Concord Consumers Hous. Coop. v. Comm'r of Internal Revenue

• Decision Date: 16 July 1987
• Docket Number: Docket No. 31365-81
• Citation: 89 T.C. No. 12,89 T.C. 105
• Parties: CONCORD CONSUMERS HOUSING COOPERATIVE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

89 T.C. 105

89 T.C. No. 12

CONCORD CONSUMERS HOUSING COOPERATIVE, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 31365-81

United States Tax Court

Filed July 16, 1987

P is a federally subsidized, nonexempt, nonprofit corporation organized to provide housing for persons of low and moderate incomes. P earned interest income on two reserve accounts and on an escrow account it was required to maintain under its agreements with the Federal Housing Administration (FHA) and the Michigan State Housing Development Authority (MSHDA).

HELD: Interest income earned on those accounts is not ‘income derived * * * from members or transactions with members‘ within the meaning of sec. 277(a), I.R.C. 1954, and constitutes nonmembership income.

HELD FURTHER: Expenses attributable to and deductible against such nonmembership income determined. Robert W. Siegel, for the petitioner.

D. Marcus Carr, for the respondent.

PARKER, JUDGE:

Respondent determined deficiencies in petitioner's Federal income tax as follows:

+-------------------------+
                ¦TYE Mar. 31-- ¦Deficiency¦
                +--------------+----------¦
                ¦1976          ¦$4,399    ¦
                +--------------+----------¦
                ¦1977          ¦3,036     ¦
                +--------------+----------¦
                ¦1978          ¦3,865     ¦
                +-------------------------+
                

After concessions ¹ the issues remaining for decision are:

(1) Whether the interest petitioner earned on two reserve accounts and a mortgage escrow account required to be established pursuant to Regulatory Agreements with the Federal Housing Administration and the Michigan State Housing Development Authority constitutes income ‘derived * * * from members or transactions with members‘ (membership income) within the meaning of section 277(a); ² and

Petitioner reported these amounts of interest as income in these years. On its U.S. Corporation Income Tax Returns (Forms 1120) for its taxable years ended March 31, 1976 and 1977, petitioner reported total gross income of $686,773 and $753,021 and total deductions of $854,672 and $925,857, respectively, resulting in a substantial loss each year. Petitioner did not specifically allocate any of the deductions to its interest income. On its U.S. Corporation Income Tax Return (Form 1120) for its taxable year ended March 31, 1978, petitioner reported interest income of $19,324 as outside (nonmember) income and specifically allocated deductions totaling $29,639 to this income resulting in a loss of $10,315 for such year. Petitioner allocated the entire annual amortization for finance cost ($6,941) and for organization cost ($5,326), for a total of $12,267 to the interest income. Petitioner also allocated $10,491 of the management fee, $3,811 of the legal fee, and $3,070 of the audit and tax appeal fee, for a total of $17,372, to the interest income.

In a statutory notice of deficiency dated September 30, 1981, respondent determined that the interest on the replacement reserve fund, the general operating reserve fund, and the mortgage escrow account during each of the years in issue constituted nonmember or nonmembership income within the meaning of section 277. Respondent further determined that petitioner failed to establish that its expenses, or any portions thereof, deducted on its tax returns were attributable to this nonmembership interest income. Respondent thus increased petitioner's taxable income for each of the years in issue by the amounts of this interest income, $21,997, $15,181, and $19,324, respectively. ⁸

Unfortunately, neither the management company nor petitioner's accountant maintained a separate accounting of the expenses attributable to petitioner's nonmembership interest income. Petitioner's allocation of these expenses is primarily based upon the testimony of Alphonse Marcus, a principal of the management firm, and John Gwizdala, petitioner's accountant.

At trial, Mr. Marcus gave his best estimate of the time his company devoted to the three interest-bearing accounts. However, his company did not work for petitioner during the years before the Court. See n.7, supra. Mr. Gwizdala gave his opinion with respect to the organizational costs, the finance costs, and the auditing fee that he considered properly allocable to the three interest-bearing accounts. While both witnesses appeared credible, ²¹ petitioner did not offer and there is nothing in the record setting forth the underlying factual data that each witness relied upon. Consequently, we are reluctant to make an allocation based solely on their unsupported conclusions.

