Estate of Maxwell v. C.I.R., 1233

• Decision Date: 23 August 1993
• Docket Number: No. 1233,D,1233
• Citation: 3 F.3d 591
• Parties: ESTATE OF Lydia G. MAXWELL, deceased; First National Bank of Long Island; Victor C. McCuaig, Jr., Executors, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. ocket 92-4230.
• Court: U.S. Court of Appeals — Second Circuit

Page 591

3 F.3d 591

62 USLW 2147

ESTATE OF Lydia G. MAXWELL, deceased; First National Bank

of Long Island; Victor C. McCuaig, Jr., Executors, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 1233, Docket 92-4230.

United States Court of Appeals, Second Circuit.

Argued March 15, 1993.

Decided Aug. 23, 1993.

Charles G. Mills, Glen Cove, NY (James M. Marrin and Jed C. Albert, Payne, Wood & Littlejohn, of counsel), for petitioners-appellants.

Marion E.M. Erickson, Atty., Tax Div., Dept. of Justice, Washington, DC (James A. Bruton, Acting Asst. Atty. Gen., Gary R. Allen and Kenneth L. Greene, Attys., Tax Div., Dept. of Justice, of counsel), for respondent-appellee.

Before: ALTIMARI and WALKER, Circuit Judges, and LASKER, District Judge. ^*

LASKER, Senior District Judge:

This appeal presents challenges to the tax court's interpretation of section 2036(a) of the Internal Revenue Code, relating to "Transfers with retained life estate." The petitioner, the Estate of Lydia G. Maxwell, contends that the tax court erred in holding that the transaction at issue (a) was a transfer with retained life estate within the meaning of 26 U.S.C. Sec. 2036 and (b) was not a bona fide sale for adequate and full consideration under that statute.

The decision of the tax court is affirmed.

I.

On March 14, 1984, Lydia G. Maxwell (the "decedent") conveyed her personal residence, which she had lived in since 1957, to her son Winslow Maxwell, her only heir, and his wife Margaret Jane Maxwell (the "Maxwells"). Following the transfer, the decedent continued to reside in the house until her death on July 30, 1986. At the time of the transfer, she was eighty-two years old and was suffering from cancer.

The transaction was structured as follows:

1) The residence was sold by the decedent to the Maxwells for $270,000; ¹

2) Simultaneously with the sale, the decedent forgave $20,000 of the purchase price (which was equal in amount to the annual gift tax exclusion to which she was entitled ²);

3) The Maxwells executed a $250,000 mortgage note in favor of decedent;

4) The Maxwells leased the premises to her for five years at the monthly rental of $1800; and

5) The Maxwells were obligated to pay and did pay certain expenses associated with the property following the transfer, including property taxes, insurance costs, and unspecified "other expenses."

While the decedent paid the Maxwells rent totalling $16,200 in 1984, $22,183 in 1985 and $12,600 in 1986, the Maxwells paid the decedent interest on the mortgage totalling $16,875 in 1984, $21,150 in 1985, and $11,475 in 1986. As can be observed, the rent paid by the decedent to the Maxwells came remarkably close to matching the mortgage interest which they paid to her. In 1984, she paid the Maxwells only $675 less than they paid her; in 1985, she paid them only $1,033 more than they paid her, and in 1986 she paid the Maxwells only $1,125 more than they paid her.

Not only did the rent functionally cancel out the interest payments made by the Maxwells, but the Maxwells were at no time called upon to pay any of the principal on the $250,000 mortgage debt; it was forgiven in its entirety. As petitioner's counsel admitted at oral argument, although the Maxwells had executed the mortgage note, "there was an intention by and large that it not be paid." Pursuant to this intention, in each of the following years preceding her death, the decedent forgave $20,000 of the mortgage principal, and, by a provision of her will executed on March 16, 1984 (that is, just two days after the transfer), she forgave the remaining indebtedness.

The decedent reported the sale of her residence on her 1984 federal income tax return but did not pay any tax on the sale because she elected to use the once-in-a-lifetime exclusion on the sale or exchange of a principal residence provided for by 26 U.S.C. Sec. 121.

She continued to occupy the house by herself until her death. At no time during her occupancy did the Maxwells attempt to sell the house to anyone else, but, on September 22, 1986, shortly after the decedent's death, they did sell the house for $550,000.

Under I.R.C. Sec. 2036(a), where property is disposed of by a decedent during her lifetime but the decedent retains "possession or enjoyment" of it until her death, that property is taxable as part of the decedent's gross estate, unless the transfer was a bona fide sale for an "adequate and full" consideration. 26 U.S.C. Sec. 2036.

