Hunt & Sons, Inc. v. Commissioner
| Decision Date | 08 March 2002 |
| Docket Number | Docket No. 5127-00. |
| Parties | Hunt & Sons, Inc. v. Commissioner. |
| Court | U.S. Tax Court |
Michael P. Casterton, for the petitioner.
Christian A. Speck, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
On March 10, 2000, respondent issued a notice of deficiency determining the following deficiencies and penalties with respect to petitioner's Federal income taxes:
Accuracy-Related
Penalty
TYE Dec. 31 Deficiency Sec. 6662(a)
1996................. $278,640 $16,173.60
1997................. 357,963 17,087.00
After concessions by the parties, the only issues remaining for determination are: (1) Whether petitioner overstated certain rental expense deductions on six properties, and (2) whether petitioner is liable for accuracy-related penalties under section 6662(a)1 for overstating rental expense deductions on these properties.
We hold that petitioner deducted rent in excess of the fair market rental value for two of the six properties of $30,300 for 1996 and $35,900 for 1997, and we therefore disallow $66,200 in deductions. We further hold that petitioner is not liable for accuracy-related penalties under section 6662(a).
Most of the facts have been stipulated and are so found. The stipulation of facts and the related exhibits are incorporated by this reference.
When petitioner filed its petition in this case, its principal place of business was in Sacramento, California. Petitioner is a supplier of petroleum products and equipment and an operator of commercial cardlocks. A commercial cardlock is an unstaffed self-service gas station for commercial vehicles. To accommodate large trucks, cardlocks are usually built on larger parcels (on the order of 1-1/2 acres) than retail gas stations. Cardlocks are usually built in industrial areas that are easily accessible to trucks, rather than the more expensive sites used for retail gas stations. Cardlocks are open 24 hours a day, 365 days a year.
When using a cardlock, the customer must supply (and the supplier electronically captures) customer and billing information, including the date, time of day, vehicle odometer reading, and other miscellaneous information, as well as product type and gallons pumped. The supplier bills the customer for the gasoline and provides on the bill the detailed information captured at the pump. Most cardlocks have video surveillance for added security.
Petitioner operated the following five cardlocks in 1996 and 1997: 5750 South Watt Ave., Sacramento (Watt Avenue); 2891 Mosquito Road, Placerville (Mosquito Road); 4200 Roseville Road, North Highlands (Roseville Road); 11341 White Rock Road, Rancho Cordova (White Rock Road); and 4200 Mother Lode Drive, Shingle Springs (Mother Lode Drive). On September 1, 1997, petitioner leased the land for a sixth cardlock located at 1201 Fee Drive, Sacramento (Fee Drive).
Petitioner is a closely held corporation. Warren Hunt, Jr., and his wife, Anita Hunt, own 48 percent of the stock of petitioner; Randall Dean Hunt and his wife, Cynthia Hunt, own 26 percent of the stock of petitioner; Warren Hunt III and his wife, Rosemarie Hunt, own 26 percent of the stock of petitioner. Randall Dean Hunt and Warren Hunt III are the sons of Warren Hunt, Jr., and Anita Hunt.
Petitioner paid Federal corporate income taxes of $256,863 for 1996 and $350,456 for 1997. For each of 1996 and 1997, petitioner paid total dividends of $24,000.
Petitioner's shareholders, through revocable living trusts, own the raw land underlying all the cardlocks operated by petitioner.2 Petitioner leases the raw land from its shareholders' revocable living trusts through ground leases. Petitioner owns the improvements and operates the cardlock businesses.
The operation of a cardlock business, which requires the use of underground storage tanks and pipes, entails a high degree of financial risk because of the potential for leaks, which can cause soil and groundwater contamination that can be very expensive to clean up. In the mid-1980s, government regulators in California imposed strict new regulations on operators of underground storage tanks, requiring the use of double-wall tanks, double-wall piping, tank-monitoring devices, and leakage alarms. Government regulators also require annual testing of the systems to prevent or minimize soil, groundwater, and air pollution. Petitioner spent $60,000 to clean up a leak at its Roseville Road site and has incurred expenses of more than $500,000 to clean up contamination at its Placerville plant.
