GYRO ENGINEERING CORPORATION v. United States

• Citation: 276 F. Supp. 454
• Decision Date: 19 October 1967
• Docket Number: Civ. No. 65-1173.
• Court: U.S. District Court — Central District of California
• Parties: GYRO ENGINEERING CORPORATION, a California corporation, Plaintiff, v. UNITED STATES of America, Defendant.

276 F. Supp. 454

GYRO ENGINEERING CORPORATION, a California corporation, Plaintiff, v. UNITED STATES of America, Defendant.

Civ. No. 65-1173.

United States District Court C. D. California.

October 19, 1967.

COPYRIGHT MATERIAL OMITTED

Nola McLane, William Lee McLane, Thaddeus Rojek, Washington, D. C., for plaintiff.

Wm. Matthew Byrne, Jr., U. S. Atty., Loyal E. Keir, Asst. U. S. Atty., Los Angeles, Cal., Chief, Tax Division, Robert T. Jones, Asst. U. S. Atty., for defendant.

FINDINGS OF FACT AND CONCLUSIONS OF LAW

FERGUSON, District Judge.

This action having come on regularly for trial without a jury on November 22, 1966, evidence both oral and documentary having been received by the court, the case having been extensively argued and briefed and submitted for decision, the court having its decision by order filed March 22, 1967, as amended by order filed June 7, 1967, now makes Findings of Fact and Conclusions of Law pursuant to Rule 52 of the Federal Rules of Civil Procedure as follows:

Findings of Fact This is an action for refund of federal income taxes for the years 1959 and 1960. In excess of $100,000.00 is claimed in plaintiff's complaint.

The court accepts and finds specifically the facts stipulated in Stipulation of Facts No. I and Stipulation of Facts No. II (both stipulations as modified in minor detail at trial and noted by the Clerk and as interpreted herein), and the pretrial order, and incorporates said stipulations and pretrial order herein by reference to the extent same are relevant to any issue herein.

Plaintiff, Gyro Engineering Corporation (occasionally referred to as "Gyro" herein), is a California corporation duly authorized to do business in this State. It was incorporated in 1952.

Plaintiff files its federal income tax returns on the basis of a fiscal year beginning November 1 and ending October 31 of the following calendar year. Plaintiff filed no federal income tax returns for the years from its incorporation through December 31, 1958. Plaintiff's 1959 return was filed for the period January 1, 1959 through October 31, 1959. Plaintiff's 1960 return was filed for the period November 1, 1959 through October 31, 1960.

The officers of plaintiff Gyro Engineering Corporation from March 1, 1954 to March 1, 1961, were Chris Mowry, President, William Mowry, Vice-president, and Natalie Mowry, Secretary-treasurer. The same persons have been the directors of plaintiff from March 1, 1954 to the present. Natalie Mowry is the wife of Chris Mowry. William Mowry is the brother of Chris Mowry.

The total authorized capital stock of Gyro Engineering Corporation consists of ten thousand (10,000) shares having a stated par value of $1.00 per share and an aggregate value of $10,000.00.

From November 1, 1958 to date the number of issued and outstanding shares of capital stock of Gyro Engineering Corporation totaled ten thousand (10,000) shares, of which four thousand, nine hundred fifty (4,950) shares were and are owned by Chris Mowry, two thousand, five hundred (2,500) shares were and are owned by William Mowry, one thousand (1,000) shares were and are owned by Patrick Mowry (a son of Chris and Natalie Mowry), one thousand (1,000) shares were and are owned by Marilyn Mowry (a daughter of Chris and Natalie Mowry) and five hundred fifty (550) shares were and are owned by Natalie Mowry.

All money "paid in" for the stock issued by Gyro Engineering Corporation and representing the paid in "capital" of Gyro Engineering Corporation from the time of its incorporation throughout the years in suit was simply money deposited in the personal bank account of Chris and Natalie Mowry. Any actual cash representing the paid in "capital" of Gyro was supplied by Chris and Natalie Mowry. Since this was cash simply on deposit in the personal bank account of Chris and Natalie Mowry, and it so remained after issuance of stock, no actual cash moved when any stock was "subscribed." Rather, the bank account of Chris and Natalie Mowry simply remained intact.

On September 21, 1955, Gyro Engineering Corporation acquired title to an unimproved parcel of real property comprised of approximately 70,000 square feet. The cost of said property was $7,800.00. Said parcel of realty was located in South Pasadena, California. It fronted on Paloma Street on the north, on East Orange Grove Avenue on the south and was bounded by the Eaton Flood control channel on the west. Said parcel of realty will hereinafter be referred to as the "Paloma St. property".

