Menz v. Comm'r of Internal Revenue
| Decision Date | 29 June 1983 |
| Docket Number | Docket No. 19179-80. |
| Citation | 80 T.C. 1174 |
| Parties | NORMAN W. MENZ and MARJORIE MENZ, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioner-husband was a limited partner in RCA, a cash basis partnership engaged in constructing a shopping center during the years in question. RCA's financing was a line-of-credit with CPI, an accrual basis real estate investment trust. X corporation was a general partner in RCA, possessing “approval power” over all major transactions of RCA. X was wholly owned by and the nominee of CPI. X was not a managing partner in RCA and was not a signatory on that partnership's bank accounts. RCA was forbidden under its financing agreements to borrow from sources other than CPI without CPI's approval. RCA would receive funds from CPI, pursuant to periodic requests by RCA, in order to pay expenses. On separate occasions in 1974 and 1975, RCA requested that CPI wire funds to RCA's bank account to pay interest owing on the amounts loaned to RCA by CPI. The funds were disbursed. Later those same days the exact same amounts were retransferred by wire to CPI's bank account at a separate institution. These exchanges in 1974 and 1975 were done pursuant to agreements between the parties. Held, RCA did not “pay” interest within the meaning of sec. 163(a), I.R.C. 1954, because it did not have unrestricted control over the funds wired to its account by CPI. John W. Adams, for the petitioners.
Richard J. Sapinski, for the respondent.
Respondent determined the following deficiencies in petitioners' Federal income taxes:
+--------------------+
¦Year ¦Deficiency ¦
+------+-------------¦
¦ ¦ ¦
+------+-------------¦
¦1971 ¦$17,370 ¦
+------+-------------¦
¦1974 ¦10,019 ¦
+------+-------------¦
¦1976 ¦6,412 ¦
+--------------------+
The deficiencies result from respondent's disallowance of petitioner Norman Menz's allocable share of partnership losses in the years 1974 and 1975. The sole issue for decision is whether that partnership “paid” interest within the meaning of section 163(a)1 through a series of wire-funds exchanges between separate bank accounts of the partnership and its lender.
Some of the facts have been stipulated and are so found. The stipulated facts and attached exhibits are incorporated herein by this reference.
Petitioners Norman Menz and Marjorie Menz, husband and wife, resided in North Caldwell, N.J., at the time of the filing of their petition herein. Petitioners timely filed their calendar year Federal income tax returns for the years 1971, 1974, 1975, and 1976 with the Internal Revenue Service Center at Philadelphia, Pa. Petitioners used the cash method of accounting.
During the years 1973 through 1978, petitioner Norman Menz was a limited partner in Rockaway Center Associates (hereinafter RCA), a New Jersey limited partnership formed in September 1973. During the years in question, the partners and their corresponding percentage interests in RCA were as follows:
RCA timely filed Form 1065 partnership returns for each of the years 1974 through 1977, and reported its income and deductions in accordance with the cash method of accounting.
RCA was organized as a successor in interest to Copaken, White & Blitt, Inc. (hereinafter CWB), a real estate development corporation whose principal offices are located in Shawnee Mission, Kans. RCA was to construct a shopping center on approximately 200 acres of land in Rockaway Township, N.J. That land had been purchased by CWB in July 1972 as part of a joint venture with Corporate Property Investors (hereinafter CPI). CPI is a Massachusetts real estate investment trust whose principal activity is investing in income producing properties. CPI's main offices during the years in issue were in New York, N.Y.
CPI's arrangement with CWB was to provide a construction development loan. The main purpose of such a loan is to fund the acquisition of land and payment of development costs (including architect's fees and site borings) in order to prepare the subject property for construction and in anticipation of a new lender making a full construction loan.3 As of September 1973, CWB had borrowed approximately $3,360,000 from CPI pursuant to the loan and development agreement.
When RCA was formed, CPI, CWB, and RCA (as successor in interest to CWB) entered into a finance agreement under which RCA was to continue the initial development of the proposed site and CPI would provide the funding necessary to do so. Under the finance agreement, RCA also covenanted to pay to CPI the $3,360,000 loaned to CWB under the loan and development agreement. CWB in turn assigned to RCA all of CWB's interest in the shopping center.
