Kwiat v. C. I. R., 072992 FEDTAX, 41301-86

Docket Nº:41301-86, 41302-86 and 41305-86.
Opinion Judge:HALPERN, Judge:
Party Name:Sheldon F. KWIAT And Rita Kwiat, et al.,[*] Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
Attorney:Arnold Y. Kapiloff, for petitioners. George Soba, for respondent.
Case Date:July 29, 1992
Court:United States Tax Court
 
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64 T.C.M. (CCH) 327

Sheldon F. KWIAT And Rita Kwiat, et al.,[*] Petitioners,

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent.

Nos. 41301-86, 41302-86 and 41305-86.

United States Tax Court

July 29, 1992

Arnold Y. Kapiloff, for petitioners.

George Soba, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

HALPERN, Judge:

Respondent determined deficiencies in petitioners' Federal income tax and additions to tax as follows:

Sheldon F. and Rita Kwiat
Increased Interest and
Additions to Tax
Year Deficiency Sec. 6621(c) Sec. 6653(a)
1980 $17,913 Interest on $17,913 ....
1981 6,077 Interest on $6,077 ....
1982 3,651 Interest on $3,651 ....

FNFormerly sec. 6621(d). It was redesignated as sec. 6621(c) by sec. 1511(c)(1)(A) of the Tax Reform Act of 1986, Pub.L. 99-514, 100 Stat. 2744, and repealed by section 7721(b) of the Omnibus Budget Reconciliation Act of 1989, Pub.L. 101-239, 103 Stat. 2106, 2399, effective for returns the due date for which (determined without regard to extensions) is after Dec. 31, 1989.

