Hensel Phelps Constr. Co. v. Comm'r of Internal Revenue, Docket Nos. 10685-78

• Decision Date: 31 July 1980
• Docket Number: Docket Nos. 10685-78,11695-78.
• Citation: 74 T.C. 939
• Parties: HENSEL PHELPS CONSTRUCTION CO., PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

74 T.C. 939

HENSEL PHELPS CONSTRUCTION CO., PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket Nos. 10685-78

11695-78.

United States Tax Court

Filed July 31, 1980.

Petitioner agreed to construct an office building for no profit in exchange for an interest in partnership capital. Held, on the facts, petitioner must include the value of the partnership interest in taxable income in the year that the partnership agreement was executed. Held, further, the value of that interest to be recognized as income to petitioner is equal to the value of the services exchanged for it by petitioner in an arm's-length agreement. Robert S. Rich, Herrick K. Lidstone, and Albert Theodore Powers, for the petitioner.

Jeff P. Ehrlich, for the respondent.

FEATHERSTON, Judge:

In these consolidated cases, respondent determined deficiencies in Federal income tax in the following amounts:

+------------------------------------------+
                ¦Docket No.  ¦FYE May 31—   ¦Deficiency  ¦
                +------------+----------------+------------¦
                ¦            ¦                ¦            ¦
                +------------+----------------+------------¦
                ¦10685-78    ¦1974            ¦$110,857    ¦
                +------------+----------------+------------¦
                ¦11695-78    ¦1975            ¦72,389      ¦
                +------------------------------------------+
                

 1976 2,314
                

Concessions having been made, the issues remaining for decision are:

(1) Whether petitioner received a partnership interest in exchange for services rendered in the tax year ended May 31, 1974; and

(2) Alternatively, whether respondent correctly allocated income in the tax years in question from the partnership to petitioner under section 482. ¹

FINDINGS OF FACT

At the time of filing its petition, petitioner Hensel Phelps Construction Co.‘s principal place of business was located at Greeley, Colo. Petitioner and its wholly owned subsidiaries, Clearwater Hydromech Corp. (Clearwater) and Stone Bridge Cellars, Inc. (Stone Bridge), filed a consolidated Federal income tax return for the tax year ended May 31, 1974, with the Internal Revenue Service Center, Ogden, Utah. Petitioner and its wholly owned subsidiaries, Clearwater, Stone Bridge, and Clearwater Constructors, Inc. (Constructors), filed consolidated Federal income tax returns for the tax years ended May 31, 1975, and May 31, 1976, with the Internal Revenue Service Center, Ogden, Utah. During the years in issue, petitioner and its subsidiaries reported their income on the accrual method of accounting, except that income from long-term contracts commenced before June 1, 1973, was reported on the percentage-of-completion method of accounting, and income from long-term contracts commenced after May 31, 1973, was reported on the completed contract method of accounting.

Petitioner is engaged in the general contracting business primarily as a prime contractor to private and public owners. Prior to 1972, petitioner's operations were limited to jobs for which petitioner competitively bid. In early 1972, petitioner hired John C. Todd (Todd) to secure negotiated contract projects in which petitioner would acquire an equity interest. During late April or early May 1972, Todd met with Louis Bansbach (Bansbach), Peyton Perry (Perry), and Donald Macy (Macy) (hereinafter collectively referred to as the individual owners) to discuss jointly developing real estate. On or about May 5, 1972, the individual owners jointly entered into a contract to purchase 5.6 acres of undeveloped land in Glendale, Colo., for.$731,160 from sellers unrelated to petitioner or the individual owners. The individual owners completed the purchase of the land on or about September 1, 1972.

After several meetings, petitioner and the individual owners agreed to study the feasibility of constructing an office building on the land purchased by the individual owners. This agreement was reduced to writing by letter dated July 6, 1972, to petitioner from the individual owners. That letter provided, inter alia:

This will confirm our oral understanding and serve as a letter of intent to guide our joint activities prior to consummation of a joint venture agreement. We have preliminarily agreed to form a joint venture depending upon satisfactory feasibility studies to develop the site into an office complex which may consist of one or more buildings to be constructed in several phases. We would contribute our contract to purchase the site to the joint venture and you would contribute your contractor's fee (profit and overhead) to the joint venture. Based upon these contributions we would each own 50% of the joint venture.