On the decedent's estate tax return, the Estate reported only the $210,000 remaining on the mortgage debt (following the decedent's forgiveness of $20,000 in the two preceding years). The Commissioner found that the 1984 transaction constituted a transfer with retained life estate--rejecting the petitioners' arguments that the decedent did not retain "possession or enjoyment" of the property, and that the transaction was exempt from section 2036(a) because it was a bona fide sale for full and adequate consideration--, and assessed a deficiency against the Estate to adjust for the difference between the fair market value of the property at the time of decedent's death ($550,000) and the reported $210,000.

The Estate appealed to the tax court, which, after a trial on stipulated facts, affirmed the Commissioner's ruling, holding:

On this record, bearing in mind petitioner's burden of proof, we hold that, notwithstanding its form, the substance of the transaction calls for the conclusion that decedent made a transfer to her son and daughter-in-law with the understanding, at least implied, that she would continue to reside in her home until her death, that the transfer was not a bona fide sale for an adequate and full consideration in money or money's worth, and that the lease represented nothing more than an attempt to add color to the characterization of the transaction as a bona fide sale.

There are two questions before us: Did the decedent retain possession or enjoyment of the property following the transfer. And if she did, was the transfer a bona fide sale for an adequate and full consideration in money or money's worth.

II.

Section 2036(a) provides in pertinent part:

The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death--

(1) the possession or enjoyment of, or the right to the income from, the property, ...

26 U.S.C. Sec. 2036(a). In the case of real property, the terms "possession" and "enjoyment" have been interpreted to mean "the lifetime use of the property." United States v. Byrum, 408 U.S. 125, 147, 92 S.Ct. 2382, 2395, 33 L.Ed.2d 238 (1972).

In numerous cases, the tax court has held, where an aged family member transferred her home to a relative and continued to reside there until her death, that the decedent-transferor had retained "possession or enjoyment" of the property within the meaning of Sec. 2036. As stated in Rapelje v. Commissioner, 73 T.C. 82, 1979 WL 3799 (1979):

Possession or enjoyment of gifted property is retained [by the transferor] when there is an express or implied understanding to that effect among the parties at the time of transfer. Guynn v. United States, 437 F.2d 1148, 1150 (4th Cir.1971); Estate of Honigman v. Commissioner, supra [66 T.C. 1080], at 1082; Estate of Hendry v. Commissioner, 62 T.C. 861, 872 (1974); Estate of Barlow v. Commissioner, 55 T.C. 666, 670 (1971). Id. at 86. As the Rapelje opinion indicates by its citation of earlier decisions, courts have held that Sec. 2036(a) requires that the fair market value of such property be included in the decedent's estate if he retained the actual possession or enjoyment thereof, even though he may have had no enforceable right to do so. Estate of Honigman v. Commissioner, 66 T.C. 1080, 1082 (1976); Estate Id.

of Linderme v. Commissioner, 52 T.C. 305, 308 (1969). Id. In such cases, the burden is on the decedent's estate to disprove the existence of any adverseimplied agreement or understanding and that burden is particularly onerous when intrafamily arrangements are involved. Skinner's Estate v. United States, 316 F.2d 517, 520 (3d Cir.1963); Estate of Hendry v. Commissioner, supra at 872; Estate of Kerdolff v. Commissioner, 57 T.C. 643, 648 (1972).

As indicated above, the tax court found as a fact that the decedent had transferred her home to the Maxwells "with the understanding, at least implied, that she would continue to reside in her home until her death." This finding was based upon the decedent's advanced age, her medical condition, and the overall result of the sale and lease. The lease was, in the tax court's words, "merely window dressing"--it had no substance. The tax court's findings of fact are reversible only if clearly erroneous. Bausch & Lomb, Inc. v. Commissioner, 933 F.2d 1084, 1088 (2d Cir.1991). We agree with the tax court's finding that the decedent transferred her home to the Maxwells "with the understanding, at least implied, that she would continue to reside in her home until her death," and certainly do not find it to be clearly erroneous.

The decedent did, in fact, live at her residence until she died, and she had sole possession of the residence during the period between the day she sold her home to the Maxwells and the day she died. There is no evidence that the Maxwells ever intended to occupy the house themselves, or to sell or lease it to anyone else during the decedent's lifetime. Moreover, the Maxwells' failure to demand payment by the estate, as they were entitled to do under the lease, of the rent due for the months following decedent's death and preceding their...