Gordon v. Comm'r of Internal Revenue

• Decision Date: 20 August 1985
• Docket Number: Docket No. 28805-82.
• Citation: 85 T.C. 309,85 T.C. No. 18
• Parties: EVERETT J. GORDON and MARIAN K. GORDON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

85 T.C. 309

85 T.C. No. 18

EVERETT J. GORDON and MARIAN K. GORDON, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 28805-82.

United States Tax Court

Filed August 20, 1985.

Petitioner husband and petitioner wife, the latter as trustee of a trust established by petitioner husband for the benefit of petitioners' children, entered into joint purchase agreements whereby, in form, petitioner husband purchased income interests for life, and the trust purchased remainder interests, in certain bonds.Petitioner husband entered into a similar agreement with himself as trustee of a pension trust for the benefit of his employees.HELD, because, in substance, petitioner husband purchased the bonds in their entirety, petitioners' amortization deductions for the cost of the income interests purportedly purchased by petitioner husband were properly disallowed. LOUIS H. DIAMOND, WAYNE K. JOHNSON, WILLIAM S. OSHINSKY, and PETER LIPRESTI, for the petitioners.

CAROLYN A. BOYER, for the respondent.

TANNENWALD, JUDGE:

Respondent determined deficiencies in petitioners' Federal income taxes for taxable years 1976, 1977, and 1978 of $4,852, $7,903, and $17,296.50, respectively.After concessions by both parties concerning petitioners' distributive share of certain partnership losses, the sole issue for decision is whether respondent properly denied petitioners' amortization deductions with respect to the purported acquisition by petitioner Everett J. Gordon (Dr. Gordon) of income interests in municipal bonds purchased pursuant to joint purchase agreements entered into by Dr. Gordon and certain trusts.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. This reference incorporates the stipulation of facts and attached exhibits. At the time they filed their petition in this case, petitioners resided in Deerfield Beach, Florida. Petitioners filed joint Federal income tax returns for 1976, 1977, and 1978.

Dr. Gordon was born on July 23, 1914.Petitioner Marian K. Gordon (‘Mrs. Gordon ‘) was born on November 23, 1926.On October 3, 1960, Dr. Gordon executed an agreement that established a trust for the benefit of petitioners' only three children—Solvin W., Stuart L., and Elissa A. Gordon.The agreement named David S. Gordon, Dr. Gordon's brother, as trustee, and provided for termination of the trust and reversion to Dr. Gordon as grantor on November 30, l970.

On April 19, 1972, after termination of the October 3, 1960 trust, Dr. Gordon, as settlor, and Mrs. Gordon, as trustee, executed an agreement establishing an irrevocable trust (the ‘Family Trust‘) to succeed the October 3, 1960 trust.The trust agreement grants to the trustee ‘full and complete power in the management and control of the Trust property,‘ but the trustee is given no power ‘to purchase, exchange, or otherwise deal with or dispose of all or any part of the corpus or income of the Trust for less than an adequate consideration in money or money's worth.‘ The agreement specifies a successor trustee in the event Mrs. Gordon fails or ceases to serve, and provides that ‘(i)n no event shall the grantor of any funds to this Trust be a TRUSTEE hereunder.‘ Stating that the Family Trust was created ‘with the purpose and intent permanently and absolutely to divest the SETTLOR of any and all beneficial interest in and over all possession, dominion, and control of the said property,‘ the trust agreement provides that it shall not be construed ‘as authorizing or empowering the SETTLOR, either with or without action of the TRUSTEE, to reinvest themselves (sic), expressly or by operation of law, of the beneficial title to all or any part of the Trust property or its revenue.‘ The settlor is given ‘no power, either alone or in conjunction with any other person or persons, * * * to alter, amend, modify, revoke, or terminate this instrument in any way except to make additions to the corpus.‘

By letter dated November 28, 1972, Louis H. Diamond and Wayne K. Johnson, both of the law firm of Danzansky, Dickey, Tydings, Quint & Gordon, advised Dr. Gordon as follows:

Everett J. Gordon, M.D. President EVERETT J. GORDON, M.D., CHARTERED 9401 Indian Head Highway Oxon Hill, Maryland20022

Dear Everett:

As we discussed with you on November 1, 1972, we believe that it is possible to develop a format for acquisition of an interest in income-producing property that will provide to an investor a substantial tax-free cash flow during his life, a proportionate tax deduction over his life expectancy of his cost of acquisition, and a reduction of his taxable estate. This arrangement is very well adapted to use by an incorporated professional with a qualified pension or profit sharing trust. The essence of the transaction is a joint purchase by the professional and the qualified trust of, respectively, a life or income interest, and a remainder interest in a portfolio of tax exempt state or municipal bonds.

