical commercial triple net lease with an initial term of 60 months, beginning April 4, 1977, which did not contain a purchase option. Bluewood entered into a Management and Remarketing Agreement with Comdisco (the ‘ Comdisco Management and Remarketing Agreement‘ ), which provided that Comdisco would manage the property until September 30, 1985, at which time either party could terminate the agreement upon 30 days written notice. If such agreement was not terminated after September 30, 1985, Comdisco had the right to attempt to sell or re-lease the Equipment. The Comdisco Management and Remarketing Agreement provided that Comdisco would solicit offers from third parties to re-lease the Equipment. Comdisco was required to obtain written consent by the owner to execute a re-lease of the Equipment except any re-lease executed prior to the expiration date and not extending beyond the expiration date of such Agreement. A schedule appended to the Comdisco Management and Remarketing Agreement allocated remarketing proceeds from the sale or re-lease as follows: ten percent of net sales proceeds or net rentals to the party remarketing the Equipment either Owner or Agent; next thirteen percent of fair market value of Equipment as of closing date to Owner; then seventy-five percent to Owner, 25 percent to Agent The Comdisco Management and Remarketing Agreement provided Comdisco the option to reacquire the Equipment from Bluewood in exchange for equipment of the same model number and condition as the Equipment. By letter dated January 31, 1984, Finalco advised petitioner that under rights granted to Comdisco under the Comdisco Management and Remarketing Agreement, Comdisco wished to exchange one of the IBM 3420 tape units on sublease to the End User from Finalco for an identical unit then on lease to Texas Instruments. Petitioner acknowledged and accepted this equipment exchange on February 21, 1984. The record does not indicate the benefit received by Comdisco on the exchange. ENTRY INTO THE TRANSACTION In the Fall of 1978, Robert Prigge (‘ Prigge‘ ), C.P.A., contacted petitioner and recommended an equipment leasing investment. Petitioner had relied on Prigge for accounting services and investment advice for over 20 years. Prigge introduced petitioner to Gerald DuBois (‘ DuBois‘ ). At that time DuBois was a self-employed individual who sold investments in computer equipment leasing transactions. DuBois described leveraged computer lease transactions and discussed the potential risks the investor faced, including the investor's obligations with respect to the promissory notes required in the arrangement. DuBois represented that to be profitable the equipment had to be re-leased or sold at the end of the leaseback. DuBois usually told investors to expect the equipment to have a residual value at the end of the leaseback term of 20 to 25 percent of the cost of the equipment. Petitioner relied on the representation of DuBois regarding the residual value of the Equipment. Neither petitioner nor Prigge sought an independent appraisal of residual value. Petitioner understood that DuBois was an agent for Finalco. DuBois presented a projected profit and loss statement prepared by Finalco that showed the anticipated after tax saving from 1978 through 1982 inclusive were projected to be $45,525; the anticipated tax liability due on profits from 1983 though 1986 was projected to be $30,976. The net after-tax savings were expected to be $14,549 during the entire transaction. Petitioner's cash investment was $25,000. As proposed, petitioner would buy the Equipment from Finalco at a purchase price of $157,923. A portion of the purchase price together with interest would be payable in four annual installments. The balance of the purchase price, together with interest, would be payable in 96 equal monthly installments. Petitioner understood that the lease payments due from Finalco equaled the payments which he was required to make to Finalco under the installment note; however, petitioner did not understand that the installment note was a nonrecourse note. Petitioner did not understand the guarantee or terms of the obligation guaranteed. Petitioner did not inquire as to the extent and nature of his personal liability in the transaction and did not...

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