Between September 1973 and May 1975, CPI made further advances to RCA pursuant to RCA's requests. The balance due in May 1975 under both the loan and development agreement and the finance agreement was approximately $6,800,000. RCA and CPI then revised the terms of the finance Once acquired, the developer obtains temporary financing and begins development until a construction-period lender is located. The construction-period lender normally lends only for the construction period (usually 1 to 2 years). Upon completion of the center, a “permanent” lender will purchase the obligation owed to the construction lender and provide long-term financing (30 to 40 years) at generally a lower interest rate than that charged during the construction period. All of the loans are secured by liens on the shopping center property and materials. See Noble v. Commissioners, 79 T.C. 751 (1982). agreement and entered into a construction loan agreement. Under the latter, CPI would make further advances to RCA (limited to an additional $3,200,000 to finance the initial construction phase of the shopping center. In light of this financing provision, RCA executed in May of 1975 a note payable to CPI in the face amount of $10 million. The note was secured by a $10 million mortgage in favor of CPI. The note was subsequently revised, but the principal amount remained the same.
Pursuant to the terms of the note and the construction loan agreement, CPI made further advances of funds to RCA in 1975 and 1976. RCA used up approximately its entire line of credit with CPI during that period.
On all loans from CPI, the rate of interest was set at a specified number of percentage points above the prime”4 rate charged by a New York bank, with the actual rate to fluctuate along with that base rate.
In May 1976, RCA entered into a building loan agreement with Chemical Realty Corp. (hereinafter CRC) whereby CRC agreed to advance up to $22,500,000 to fund the cost of completing the site preparation work and to commence construction.
The mechanics whereby RCA obtained funds from CPI under the various financial agreements affect whether or not RCA qualifies as having “paid” interest during the years in question.
The normal practice in some construction projects is for the lender to disburse loan proceeds upon receipt of a request from the borrower to enable the borrower to pay itemized bills. Before this would occur, the lender first reviews the appropriateness of the request. In the instant case, RCA was required under its financing agreements with CPI to prepare an annual estimated budget each year and forward it to CPI for approval. During those years, CPI would compare each request with the estimated budget amount and then, after approval, disburse the requested funds.
The loan and development agreement negotiated between CWB and CPI contained the following provision for the payment of interest:
Section 3.05 Term, Interest, Payment of Loans by the Trust. Except as provided in paragraph (b) of this Section 3.05,
(a) all loans made by CPI as provided in * * * this agreement shall mature three years from the date the title to the land is acquired * * * . Interest shall accrue and be payable when the loans are due, unless the construction Mortgage Financing or the Permanent Mortgage Financing is sufficient to permit payment of accrued interest.
Under the finance agreement between CPI and RCA, though, a reserve was established to fund the estimated interest accruing on the loan. This reserve was to be part of the overall $10 million ceiling amount to be lent to RCA by CPI.
CPI was to receive satisfaction for these loan and reserve amounts out of the funds advanced from the construction mortgage financing (if available) or the permanent mortgage financing. Payment was to be made on December 31, 1977, or on the completion of the shopping center, whichever date occurred first.
CPI is an accrual basis, calendar year taxpayer. CPI calculated and recognized as income for both financial and tax reporting purposes the amount of interest accruing each month on the loan balance due from RCA (and previously CWB). For the year 1973, this amount totaled $407,436.99. CPI never billed RCA for any of this interest which CPI was accruing as income.
Between September 1973 and December 26, 1973, CPI made additional advances to RCA. On December 26, 1973, the total outstanding amount owed to CPI by RCA was approximately $3,500,000. On or about that date, RCA requested a $432,654.57 advance from CPI for expenses to be incurred during the period December 10 through 31, 1973. The request was itemized as follows:
+--------------------------------------------+
¦Interest to CPI through 11/30/73¦$432,266.00¦
+--------------------------------+-----------¦
¦Mtg. rents, through 12/31/73 ¦300.57 ¦...To continue reading
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