Furman v. Comm'r of Internal Revenue

• Decision Date: 10 January 1966
• Docket Number: Docket No. 4813-63.
• Citation: 45 T.C. 360
• Parties: IRVINE K. FURMAN AND LORENA K. FURMAN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

45 T.C. 360

IRVINE K. FURMAN AND LORENA K. FURMAN, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 4813-63.

Tax Court of the United States.

Filed January 10, 1966.

Samuel L. Payne and Frank C. Decker, for the petitioners.

Eugene Boyd Smith, for the respondent.

Petitioner Irvine and his wife owned real property which was encumbered

by two mortgages. Part of the property was used by Irvine in his medical practice and part was occupied as a residence by him and his family. In 1960 they conveyed the property in trust for the benefit of their minor children for 10 years and 5 months, with reversion to Irvine. Irvine's wife was named trustee and the deed specified that the trustee was to pay the mortgage principal and interest as they fell

due. Concurrently with creation of the trust Irvine, in separate leases,

rented both the office portion and the residential portion of the property for 2 years. Held, the transaction, viewed in its totality,

lacked economic reality, and the trust will be treated as a nullity for Federal income tax purposes.

TANNENWALD, Judge:¹

Respondent determined deficiencies in petitioners' income tax for the years 1960, 1961, and 1962, in the amounts of $613.34, $987.22, and $1,217.59, respectively, initially on the theory that the income of a trust was being distributed to them through its use to discharge their legal obligation and/or accumulated for them in the form of increased equity in the reversion. In his first amended answer respondent contended, in the alternative, that the trust was invalid and that consequently certain rental deductions should be disallowed with the result that the deficiencies were alleged to be $605.76, $1,036.04, and $1,152.13, respectively. In his second amended answer respondent made minor modifications in his allegations and proposed deficiencies of $638.01, $1,036.04, and $1,267.53 for 1960, 1961, and 1962, respectively.

FINDINGS OF FACT

Certain facts have been stipulated by the parties and are found accordingly.

Petitioners (hereinafter sometimes referred to as Irvine and Lorena) are husband and wife. During the taxable years in issue they resided in Jacksonville, Fla., and filed their Joint Federal income tax returns for such years with the district director of internal revenue, Jacksonville, Fla.

During the years in issue Irvine was a physician engaged in practice in Jacksonville and Lorena was a housewife. They had five minor children.

Since October 19, 1956, petitioners had owned, as tenants by the entirety, property located in Jacksonville and denominated 2819-21 Oak Street. During 1957, petitioners constructed on the property a two-story building at a cost of approximately $27,500. From completion of construction and through the taxable years involved herein, the lower story, 2819 Oak, was used by Irvine as his professional office, and the upper story, 2821 Oak, was used by petitioners and their family as a personal residence.

In April 1957, petitioners executed a note in the principal sum of $25,000 and bearing 5-percent interest in favor of the Independent Life & Accident Insurance Co. (hereinafter referred to as mortgagee). Concurrently, petitioners executed, as security for said debt, a mortgage deed covering the property. On May 19, 1959, petitioners executed a note in the principal sum of $8,000 and bearing 5 1/2 percent interest in favor of the mortgagee and concurrently executed a second mortgage deed covering the property. The monthly payments of principal and interest on the $25,000 note and the $8,000 note were $265 and $103, respectively. Under these terms of payment, both notes would be satisfied during 1967.

On June 30, 1960, a document entitled ‘Trust Indenture, Irvine K. Furman Trust’ was executed. It named Irvine as ‘Donor’ and Lorena as Trustee. The document recited that the trust was established for the benefit of the donor's children and that the donor had delivered the Oak Street property to the trustee. The indenture was to be construed and rights, duties, and obligations, flowing therefrom were to be determined under Florida law. The document contained the following terms:

ARTICLE III.

Termination of Trust

This Trust shall terminate on December 1, 1970, or upon the death of the survivor of the income beneficiaries of this Trust, whichever shall first occur. * * *

ARTICLE IV.

Trustee— Powers

3. The Trustee shall have the power and authority in addition to such power and authority as conferred by the laws of the State of Florida, as follows:

(a) To invest and reinvest the trust funds in property of any kind, real, personal, or mixed, or in choses in action, or in any business, irrespective of any statute, case, rule or custom limiting the investment of trust funds, except the Trustee shall not sell the * * * (Oak Street property), unless permission is given in writing by the Donor.

