KLOPPENBERG AND COMPANY v. Commissioner

• Decision Date: 29 July 1986
• Docket Number: 14931-83,Docket No. 14926-83,14929-83,14928-83,14934-83.,14927-83,14932-83,14930-83,14933-83
• Citation: 1986 TC Memo 325,51 TCM (CCH) 1607
• Parties: Kloppenberg and Company, et al. v. Commissioner.
• Court: U.S. Tax Court

51 T.C.M. (CCH) 1607 (1986)

T.C. Memo. 1986-325.

Kloppenberg and Company, et al.¹ v. Commissioner.

Docket Nos. 14926-83, 14927-83, 14928-83, 14929-83, 14930-83, 14931-83, 14932-83, 14933-83, 14934-83.

United States Tax Court.

Filed July 29, 1986.

Melvin A. Coffee and Theodore H. Merriam, for the petitioners. Mark H. Howard and Christopher L. Neal, for the respondent.

Memorandum Findings of Fact and Opinion

WHITAKER, Judge:

Respondent determined deficiencies in petitioner Kloppenberg and Company's Federal income taxes for the years ending January 31, 1979 and January 31, 1980 of $10,883 and $13,053, respectively. Respondent also determined deficiencies in the individual petitioners' Federal income tax as follows:

                Petitioner(s) 1978 1979
                  George A. and
                    Zona B. Kloppenberg..........  $23,654  $3,188
                  George F. and
                    Helen S. Kloppenberg ........  $ 6,222  $  337
                  Joseph R. and
                    Mary C. Kloppenberg .........  $ 9,544  $  810
                  James T. and
                    Mary C. Kloppenberg..........  $ 4,828  $  808
                  Laura A. Kloppenberg2 ....  $   286  $   16
                  Christine A. Kloppenberg2.  $   286  $   16
                  Brian A. Kloppenberg2 ....  $   286  $   16
                  Paul A. Kloppenberg2 .....  $   286  $   16
                

Explanation of Issues. The issues in this case arise out of a multi-step transaction involving two corporations (Kloppenberg and Company (Kloppenberg Co.) and G.A.Z.B. Corporation (GAZB)) and the G.A.Z.B. Trust (Trust), all of which were owned by some or all of the individual petitioners prior to May 3, 1978, and Tejon General Partnership (TGP), an unrelated entity. As structured by the Kloppenbergs and the principals of TGP, the May 3, 1978 transaction occurred as follows: (1) the shareholders of GAZB transferred all of their stock in GAZB to the Trust; (2) the Trust sold all of the GAZB stock to TGP; (3) GAZB was immediately liquidated and its assets, which were principally three parcels of real estate, viz the Oxford, the Elati, and the Tejon properties, were distributed to TGP; (4) TGP sold its interest in the Oxford property to Kloppenberg Co. for $1 million.³ Kloppenberg Co. had been the sole tenant of the Oxford property for some years.

Respondent determined that, in contrast to its form, the substance of the portion of the transaction relating to the Oxford property was a sale of an interest in that property at a price in excess of fair market value by GAZB to Kloppenberg Co. with a subsequent distribution of sale proceeds to the shareholders of GAZB. According to respondent, TGP's role was that of a conduit or "straw man" for the multi-step transaction as far as the interest in the Oxford property is concerned. Based on respondent's pre-trial position, the issues for decision are:⁴

(1) Whether Kloppenberg Co. purchased an interest in the Oxford property at a price in excess of its fair market value;

(2) if (1), whether the individual petitioners received constructive dividends from Kloppenberg Co. as a result of the purchase of the Oxford property interest;

(3) if (2), whether the interest deductions flowing from the May 3, 1978, transaction claimed by Kloppenberg Co. must be decreased as a consequence of the constructive dividends;

(4) whether the individual petitioners received ordinary income pursuant to section 1239⁵ on the transfer of GAZB's interest in the Oxford property, a depreciable asset, to Kloppenberg Co.; and (5) whether assessment of deficiencies as to Kloppenberg Co. for the year ending January 31, 1979, and the individual petitioners for 1978 is barred by the running of the applicable statute of limitations.

On brief, respondent requests that the Court allow him to amend the pleadings in a number of respects which requests will be addressed in the opinion portion of this report. The most significant of these requested amendments is consideration of a different "form" of the challenged transaction, i.e., a distribution of the interest in the Oxford property by GAZB or the Trust to the shareholders/beneficiaries followed by a sale of the Oxford property to Kloppenberg Co. Based on this reformulation, respondent asserts that the individual petitioners also received constructive dividends from GAZB.

Findings of Fact

Some of the facts have been stipulated and are so found. The stipulations of fact and exhibits are incorporated herein by this reference. Kloppenberg Co.'s principal place of business at the time its petition was filed was Englewood, Colorado. The individual petitioners were all residents of Colorado at the time their respective petitions were filed.

