Heyman v. Comm'r of Internal Revenue
| Decision Date | 26 June 1978 |
| Docket Number | 5295-76.,Docket Nos. 5294-76 |
| Parties | RICHARD S. HEYMAN and ROSALEE A. HEYMAN, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENTJOSEPH S. HEYMAN and VIRGINIA S. HEYMAN, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Interest charged by the construction lender during the construction period by simply debiting the borrower's loan accounts, thus reducing the amounts available to the borrower on the loans, was not interest “paid” by the borrower during the taxable year and, hence, is not fully deductible by the borrower in that year. Andrew E. Anderson, for the petitioners.
R. Gary Lowen and Jack E. Prestrud, for the respondent.
In these consolidated cases respondent determined 1972 income tax deficiencies as follows:
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¦Docket No. ¦Petitioners ¦Deficiency ¦
+------------+---------------------------------------+------------¦
¦ ¦ ¦ ¦
+------------+---------------------------------------+------------¦
¦5294-76 ¦Richard S. Heyman and Rosalee A. Heyman¦$2,027.70 ¦
+------------+---------------------------------------+------------¦
¦5295-76 ¦Joseph S. Heyman and Virginia S. Heyman¦7,679.27 ¦
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The only issue for decision is whether interest charges for construction loans of petitioner-husbands' partnership were paid in 1972 as required by section 163(a), I.R.C. 1954,1 for their deduction.
Some facts have been stipulated and are so found.
Petitioners Richard S. Heyman and Rosalee A. Heyman, husband and wife, resided in Bowling Green, Ohio, when their petition was filed.
Petitioners Joseph S. Heyman and Virginia S. Heyman, husband and wife, resided in Perrysburg, Ohio, when their petition was filed.
Both couples filed cash basis 1972 joint income tax returns with the Office of Internal Revenue at Cleveland, Ohio.
Richard S. Heyman and Joseph S. Heyman were partners in University Development Co. with respective partnership interests of 30 percent and 50 percent on December 31, 1972. University Development Co. was a cash basis, calendar year partnership engaged in the business of constructing and operating apartment buildings in Bowling Green, Ohio.
During 1971 University Development Co. negotiated a loan with First Federal Savings & Loan Association of Toledo (First Federal) to finance construction of an apartment complex. On March 22, 1971, a secured note in the amount of $1 million with interest at 91;2 percent per annum was executed on behalf of the partnership to First Federal. On December 7, 1971, a second secured note, in the amount of $100,000 with interest at 91;2 percent per annum, was executed on behalf of the partnership to First Federal.
The note for $1 million provided for monthly payments of $8,828 to begin March 22, 1972, and to continue for 24 years. These payments were to include principal and interest. Likewise, the note for $100,000 provided for monthly payments of $883, covering principal and interest, payable over the same 24-year term. On March 22, 1972, however, the apartment buildings were not completed, and the parties agreed to postpone payments under the notes until June of 1972.
For First Federal's bookkeeping purposes, the loans were converted from “construction loans” to conventional mortgage loans in June of 1972. No new loan documents were executed.
Two construction loan accounts were maintained by University Development Co. with First Federal. The loan accounts consisted of the $1 million and $100,000 loans, respectively. The partnership's right to draw funds from these accounts was based upon levels of construction completed. During the construction period First Federal charged interest on a monthly basis on the amount of the loan proceeds actually drawn. Pursuant to its custom First Federal simply debited the loan account each month for the interest charges rather than collect the interest from the borrower. Following are debits to these accounts representing interest due and owing for a particular month. These debits reduced the balance of each account subject to withdrawal.
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¦$ 1 million loan account ¦$100,000 loan account ¦
+--------------------------+-------------------------¦
¦ ¦ ¦ ¦ ¦
+----------+---------------+------------+------------¦
¦1/31/72 ¦$6,715.86 ¦5/31/72 ¦$186.54 ¦
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¦2/29/72 ¦7,051.18 ¦ ¦ ¦
+----------+---------------+------------+------------¦
¦3/31/72 ¦7,468.58 ¦ ¦ ¦
+----------+---------------+------------+------------¦
¦4/30/72 ¦7,626.94 ¦ ¦ ¦
+----------+---------------+------------+------------¦
¦5/31/72 ¦7,687.33 ¦ ¦ ¦
+----------------------------------------------------+
When the construction was completed in June 1972 and the construction loans were converted to conventional loans, the partnership was obligated to make monthly payments on the entire face amounts of the loans, plus interest at 91;2 percent, over a 24-year period as specified in the notes.
The above interest charges of $36,736.432 were deducted by the partnership and thus by petitioners as partners according to their respective interests. Respondent has determined that these amounts are not fully deductible in 1972 on the ground they were not paid in that year.3
The interest debited to the partnership's loan accounts did not constitute payments of interest at those times.
OPINIONPetitioner Richard S. Heyman and petitioner Joseph S. Heyman were partners in University Development Co. with partnership interests of 30 percent and 50 percent, respectively, as of December 31, 1972. In 1971 the partnership secured financing to build an apartment complex. Notes were executed on March 22, 1971, for $1 million and on December 7, 1971, for $100,000 to the lender, First Federal.
Under an agreement with First Federal, the partnership withdrew funds from the two construction loans as required during construction. These funds were released by the bank based on levels of completion. First Federal computed interest monthly on the loan proceeds actually withdrawn. These interest charges were debited to the construction loan accounts, reducing the balance in the accounts subject to withdrawal by the partnership. When the construction project was finished in June of 1972, the partnership became obligated to repay the entire face amounts of the notes with 91;2 percent interest per annum over a 24-year period, as specified in the notes.
The only issue before us is whether the $36,736.43 of interest which First Federal debited to the partnership's loan accounts in 1972 was, as a result thereof, paid in 1972.
For cash basis taxpayers, section 163(a) generally permits a deduction only for interest “paid” within the taxable year. The payment required to secure a deduction is the payment of cash or its equivalent and the giving of the taxpayer's note is not the equivalent of cash. Helvering v. Price, 309 U.S. 409 (1940). Similarly, interest withheld by a lender from loan proceeds is not fully deductible in the year the interest is withheld, but rather is deductible only as principal payments are made. Cleaver v. Commissioner, 6 T.C 452 (1946) (reviewed by the Court), affd. 158 F.2d 342 (7th Cir. 1946), cert. denied 330 U.S. 849 (1947). The theory is that giving a promissory note and having interest withheld from the loan proceeds (that is, “discounting” the loan) are indistinguishable. Wilkerson v. Commissioner, 70 T.C. 240 (1978); Rubnitz v. Commissioner, 67 T.C. 621 (19...
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