ARTICLE V.

Distribution and Use of Income

1. My Trustee shall collect and receive the income from the Trust Estate, and after paying and discharging all necessary expenses incident to the administration of the Trust, shall use such portion of the net income of this Trust as may be needed for the care, comfort, or education of my children. Any such portion of the net income of this Trust not expended by my Trustee under this paragraph may be accumulated. * * *

4. Upon the termination of this Trust as hereinabove provided the Trustee shall distribute the corpus to the Donor, if living, otherwise to his estate and shall distribute any accumulated income to my children, in equal shares if living, otherwise to their respective estates.

On July 1, 1960, Irvine, as grantor, conveyed to Lorena, as grantee, the Oak Street property. The conveyance was subject to the mortgages hereinbefore mentioned. The deed contained the following statements:

It being the intention of the Grantor, that the Grantee shall assume the said liabilities and make the timely payments on the first above mentioned mortgage as provided therein in the sum of $265.00 on the first of each month, and make the payments as provided in that second mortgage in the sum of $103.00 per month on the first of each month.

TO HAVE AND TO HOLD, the same in fee simple forever.

The deed was signed and acknowledged by both Irvine and Lorena.

Neither the trust indenture nor the deed was recorded on the county records, nor was the mortgagee notified of the change of ownership.

On July 1, 1960, an instrument entitled ‘Lease’ was executed on the lower story and office portion of the property, 2819 Oak, by the trustee as lessor and Irvine as lessee. The monthly rent was $350 and the period of the lease was from July 1, 1960, to June 30, 1962.

On the same day, the trustee and Irvine executed a lease covering the upper story and residential portion of the property, 2821 Oak, at a rental of $75 per month. The period of the lease was the same as the lease covering 2819 Oak.

In each of the taxable years involved, petitioners filed a joint application, as individuals, for homestead exemption of the Oak Street property with their county tax assessor. Each application was granted.

On their Federal income tax returns for 1960, 1962 and 1962, petitioners claimed business expense deductions of $2,100, $4,200, and $4,200, respectively, for the annual rental payments made by Irvine on the lower story. Petitioners also claimed depreciation on 50 percent of the adjusted basis of the Oak Street property for the period prior to its conveyance to Lorena as trustee.

In its Federal income tax returns for its initial taxable year of July 1 to December 31, 1960, and the years 1961 and 1962, the trust included as income Irvine's payments under the leases and claimed depreciation of an ‘Office Bldg.— Dwelling.’

During the years in issue, the trust made the payments to the mortgagee required by the notes of 1957 and 1959 and claimed deductions for the portion of the payments representing interest.

OPINION

Both petitioner and respondent have argued at length as to the validity of the trust herein under Florida law. In our judgment, this issue is not material to our decision. We shall assume, although the evidence is something less than overwhelming, that a valid trust was created under Florida law.²

A finding of validity under State law, however, does not mean that the trust will necessarily be recognized for tax purposes. It cannot be gainsaid that a taxpayer has ‘the legal right * * * to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits.’ See Gregory v. Helvering, 293 U.S. 465, 469 (1935). While this may be doctrine, it is not dogma and certainly it does not confer a license to substitute form for substance. As has recently been stated: ‘It is always open to the Commissioner to assess deficiencies on the ground that regardless of regularity of form as a matter of plutological reality, there was no substantial change in economic ownership.’ Burde v. Commissioner, 352 F.2d 995 (C.A. 2, 1965).

The inescapable conclusion flowing from the touchstone of economic reality is that the trust should not be recognized and that petitioners should be treated as the owners of the Oak Street property for Federal income tax purposes. We rest our decision on the totality of the following considerations:

(1) The trustee was Lorena. There is no evidence that she did anything more than passively acquiesce in Irvine's wishes, much less act independently of his wishes. Cf. sec. 672(c); Hall v. United States, 208 F.Supp. 584 (N.D.N.Y. 1962); see White v. Fitzpatrick, 193 F.2d 398, 402 (C.A. 2, 1951), certiorari denied 343 U.S. 928 (1952).

(2) Under section 3(a) of article IV of the trust indenture the Oak Street property could not be sold without Irvine's written consent.

(3) After giving the trustee broad powers to deal with the trust property, Irvine withdrew the trustee's power to sell the Oak Street property, the only significant corpus of the trust,³...