From the time of acquisition of title to the Paloma St. property to 1958, Gyro simply held title to said property, and did nothing with it.

The Paloma St. property was condemned by the County of Los Angeles in 1958. The amount of the compensation therefor became the subject of litigation.

The proceeds of the condemnation award on the Paloma St. property were not received by Gyro or the Mowrys until late March of 1959. The amount of the award, less attorney's fees, was ultimately $30,896.65. It is stipulated that the receipt of the award was not entered in the books of account of Gyro Engineering Corporation. It is further stipulated the proceeds of the condemnation award were deposited in the joint bank account of Chris and Natalie Mowry, which account was also used by the Gyro Engineering Corporation.

On January 1, 1959, Gyro Engineering Corporation entered into what purported to be a written "sales and purchase agreement" (Exhibit 4 to Stipulation of Facts No. I) with Chris and Natalie Mowry by which Gyro Engineering Corporation purported to buy three parcels of improved real property consisting of apartment buildings and the land on which they are situated known as The Tropics, The Carousel and The Orange Grove Circle Apartments, together with certain furniture and equipment. The total "sale price" was purported to be $3,164,000.00 payable $30,000.00 down, the balance of the "sale price" after allowance for existing first mortgages to be evidenced by non-interest bearing "promissory notes" in a total amount of $2,342,361.50 due in amounts of $30,000.00 semi-annually. The agreement called for an assignment of rents and management of the properties back to the transferors, Chris and Natalie Mowry, exercisable upon default or "the insolvency of the buyer or the happening of the reasonable likelihood of any event which would reasonably be expected to prevent buyer from carrying out his obligation." Stipulation of Facts No. II, ¶ 16.

A deed evidencing the transfer of said apartment buildings to Gyro Engineering Corporation was executed by Chris and Natalie Mowry, but was not recorded in the Office of the County Recorder until March 17, 1961.

Chris and Natalie Mowry had constructed the apartment buildings referred to in paragraph 13 above in the early 1950's and had depreciated them under the so-called "accelerated depreciation" provisions of the Internal Revenue Code. The adjusted basis for purposes of depreciation of the three apartment buildings to the Mowrys immediately prior to the sale was $805,222.09. Stipulation of Facts No. II, ¶ 33. After the sale, Gyro Engineering Corporation on its federal income tax returns for 1959 and 1960, as well as later years not in suit, depreciated the apartment buildings (leaving aside the furniture and equipment, etc., for the sake of simplicity) upon the basis of the sale price of $3,164,000.00, allocating a total cost of $2,745,300.00 to the three buildings exclusive of furniture and equipment. The difference, again excluding cost of furniture and equipment, was allocated to the cost of the land on which the apartments were situated. Stipulation of Facts No. I, ¶¶ 17, 23, and 28.

By virtue of using this "stepped-up basis" for computing its federal tax deductions for depreciation, the depreciation deductions cancelled out all of the taxable income of Gyro Engineering Corporation (consisting almost exclusively of rental income from said apartment buildings) for the years in suit. Compounding the tax advantages of the transaction, the transferors reported capital gain on the sales price on the installment basis, all of which gain was not taxable due to offsetting losses reported by the Mowrys on a farming venture from 1958-1964.

Gyro also claimed "non-recognition" treatment pursuant to Internal Revenue Code § 1033 for the condemnation award on its federal income tax return for 1959, based upon its contention that the condemnation award was re-invested within the terms of § 1033 by means of the transaction referred to in paragraph 13 above. In other words, the gain over basis of $23,096.65 upon the condemnation award on the Paloma St. property was not reported on the federal income tax returns of Gyro for 1959. Instead, Gyro deducted the amount of the gain from what it alleged to be the cost basis of the Orange Grove Circle Apartments on its federal income tax return for 1959.

In a deficiency notice for the taxable years 1959 and 1960, issued December 24, 1963 Exhibit 10 to Stipulation of Facts No. II, the Commissioner of Internal Revenue, inter alia, denied plaintiff the "stepped-up basis" for depreciation, determining plaintiff must use its transferors' basis for depreciation, and denied plaintiff non-recognition treatment on the condemnation award. The basis for the Commissioner's assertion of deficiency was his determination that the transfer was not, for federal income tax purposes, a bona fide sale, but rather was, as a matter of substance for federal income tax purposes, a contribution to capital.

Plaintiff's contention that the transfer was, for federal income tax purposes, a bona fide and valid sale over against defendant's contention that, for federal income tax purposes, the sale was a sham and the transfer was in substance a contribution to capital presents the principal issue for decision here.

Outside of holding title to a piece of unimproved real property, Gyro Engineering Corporation had been substantially...