It is our understanding that you have agreed to spend up to $20,000 beginning at once for the initial feasibility studies and planning. This would include, among other things, a proposed design of the project, site planning, space planning, suggested types of construction, estimated construction costs and preliminary drawings, and schematic designs. At the earliest practical date after your acceptance of this letter, we will jointly select the design and planning team. Copies of all drawings, maps and other data will be made available to both of us for inspection and copying at any reasonable time.

The timely completion of the feasibility studies and entering into a formal joint venture agreement are critical to all of us as well as the viability of the project. Therefore, we believe it would be desirable to set forth some target dates. We feel the feasibility studies should be completed by September 10, 1972 and the execution of a joint venture agreement should be done by October 10, 1972. If we elect to terminate this letter of intent for any reason prior to October 10, 1972, we will reimburse you for all of your out-of-pocket expenses paid to outside parties up to $20,000 for work which we have mutually authorized to be done on this project. In addition to the actual expenses, we will pay to you an amount of 10% of said expenses as administrative overhead.

It has been a pleasure to discuss this project with you and we are looking forward to a mutually satisfactory venture.

On July 10, 1972, Todd endorsed the letter on behalf of petitioner and returned it to the individual owners. On the same day, the individual owners organized Bansbach, Perry & Macy, Inc. (BPM, Inc.), a Colorado corporation wholly owned by the individual owners in equal shares. Subsequent to the date of the letter, petitioner and the individual owners jointly selected and petitioner financed the hiring of various engineers, architects, and consultants to assist in the initial feasibility studies and planning for the construction of an office complex on the land. The individual owners did not exercise their right to terminate the agreement by October 10, 1972, as provided for in the July 6, 1972, letter. Additionally, the parties did not, as was contemplated in the letter, execute a joint venture agreement by October 10, 1972, because they were unable to arrange financing by that date.

By letter dated April 27, 1973, petitioner and the individual owners received a proposal from General Electric Credit Corp. of Colorado (G.E. Credit) to provide a combination construction and permanent mortgage loan in the amount of $6,200,000. The letter was addressed to Cherry Creek Plaza Associates (CCP Associates), described as a general partnership consisting of petitioner and the individual owners. Pursuant to the terms of the letter, petitioner paid $20,000 to G.E. Credit as a deposit to cover G.E. Credit's expenses in making the loan.

On May 2, 1973, petitioner and the individual owners conditionally agreed upon arrangements to develop the office complex. This agreement was reduced to writing by letter dated May 3, 1973, to petitioner from the individual owners. That letter provided, inter alia:

This will confirm our understanding of the agreements reached between your company and us regarding the project referred to above during the meeting held in our office yesterday.

1. Entity and Interest. We will proceed at once to form an appropriate entity, probably a limited partnership with HPCC (petitioner) and each of us or our corporation as general partners. We will contribute to the partnership our equity in the 5.6 acres on the east side of Cherry Street and HPCC will contribute its contractor's profit and overhead for building the first proposed office building. HPCC will be entitled to one-half of the profits, losses and capital of the partnership and we will be entitled to the other one-half. Any parties to the entity other than HPCC and us will be admitted only as limited partners.

5. Expenses. HPCC will advance all expenses which have been and which will continue to accrue until satisfactory financing is obtained and such amounts can be reimbursed to HPCC. If satisfactory financing is not obtained or if the first building is not constructed, the HPCC shall be reimbursed for 110% of its out-of-pocket expenses from the profit in the 5.6 acres at such time as the profit is realized. Any additional profit realized after payment to HPCC shall accrue solely to us.

6. Liability. It is agreed we have a substantial equity in the land which we are contributing to the partnership and we will pledge our interests in the partnership to HPCC as collateral for any advances made on our behalf. Therefore, it is understood that we will not be personally liable for making any cash contributions to the partnership nor for repayment of any advances made by HPCC on our behalf whether such advances are made to the partnership or to third parties for project expenses.

We are pleased to be partners with you in this project and look forward to a mutually satisfactory and successful venture.

The letter was approved the following day by Todd on behalf of petitioner.

Petitioner and CCP Associates, as the owner of the property, entered into a contract for the construction of the office building. The contract, which described CCP Associates as a limited...