Cody v. U.S.

• Decision Date: 13 December 2004
• Docket Number: No. 1:04CV171.,1:04CV171.
• Citation: 348 F.Supp.2d 682
• Parties: Richard F. CODY, et al., Plaintiffs, v. UNITED STATES of America, Defendant/Third Party Plaintiff, v. Jerome P. Friedlander II, et al., Third Party Defendants.
• Court: U.S. District Court — Eastern District of Virginia

Page 682

348 F.Supp.2d 682

Richard F. CODY, et al., Plaintiffs, v. UNITED STATES of America, Defendant/Third Party Plaintiff, v. Jerome P. Friedlander II, et al., Third Party Defendants.

No. 1:04CV171.

United States District Court, E.D. Virginia, Alexandria Division.

December 13, 2004.

Roger J. McClure, Alexandria, VA, for Plaintiffs.

MEMORANDUM OPINION

ELLIS, District Judge.

This suit concerns the validity of a federal tax lien. The central question presented is whether plaintiffs, who claim to own the liened townhouse property, are merely the nominee owners on behalf of the third-party defendant taxpayers, who live in the townhouse, are relatives of plaintiffs, and whose tax liability is the basis for the lien.

Plaintiffs commenced this declaratory judgment action against the United States in February 2004 seeking to invalidate a federal tax lien on a townhouse. The defendant United States responded by claiming that plaintiffs were mere nominee owners of the property and additionally filed (i) a counterclaim against plaintiffs to set aside certain transfers of assets, and (ii) a third-party claim against the taxpayers to reduce the taxpayers' income tax deficiency assessments to judgment and to foreclose on the lien. Following a one-day bench trial on October 28, 2004, the parties filed supplemental briefs and presented oral argument. As the matter has now been fully briefed and argued, it is ripe for resolution. This Memorandum Opinion sets forth the Court's findings of fact and conclusions of law pursuant to Rule 52, Fed.R.Civ.P.

FINDINGS OF FACT

I. The Parties

1. Taxpayers and third-party defendants Jerome P. Friedlander II and Irene B. Friedlander, husband and wife, have experienced financial difficulties since the late 1980s and have been insolvent since 1995. While they have not filed for bankruptcy, their insolvency has precluded them from paying the full amount of their income taxes for any year from 1996 until 2001. Since 1999, the Friedlanders have lived in a townhouse at 7439 Hallcrest Drive, McLean, Virginia, the deed to which indicates that it is owned by their relatives, Richard and Janet Cody. While living there, the Friedlanders have made all the mortgage payments, paid all expenses attendant to the maintenance of the townhouse, and treated the mortgage interest paid as a deduction on their federal income taxes.

2. Plaintiffs Richard Cody, his wife Janet Cody, and her father Herbert Bluethenthal are relatives of the Friedlanders. Irene Friedlander and Janet Cody are sisters and the daughters of Bluethenthal. In 1999, the Codys and Bluethenthal sought to assist the insolvent and financially troubled Friedlanders by devising a plan for acquiring a townhouse located at 7439 Hallcrest Drive, McLean, Virginia to serve as the Friedlanders' home. It is this transaction, more fully described in Part II infra, that is at the heart of this case.

3. The United States ("the government"), defendant and third-party plaintiff, has assessed federal income tax deficiencies against the Friedlanders for the years 1996-2001 totaling $199,118, including penalties and interest, as of July 12, 2004, and therefore claims a lien against all of the taxpayers' real and personal property to that extent. Based on the circumstances of the 1999 purchase of the townhouse at 7439 Hallcrest Drive, and on the Friedlanders' and Codys' subsequent conduct with respect to the property, the government contends that the Codys hold title to the townhouse as the Friedlanders' nominees, and therefore that its lien attaches to the townhouse and also to $24,000 in refinancing proceeds that the Codys received in February 2002.

II. The Purchase of the Townhouse

4. In 1995, the Friedlanders defaulted on the mortgage on their Arlington, Virginia residence and were compelled to quit the premises. Because the Friedlanders' troubled financial circumstances made it difficult for them to rent or buy a home on their own credit, the Codys came to the Friedlanders' aid by co-signing a residential lease for them on a house in Arlington.