Petitioner paid and deducted the following amounts as rent during 1996 and 1997 with respect to its cardlock locations:
Property 1996 1997
Watt Avenue ................ $120,000 $120,000
Mosquito Road .............. 55,200 53,400
Roseville Road ............. 48,000 54,000
White Rock Road ............ 54,000 55,500
Mother Lode Drive .......... 27,600 28,800
Fee Drive .................. -- 116,000
_______ ________
Total .................... 304,800 327,700
1 The Fee Drive property was leased for only 4 months in 1997, at a rent of $4,000 per month
The annual fair market rental value for both 1996 and 1997 of Watt Avenue was $89,700 and of Mother Lode Drive was $29,900. The fair market rental value of Fee Drive for the 4 months of 1997 (during which the property was leased to petitioner) was $10,400. Respondent offered no evidence to contradict petitioner's and petitioner's experts' testimony that petitioner paid fair market rental value for the other properties (Mosquito Road, Roseville Road, and White Rock Road).
1. Petitioner paid the following amounts to its shareholders in excess of the fair rental value of the properties:
Property 1996 1997 Total
Watt Avenue ............... $30,300 $30,300 $60,600
Fee Drive ................. -- 5,600 5,600
_______ _______ _______
Total 30,300 35,900 66,200
Petitioner paid fair market rental value for the other cardlock properties.
2. Petitioner's payments in excess of the fair market rental value of the properties are not deductible in computing taxable income.
3. Petitioner was not negligent in deducting rent in excess of the fair market rental value of the Watt Avenue and Fee Drive properties.
OPINIONThe parties agree that potential for abuse is inherent in rental transactions between a corporation and its shareholders. As we stated in Wy'East Color v. Commissioner [Dec. 51,243(M)], T.C. Memo. 1996-136:
A taxpayer generally may deduct reasonable rents paid for property used in a trade or business. A taxpayer who rents property from a related person may not deduct more than he or she would have paid if the parties had dealt at arm's length. A taxpayer may deduct only the fair rental value of premises it rents from related persons. We closely scrutinize whether rents exceed fair rental value if the lessor and lessee are related. Fair rental value is a question of fact. * * * [Citations omitted.]
See also, e.g., Limericks, Inc. v. Commissioner [48-1 USTC ¶ 9146], 165 F.2d 483, 484 (5th Cir. 1948), affg. [Dec. 15,466] 7 T.C. 1129 (1946); Associated Dentists v. Commissioner [Dec. 52,825(M)], T.C. Memo. 1998-287. We must therefore determine whether (and if so, to what extent) the rents paid by petitioner to its shareholders, and deducted by petitioner, were in excess of the fair market rental values of the properties.
Before enactment of section 7491 by the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA), Pub. L. 105-206, sec. 3001(a), 112 Stat. 726, it would have been clear that respondent's determinations in the notice of deficiency of the fair market rental values of the properties were entitled to a presumption of correctness, and petitioner would bear the burden of proving that respondent's determinations were incorrect. Rule 142(a)(1); Welch v. Helvering [3 USTC ¶ 1164], 290 U.S. 111, 115 (1933); Wy'East Color v. Commissioner, supra.
The Court of Appeals for the Ninth Circuit has held that the presumption of correctness does not apply where the Commissioner takes a position in Court that abandons the determination in the notice of deficiency. Morrissey v. Commissioner [2001-1 USTC ¶ 60,395], 243 F.3d 1145 (9th Cir. 2001), revg. and remanding Estate of Kaufman v. Commissioner [Dec. 53,223(M)], T.C. Memo. 1999-119.
In the case at hand, the notice of deficiency does not segregate the portion of the excess rental expense disallowance attributable to each property for each year. We are therefore unable to determine, on a property-by-property basis, whether the appraisals of respondent's expert, Mr. Harris, are consistent with the determinations contained in the notice of deficiency.
Section 7491 shifts the burden of proof to the Commissioner if certain requirements are met. However, section 7491 applies only to court proceedings arising in connection with examinations commenced after July 22, 1998. RRA sec. 3001(c), 112 Stat. 727. Neither party offered evidence to show whether the audit in the case at hand was commenced before July 23, 1998. However, respondent claimed in his pretrial memorandum that the audit was commenced before July 23, 1998, and petitioner in its opening brief appears to accept respondent's allegation by asserting that it has met its burden of proof.
Both parties introduced evidence as to the fair market rental values of the Watt Avenue, Mother Lode Drive, and Fee Drive properties. The case at hand is not one of those rare cases in which the weight of the evidence adduced by the parties is in equipoise. We will therefore determine the fair market...
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