However, when a taxpayer proves that some part of an expenditure was made for deductible purposes and when the record contains sufficient evidence for us to make some reasonable approximation, we will do so. Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930). Although the evidence is less than satisfactory for this purpose, we will do our best with the materials at hand ‘bearing heavily * * * upon the taxpayer whose inexactitude is of his own making * * *.‘ Cohan v. Commissioner, supra, 39 F.2d at 543-544.

There is no dispute in this case as to the amounts that petitioner expended during the years in issue with respect to its amortized organizational costs and finance costs, management fees, and auditing fees. Moreover, there is no dispute in this case that some portion of each expense is allocable to the nonmembership interest income. Accordingly, based on all the facts and circumstances, but bearing heavily against petitioner for the inexactitude of its evidence, we conclude that five percent of each of the above expenses is properly allocable to the nonmembership income and petitioner is entitled to deduct such amounts in each of the years in issue.

To reflect the parties' stipulation and our holdings, ²²

Concord is a federally subsidized, nonprofit corporation organized exclusively to provide housing facilities for persons of low and moderate incomes and such social, recreational, commercial, and communal facilities as may be incidental or appurtenant thereto and, in general, to carry on any business in connection therewith and incidental thereto, with all powers conferred upon corporations by the laws of the State of Michigan but not inconsistent with Act No. 346 of Public Acts of 1966 of the State of Michigan, as amended.

Concord obtained mortgages from the Michigan State Housing Development Authority (MSHDA) and obtained mortgage insurance and the benefits of special financing through the Federal Housing Administration (FHA), Department of Housing and Urban Development (HUD), in accordance with section 236 of the National Housing Act, as amended. ⁴ MSHDA is the mortgagee on all the real property owned by petitioner. In order to obtain these mortgages from MSHDA and to qualify under section 236 of the National Housing Act for Federal assistance, petitioner was required to enter into Regulatory Agreements with FHA. The Regulatory Agreements set forth extensive rules and regulations governing virtually every aspect of petitioner's activities. In the event petitioner fails to comply with the terms of the Regulatory Agreements, FHA, among other things, can institute mortgage foreclosure proceedings or any other appropriate legal proceeding and assume management of petitioner. Petitioner's members, who will be described below, elect their own board of directors to conduct corporate activities. Corporate activity, however, is restricted by the terms and conditions of the Regulatory Agreements, which effectively provide FHA and MSHDA with the ultimate authority to regulate petitioner.

Concord was constructed in eight phases or sections. Seven sections contain 50 dwelling units each and the eighth section contains 41 units, for a total of 391 units. Separate mortgages were obtained from MSHDA for each section, and petitioner and FHA executed separate Regulatory Agreements with respect to each section. These eight Regulatory Agreements were executed in the period from March 20, 1970 through June 9, 1971. The terms and conditions set forth in each of these Regulatory Agreements are essentially identical.

Occupancy in Concord is limited to those families whose incomes do not exceed the limits prescribed by the Federal Housing Commissioner (hereinafter referred to as ‘the Housing Commissioner‘) with the exception of those occupants who agree to pay fair market rental value. However, preference is given to those families displaced from an urban renewal area, or as a result of governmental action, or as a result of a disaster determined by the President to be a major disaster, and to those families whose incomes are within the lowest practicable limits for obtaining membership in the project.

Membership in petitioner is limited to 391 members, i.e., one per unit. Each applicant for membership submits a certification of income and written evidence substantiating the information given on the certification. Memberships in petitioner are sold at a cost of approximately $900 to $1,000. ⁵ After becoming a member, the individual is assigned a unit and pays rent for that unit commonly referred to as a ‘carrying charge.’

With the prior approval of the Housing Commissioner, petitioner established for each dwelling unit a basic carrying charge and a fair market carrying charge. The basic carrying charge was determined on the basis of operating Concord with payments of principal and interest under a mortgage bearing interest at one percent. See n.4, supra. The fair market carrying charge was determined on the basis of operating Concord with payments of principal, interest, and mortgage insurance premiums due under the insured mortgage on the project. The amount of the basic carrying charges and the fair market carrying charges can be changed only with the approval of the Housing Commissioner.

Generally, the actual carrying charge to be collected for each unit is the greater of either the basic carrying charge or 25 percent of the member's income. However, in no event is...