5. In 1999, the Friedlanders' residential lease on the Arlington house was due to expire and hence they began the search for a new place to live. Because their financial circumstances had not improved, the Friedlanders discussed with the Codys the possibility of the Codys again co-signing a residential lease. Over the course of several discussions, the Codys suggested to the Friedlanders that it might be preferable for the Codys to buy a house and lease it to the Friedlanders rather than co-sign another residential lease. Richard Cody further suggested to Jerome Friedlander that under such an arrangement, the Friedlanders could simply make the mortgage payments directly to the lender instead of paying rent to the Codys. Jerome Friedlander, an experienced attorney, then suggested that the contemplated arrangement take the form of a land trust rather than a lease. Friedlander explained to Cody that through a land trust, the Friedlanders could be granted a beneficial interest in the property and thereby be permitted to treat the mortgage interest as a deduction on their federal income tax returns.¹

6. At the same time or shortly thereafter, the Friedlanders discovered the townhouse located 7439 Hallcrest Drive, McLean, Virginia, their current home. Herbert Bluethenthal, meanwhile, was brought into the Codys and Friedlanders' discussions regarding the proposed purchase and land trust, and the following plan was devised: First, the Codys would apply for a mortgage on the McLean townhouse, purchase the property in their own names, and then settle it in a land trust. Bluethenthal, for his part, would contribute $50,000 as a down payment. The Friedlanders would then live in the townhouse, paying the mortgage, taxes, insurance and all other expenses and carrying costs. The beneficial interests in the property were to be allocated as follows: Bluethenthal would receive a 19% beneficial interest in the trust property, the Codys an 80% share, and the Friedlanders 1%.

7. At trial, Jerome Friedlander and Richard Cody testified that the allocation of beneficial interests was determined as follows. Given that the townhouse's purchase price was $267,500, Bluethenthal's 19% share of the trust was intended to reflect his $50,000 down payment contribution, which amount is roughly that percentage of the purchase price. The Codys' 80% share was intended to reflect the financial risk they would incur by assuming personal liability for the mortgage. Lastly, the Friedlanders' interest was fixed at 1% because that was all that was required to permit them to deduct mortgage interest from their annual income for federal income tax purposes. In the course of his testimony, Jerome Friedlander admitted, however, that part of the motivation for assuming the minimum interest necessary for tax purposes was the desire to minimize the portion of the trust property subject to a federal tax lien in the event that the government were later to levy on his assets.²

8. Pursuant to the plan, the Codys entered into a contract to purchase the townhouse in May 1999. They paid $445 in connection with their mortgage loan application. Around the same time, the Friedlanders paid $5,000 as a deposit on the purchase contract and $350 for an inspection of the townhouse.

9. Closing occurred on June 24, 1999, with the Codys taking title to the townhouse in their own names and assuming a $208,000 loan on the property secured with a first deed of trust. Bluethenthal, as agreed, made a $50,000 down payment, and the Friedlanders contributed an additional $8,164. The latter contribution was made possible by a $30,000 loan obtained by Jerome Friedlander and secured by a second deed of trust on the townhouse. The Friedlanders used the $21,800 remaining from this loan to pay personal debts.

10. Shortly thereafter, the Friedlanders moved into the townhouse and have since paid all expenses and carrying costs attendant to occupancy. For the period from closing until June 30, 2004, those expenses amounted to approximately $170,000. More specifically, the Friedlanders paid:

a. $119,000 in mortgage payments;

b. $28,000 in utilities;

c. $4,700 in homeowners' association fees;

d. $15,000 in real estate taxes;

e. $2,600 in insurance premiums;

f. $1,900 in maintenance expenses; and

g. $2,700 in equipment replacement expenses.

Additionally, Jerome Friedlander carries an insurance policy on his life for the purpose of paying off the mortgage on the townhouse in the event of his death.

11. In sum, the respective contributions of the Friedlanders, Codys, and Bluethenthal toward the purchase and upkeep of the townhouse at 7439 Hallcrest Drive are as follows:

a. the Friedlanders paid $5,000 as deposit, $350 for a home inspection, $8,164 at closing, and $170,000 in mortgage payments and other expenses, for a total contribution of approximately $183,500;

b. Bluethenthal paid $50,000 at closing; and

c. the Codys paid a $445 mortgage application fee.

12. During the five-year period from June 1999 to June 2004, the aggregate fair market rental value of the townhouse was $135,000. The Friedlanders, therefore, paid approximately $48,500 more toward the townhouse than they would have paid under a fair market rental arrangement for the same period.

III. The 7439 Hallcrest Trust

13. Approximately three months after closing on the townhouse, the Codys, as planned, settled the townhouse in a land trust by conveying title to the townhouse to themselves as co-trustees of the "7439 Hallcrest Trust" ("the Trust"). The instrument creating the Trust had been prepared several months earlier by Jerome Friedlander, an experienced attorney, using the Illinois land trust as a model.³ Under the terms of the Trust:

a. The Codys are both settlors and trustees of the Trust. In those capacities, the Codys have "the express and total power to revoke or amend [the][T]rust," and also...