Lowell M. and Fern Kwiat
Increased Interest and
Additions to Tax
Year Deficiency Sec. 6621(c) Sec. 6653(a)
1980 $17,853 Interest on $17,853 ....
1981 6,139 Interest on $6,139 $307
1982 3,351 Interest on $3,351 ....
David S. and Shirley R. Kwiat
Increased Interest and
Additions to Tax
Year Deficiency Sec. 6621(c) Sec. 6653(a)
1980 $18,534 Interest on $18,534 $927
1981 12,939 Interest on $12,939 ....
1982 3,651 Interest on $3,651 ....
Unless otherwise noted, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. The issues for decision are: (1) Whether the purported lease by petitioners (and one other individual) of certain industrial shelving (pallet racking) to Standard Folding Cartons, Inc., constituted, for tax purposes, a sale, thereby depriving petitioners of any depreciable interest in, and rendering them ineligible for any depreciation deduction on account of, that pallet racking; (2) if the purported lease is, for tax purposes, a sale, whether petitioners are entitled to some readjustment as a consequence of the proper restructuring of that transaction; (3) if petitioners do have a depreciable interest in the pallet racking, whether they properly applied the half-year convention for 1980 and the extent to which 1980 depreciation deductions must be adjusted because the racking was not fully installed at the end of 1980; (4) whether petitioners are entitled to an investment tax credit for 1980 or 1981; (5) whether petitioners (and one other individual, collectively) are entitled to interest expense deductions in excess of $30,641.05 for 1981 and $28,265.48 for 1982; (6) whether petitioners are entitled to various other deductions; and (7) whether petitioners are liable for increased interest and additions to tax. FINDINGS OF FACT Some facts have been stipulated and are so found. The stipulations of facts filed by the parties and accompanying exhibits are incorporated herein by this reference. At the time their respective petitions were filed, petitioners Sheldon F. Kwiat and Rita Kwiat resided in Great Neck, New York; petitioners Lowell M. Kwiat and Fern Kwiat resided in Muttontown, New York; and petitioners David S. Kwiat and Shirley R. Kwiat resided in Tamarac, Florida. All petitioners elected the accrual method of accounting in reporting the transactions here described. Lowell M. Kwiat, David S. Kwiat, Sheldon F. Kwiat, and Jacques Roisen, Sheldon Kwiat's father-in-law (the Kwiat Group), are the ostensible lessors of the pallet racking and Standard Folding Cartons, Inc. (Standard), is the ostensible lessee. Standard is a domestic corporation, doing business in Jackson Heights, New York City, which manufactures printed paperboard packaging. In 1980, Standard had a need for additional shelving in its Maspeth, New York, warehouse for storing paperboard packaging prior to shipment. In 1980, Steven Levkoff (Levkoff) was the vice president of Standard. In the summer of 1980, Levkoff began investigating various ways of financing the acquisition of industrial shelving for the Maspeth warehouse. In 1980, Levkoff discussed Standard's need for shelving with his friend Lowell Kwiat. Standard required a method of financing that would not consume its line of credit or otherwise affect its borrowing capacity. Levkoff and Lowell Kwiat discussed the possibility of Kwiat Capital Corp. (Kwiat Capital), a small business investment company then in the process of formation, financing the acquisition of the shelves. Kwiat Capital was not yet licensed, however, and the Kwiat Group engaged in the property transactions here in question as cotenants. In 1980, the Kwiats principally were engaged in the business of importing, manufacturing, and selling diamonds. Prior to 1980, the Kwiats also had invested in several other businesses, and, in connection with the formation of Kwiat Capital, were investigating various leasing transactions. Kwiat and Levkoff negotiated the terms and conditions of the transaction between the Kwiat Group and Standard. Leon C. Baker, Esq. (Baker), represented the Kwiat Group. His activities were limited to legal drafting and legal advice; the conception, negotiation, and administration of the transaction were the work of Lowell Kwiat. The 1980 Transaction The original transaction between the Kwiat Group and Standard (the 1980 Transaction) comprised three agreements which were captioned " Agreement of Lease" (the 1980 Lease), " Put Agreement" (the 1980 Put), and " Call Agreement" (the 1980 Call). The 1980 Lease The 1980 Lease was for a stated term of 4 years and 11 months, from December 12, 1980, through November 11, 1985. Thereunder, Standard was obligated to make payments to the Kwiat Group on the 12th of each month, commencing December 12, 1980, and ending October 12, 1985. Each monthly payment was to be $5,315, except that if the prime interest rate of European American Bank and Trust Co. (EAB) exceeded 16 percent, each monthly payment would be increased by $55 for each quarter percent above 16 percent. Similarly, if the prime interest rate of EAB fell below 16 percent, each monthly payment would be decreased by $55 for each quarter percent below 16 percent. Under the terms of the 1980 Lease, Standard had the option of providing the Kwiat Group with a commitment from a lender to finance the balance of the Kwiat Group's unamortized investment in the pallet racking (based on a cost of $359,799 and a 13 percent per annum rate of return on unrecovered investment) at a fixed rate of interest, but otherwise on the same terms as the Kwiat Group's then-current financing. If Standard were to deliver such a commitment to the Kwiat Group, then, effective as of the date when such financing would become available under the commitment, the adjustment would be constant for the balance of the lease term and would be computed as if the rate provided for in the commitment were the prime interest rate of EAB. The 1980 Lease required Standard to pay to the Kwiat Group all sales, use, property, or other taxes, licenses or other fees which might become payable on sums being paid by Standard to the Kwiat Group, on the use, lease, operation, control, or value of the pallet racking, as well as any costs incurred by the Kwiat Group in curing any default by Standard. Standard was to be held responsible for all costs and expenses relating to the pallet racking. Standard was required to maintain and repair the pallet racking at its own cost and expense. The risk of loss or damage to the pallet racking was on Standard and Standard was to maintain insurance against any loss or damage to the pallet racking and provide any additional funds required for repair or replacement. Standard was required to hold the Kwiat Group harmless and to indemnify them against any and all claims related to the pallet racking during the term of the 1980 Lease. Standard also was required to protect, at its own cost, the Kwiat Group's interest in the pallet racking against any claims, liens, charges, encumbrances, or legal processes of Standard's creditors. Standard could sell, assign, transfer, encumber, or hypothecate its interest in the pallet racking, with the consent of the Kwiat Group, which could not unreasonably be withheld or delayed. Any such sale, assignment, transfer, encumbrance, or hypothecation would not relieve Standard of its obligations under the 1980 Lease. Standard was to receive the benefit of all manufacturer's warranties on the pallet racking. At the conclusion of the 1980 Lease, Standard was to return the pallet racking to the Kwiat Group (in New York City) in the same condition as when received, reasonable wear and tear excepted. The 1980 Put The 1980 Put granted the Kwiat Group the right to force Standard to purchase the Kwiat Group's interest in the pallet racking for $238,910. The 1980 Put could be exercised by the Kwiat Group between October 13, 1985, and December 31, 1986. The 1980 Put could be exercised only if the parties to the 1980 Lease failed to extend or renew that lease. The 1980 Put never was exercised and has expired. The 1980 Call The 1980 Call granted Standard the option to purchase the Kwiat Group's interest in the pallet racking for $159,452. Standard could pay that amount in one lump-sum, or it could make installment payments. If it chose the latter, it was obligated to pay 36 monthly installments of $5,315, each installment (after the first) including interest at 13 percent per annum. [2]...

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