Collins v. Comm'r of Internal Revenue

• Decision Date: 27 August 1970
• Docket Number: Docket No. 3116-67.
• Citation: 54 T.C. 1656
• Parties: JAMES A. COLLINS AND DOROTHY O. COLLINS, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

54 T.C. 1656

JAMES A. COLLINS AND DOROTHY O. COLLINS, PETITIONERS

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 3116-67.

United States Tax Court

Filed August 27, 1970.

Justin L. Goldner, for the petitioners.

Myron A. Weiss and Robert H. Feldman, for the respondent.

1. Held, amount paid as prepaid interest in a transaction wherein petitioners purchased an apartment building was not deductible because the installment debt and prepayment-of-interest provisions in the purchase contract were shams and lacking in substance. The purchase contract did not give rise to a bona fide indebtedness that would support the interest deduction.

2. Held, further, fee of $250 paid to petitioners' attorney for legal services in connection with the acquisition of income-producing property was a capital expenditure and not deductible as an ordinary and necessary expense.

3. Held, further, fee paid C.P.A. of $4,511 for tax advice and services with respect to the tax consequences of the apartment house purchase and preparation of income tax return and defending same before Internal Revenue Service, was properly deductible under sec. 212, I.R.C. 1954.

MULRONEY, Judge:

Respondent determined a deficiency in petitioners' 1962 income tax in the amount of $36,276.50. Certain adjustments have not been contested by the parties. The issues to be decided are (1) whether petitioners are entitled to deduct $44,299.70 as interest expense under section 163, I.R.C. 1954, ¹ and (2) whether petitioners are entitled to deduct all or any part over $300 of the sum of $4,461 paid by them as legal and accounting fees as an ordinary and necessary business expense under section 212 or whether that part of said payment over $300 represents a capital expenditure under section 263.

FINDINGS OF FACT

Some of the facts have been stipulated and they are so found.

Petitioners James A. Collins and Dorothy O. Collins are husband and wife. They resided in Norwalk, Calif., at the time they filed the petition in this case. They employed a cash receipts and disbursements method of accounting. They filed their joint income tax return for 1962 with the district director of internal revenue in Los Angeles, Calif.

Miles P. Shook and his wife Alene owned a 20-unit apartment building situated at 13919 Paramount Boulevard, Calif. Harley A. Sullivan and his wife Elizabeth owned a security interest in the apartment building represented by a trust deed held as security for money Shook had borrowed from Sullivan. This building was less than 1 year old in 1962. There was an existing first mortgage against the property in the sum of approximately $105,000 which bore interest at the rate of 7.2 percent and provided for payments to the mortgagee in the sum of $827 per month.

This apartment property was listed for sale with the Humphries Realty Co. of Paramount and Shook's original asking price was $178,000. The original listing called for cash to be paid to Shook above the loan balance and assumption of the first mortgage loan.

In 1962 petitioners won the Irish Sweepstakes, receiving $140,100, which was properly reported on their 1962 income tax return. A salesman from Humphries Realty Co. named Norman P. Murray read a news report of petitioners' winning $140,100 and he called on petitioners to try to interest them in purchasing income-producing property. Petitioners purchased the apartment building pursuant to a planned purchase and sale transaction that was designed to secure for petitioners a deduction that could be used to offset their large sudden increase in income in 1962.

The purchase and sale transaction starts with a document entitled ‘Deposit Receipt and Purchase Contract’ which was signed by buyers and sellers on November 12, 1962. The front page of this document signed by the Collinses is their written offer to buy the apartment building ‘for the total purchase price of One Hundred sixty eight thousand ($168,000.00) Dollars; * * * Sixty three thousand ($63,000.00) Dollars Cash * * * balance and terms as follows: Buyer to purchase property on contract subject to existing loan of 105,000.00.’ The offer provided for the cash to be placed in escrow with Eastern Pacific Escrow Co. and further provided that ‘purchase must be completed prior to Dec. 31, 1962 and escrow closed or this offer is null and void. Contract papers will be submitted to escrow by C.P.A. (and approved by attorney.)’

The reverse side of this single-sheet document signed by Shook and his wife Alene and Harley A. Sullivan is the written acceptance of the offer to buy and the sellers' agreement to sell the property on the terms and conditions set forth in the offer, and also their agreement to pay Humphries Realty Co. a commission of 6 percent of the selling price.