The Kloppenberg Family Corporations. Kloppenberg Co. manufactures ice machines and is a custom fabricator of stainless steel food service equipment. During the years in issue Kloppenberg Co.'s plant and offices were located in a building specifically built for the company on the Oxford property.

In April 1978, the stock of Kloppenberg Co. was owned by petitioners George A. and Zona B. Kloppenberg and their sons (referred to collectively as the Kloppenberg Family) as follows:

                Ownership
                Petitioner Percentage
                  George A. Kloppenberg ..............  35
                  Zona B. Kloppenberg ................  35
                  George F. Kloppenberg ..............  10
                  Joseph R. Kloppenberg ..............  10
                  James T. Kloppenberg ...............  10
                

In addition to their status as shareholders, with the exception of Joseph R. Kloppenberg who was a consultant to the Board of Directors, each member of the Kloppenberg Family was a director and officer of Kloppenberg Co. in April 1978. Kloppenberg Co.'s retained earnings and profits on May 3, 1978, the date of the challenged transaction, were in excess of $473,000.

In 1978 GAZB's only business was holding the Oxford property and properties located on Elati Street (the Elati property) and Tejon Street (the Tejon property) and collecting rents thereon. The retained earnings of GAZB shown on the final return filed for the period ended May 3, 1978, were $173,119.

On April 25, 1978, George F. Kloppenberg transferred six shares of his GAZB stock to each of his four minor children under the Colorado Uniform Gifts to Minors Act.⁶ As of that date, the shares of the GAZB stock were held as follows:

                Number
                of
                Petitioner Shares
                  George A. Kloppenberg ............     95
                  Zona B. Kloppenberg ..............     95
                  George F. Kloppenberg ............     36
                  Joseph R. Kloppenberg ............     60
                  James T. Kloppenberg .............     60
                  Christine A. Kloppenberg .........      6
                  Paul A. Kloppenberg ..............      6
                  Brian A. Kloppenberg .............      6
                  Laura A. Kloppenberg .............      6
                

With the exception of the children, each shareholder was a director and officer of GAZB.

The Oxford Property. In 1966, GAZB acquired the land on West Oxford Street at a cost of $50,111. On September 8, 1966, a net ground lease was executed between GAZB and Kloppenberg Co. The lease term was 30 years and the rent was $12,000 per year payable on a monthly basis. Pursuant to the terms of the lease, Kloppenberg Co. was required to erect a building on the Oxford property in accordance with a previously approved plan⁷ at a cost of not less than $430,000. At the expiration of the lease, the building would be surrendered to GAZB. The lease specially provided that "the covenants, stipulations, and conditions herein contained shall inure to the benefit of and shall be binding upon the successors and assigns of the lessor and the successors and assigns of the lessee."

On November 10, 1966, Kloppenberg Co. entered into construction and permanent financing agreements with the Engelwood State Bank concerning construction of the building on the Oxford property. The loan was in the amount of $310,000 and was for a term of 15 years. As security for this loan, Kloppenberg Co. delivered to the Bank a promissory note which was secured by a deed of trust on the Oxford property executed by GAZB and Kloppenberg Co. To provide additional security for payment of the note, GAZB assigned to the Bank its lease agreement with Kloppenberg Co. In fact, the lease agreement had originally been executed because the Bank required a written lease before it would provide the construction financing. The Bank loan was paid in full on January 31, 1972 and shortly thereafter the Bank released all collateral on the loan. During the years in issue, Kloppenberg Co. claimed depreciation for the building on its Federal corporate income tax returns.

As noted above, the rent specified in the lease was $1,000 per month. However, at a special meeting of the Board of Directors of Kloppenberg Co. on April 17, 1974, George A. Kloppenberg, the president of both GAZB and Kloppenberg Co., recommended increasing the rent to $1,500 per month, retroactive to April 1, 1974. A motion to this effect was unanimously approved and, thereafter, Kloppenberg Co. paid this increased rent. The lease agreement was not amended to reflect this increased rent.

Four appraisals of the Oxford property were received in evidence. Each appraisal valued the property as of May 3, 1978. The first appraisal is a September 23, 1980 Engineer Memorandum Report prepared by Eddie T. Fernandez, an engineer in respondent's employ. Based on an assumed fee simple fair market value of $442,000, Mr. Fernandez concluded that the fair market value of the Oxford property subject to the leasehold interest held by Kloppenberg Co. was $300,000.

The second appraisal, obtained by petitioner Kloppenberg Co., is dated November 29, 1980, and was prepared by Watson A. Bowes. This appraisal was based on the assumption that the property was "free and clear" of all encumbrances, i.e., Mr. Bowes did not consider the outstanding leasehold interest of Kloppenberg Co. Using three methods of appraisal, Mr. Bowes concluded that the value of Oxford property was $1,940,000.

Apparently in response to petitioners' appraisal, Mr. Fernandez prepared a supplemental Engineer Memorandum Report dated February 12, 1981. The same...