Under such an arrangement, the professional would purchase at fair value a life estate in the bond portfolio and the trust would purchase the remainder interest.Assuming a bond portfolio of $100,000, for example, and a male professional, age 55, the Life Tenant's cost would be approximately $61,780, and the cost to the qualified trust would be approximately $38,220. Assuming a 5 percent bond coupon, the Life Tenant's income would be $5,000 per year.The Life Tenant would also be entitled to deduct $6,000 per year as depreciation on his purchase life interest until he had fully recovered $61,780. If the professional lived beyond the actuarial assumption of 10.3 years, the $5,000 per year would still be received as tax-free interest, but there would be no more further depreciation deductions.To protect the trust and assure that its return on its investment would not fall below a 4 percent compounded rate, however, we would recommend that the terms of the agreement provide that the Life Tenant's interest is to terminate, in any event, after 25 years from date of execution of the agreement. If the Life Tenant were to die before the assumed 10.3 years, a loss deduction would be allowed for the amount of his unrecovered basis.

The tax advantages of this arrangement for the Life Tenant may be summarized as follows:

1. The interest received each year by the Life Tenant is exempt from federal income tax.The joint purchase agreement would be prepared to create a legal life estate in the Life Tenant.The interest received by the Life Tenant, like that received by the income beneficiary of a trust, will be entitled to tax exemption.

2. The Life Tenant receives each year the benefit of a deduction of a proportionate part of the cost of his interest. The Internal Revenue Service recognizes the cost of a purchased life estate as a depreciable asset with a useful life equal to the life expectancy of the Life Tenant.See Rev. Rul. 62-132, 1962-2 C.B. 72.In our opinion, a depreciation deduction will be allowed for such cost even though the income received by the Life Tenant is tax exempt. Manufacturers Hanover Trust Co. v. Commissioner, 431 F.2d 634 (2d Cir. 1970).

3. At the death of the Life Tenant, no portion of the bond portfolio will be included in his gross estate.

The qualified trust as remainderman is not subject to income tax and would derive no advantage from the receipt of tax exempt interest. Upon termination of the Life Tenant's interest, the logical step would therefore be for the qualified trust to sell the property and to invest the proceeds in higher yielding securities or other investments.

If you are interested in pursuing this matter, we would be glad to prepare the necessary documents for execution by you and by the qualified trust.

Best regards.

Sincerely, LOUIS H. DIAMOND, Wayne K. Johnson WAYNE K. JOHNSON For the Firm

As of May 26, 1972, the value of the corpus of the Family Trust, consisting of common stock holdings, was $45,261.38.In early 1973, Dr. Gordon contemplated implementing the transaction detailed in the letter, and, because there was at that time either no or insufficient cash in the Family Trust, Dr. Gordon turned to the Everett J. Gordon, Chartered Pension Trust (the ‘Pension Trust‘) as his investment vehicle.Dr. Gordon never contemplated either selling the stock holdings of the Family Trust to buy the bonds or engaging in the transaction with an outside party.The Pension Trust had been established in 1969 for the benefit of Dr. Gordon's employees.¹ On January 22, 1973, Mr. Johnson wrote to Harvey R. Hale, an investment adviser at Ferris & Co., the investment firm used by petitioners from 1949, reflecting Dr. Gordon's intention to purchase $100,000 in bonds under a joint purchase agreement with the Pension Trust.Mr.Hale, by letter of February 2, 1973, recommended bonds for purchase to Mr. Johnson; aside from such recommendations of specific bonds, Ferris & Co. had nothing to do with the development of the investment strategy at issue herein.

On February 12, 1973, Dr. Gordon, individually, entered into a joint purchase agreement with himself as trustee of the Pension Trust providing as follows:

JOINT PURCHASE AGREEMENT

For their mutual economic advantage, the undersigned, EVERETT J. GORDON, M.D. (‘Life Tenant‘), and EVERETT J. GORDON, M.D., CHARTERED, MONEY-PURCHASE PENSION TRUST (‘Remainderman‘), agree to contribute in proportion to their actuarial interests the amounts necessary to purchase municipal bonds in the principal amount of ONE HUNDRED THOUSAND ($100,000.00) DOLLARS (‘the Corpus‘) from FERRIS & COMPANY, INCORPORATED, at a total price not to exceed ONE HUNDRED TEN THOUSAND ($110,000.00) DOLLARS.The contribution percentages of each of the parties are specified above their signatures at the foot of this Agreement.

It is agreed by and between the parties that the Life Tenant shall be entitled to receive the full benefit of any income derived from the Corpus purchased under this Agreement from the later of the date of its...