After the foregoing offer and acceptance a purchase contract for the purchase of the apartment building was prepared by buyers' attorney J. K. Walker. He used figures supplied by David Menkes, a certified public accountant (who will hereafter be called the C.P.A.), who was representing petitioners with respect to securing any possible tax advantages for them.

The purchase contract the attorney prepared using the C.P.A.‘S figures is entitled ‘Agreement.’ It was executed by petitioners as buyers and the Shooks and Sullivans as sellers on different days in the first week in December 1962 and it was recorded in the Office of the County Recorder of Los Angeles County, Calif., on December 12, 1962. We will hereafter refer to this as the December 12 contract.

This contract provides that in consideration of the covenants and agreements contained in the contract the buyers agree to buy and the sellers agree to sell the said apartment building. The agreement goes on to provide, in part:

II

The total consideration for this sale is ONE HUNDRED FIFTY EIGHT THOUSAND EIGHT HUNDRED AND NO/100 ($158,800.00) DOLLARS.

III

Said consideration is payable as follows:

(a) The cash sum of NINETEEN THOUSAND THREE HUNDRED FIFTEEN AND NO/100 ($19,315.00) DOLLARS down, receipt of which in escrow is hereby acknowledged,

(b) The balance in the amount of ONE HUNDRED THIRTY-NINE THOUSAND FOUR HUNDRED EIGHTY-FIVE AND NO/100 ($139,485.00) Dollars, in installments of EIGHT HUNDRED THIRTY AND NO/100 ($830.00) DOLLARS, or more per month, plus interest at the rate of eight and four tenths (8.4%) per cent annum, payable on the first day of each month, commencing on the first day of January, 1963 and continuing until paid in full.

VI

It is understood that the property is presently encumbered by a note secured by a First Deed of Trust to Community Savings and Loan of Compton with an approximate balance due thereon of ONE HUNDRED FOUR THOUSAND TWO HUNDRED FOUR AND 86/100 ($104,204.86) DOLLARS, payable at the rate of $827.00 per month, including interest at the rate of 7.2% per annum. Sellers covenant and agree to promptly pay and satisfy when due any and all payments of principal and interest upon said existing encumbrances of record against said real property. In the event the Sellers default in any payment of principal and interest due thereon, Buyers are given the right to make any such payments and any such payments by the Buyers shall be fully credited upon the balance due on this contract.

VIII

Possession of the premises shall be delivered as of close of escrow.

IX

When the balance due hereunder is paid in full and upon fulfillment of the Buyers obligations as herein provided, Sellers shall deliver to Buyers a good and sufficient Grant Deed, conveying a good and merchantable title to said premises, free and clear of all liens and encumbrances, excepting conditions, restrictions, reservations and easements of record or any encumbrance hereinafter incurred by Buyers herein. Buyers are given the right at any time after the balance due hereunder is equal to the then balance due on the First Deed of Trust to Community Savings and Loan Association to assume the said obligation and in such event and upon Buyers executing said assumption, Sellers shall then cause to be delivered to Buyers the above Deed.

X

In order to insure delivery of the Grant Deed as hereinabove referred to, Sellers agree to deposit in escrow a duly executed and acknowledged Deed with instructions that the same shall be deposited with Title Insurance and Trust Company or such other entity as the parties may direct for delivery to Buyers when they are under the terms of this contract entitled thereto.

XIX

To carry out the terms of this agreement, the parties have opened an escrow with Charter Savings and Loan Association and Buyers and Sellers will deposit in said escrow all instruments required of each. The sum of $19,315.00 payable to Sellers as down payment herein shall be deposited by Buyers in said escrow. The Sellers shall deposit in escrow Bill of Sale of personality from Sellers to Buyers; executed and acknowledged Contract of Purchase and Sale which shall be recorded in the office of the County Recorder of Los Angeles County; request for notice properly executed and recorded with the County Recorder of Los Angeles County giving notice to the Buyers of any notice of default under an indebtedness of Sellers to Community Savings and Loan Association; offset statement from Community Savings and Loan Association showing the unpaid balance on the first trust deed hereinabove referred to and stating that same is not in default. The parties shall each pay the usual Buyers and Sellers expenses of escrow.

XXI

This agreement and the close of escrow are subject to Buyers' written approval of a preliminary title report. If Buyers disapprove of any portion of said report, the Sellers shall have fifteen (15) days within which to correct same.

It is further agreed between the parties that the escrow and instructions therein shall be solely for the purpose of enabling the Charter Savings and Loan Association to close the escrow in accordance with the terms of its agreement, and the instructions in said...