Miller v. Department of Revenue, State of Or.

• Decision Date: 21 May 1998
• Citation: 327 Or. 129,958 P.2d 833
• Parties: Paul MILLER and Robin Miller, Appellants, v. DEPARTMENT OF REVENUE, STATE of OREGON, Respondent. Kathleen JOHNSTON and Frank Johnston, Appellants, v. DEPARTMENT OF REVENUE, STATE of OREGON, Respondent. Robert H. LOVERIN and Jane Loverin, Appellants, v. DEPARTMENT OF REVENUE, STATE of OREGON, Respondent. OTC 3763, 3764, 3768; SC S43674.
• Court: Oregon Supreme Court

Page 833

958 P.2d 833

327 Or. 129

Paul MILLER and Robin Miller, Appellants, v. DEPARTMENT OF REVENUE, STATE of OREGON, Respondent.

Kathleen JOHNSTON and Frank Johnston, Appellants, v. DEPARTMENT OF REVENUE, STATE of OREGON, Respondent.

Robert H. LOVERIN and Jane Loverin, Appellants, v. DEPARTMENT OF REVENUE, STATE of OREGON, Respondent.

OTC 3763, 3764, 3768; SC S43674.

Supreme Court of Oregon.

Argued and Submitted March 5, 1998.

Decided May 21, 1998.

Steven W. Seymour, of Samuels, Yoelin, Kantor, Seymour & Spinrad, LLP, Portland, argued the cause and filed the briefs for appellants.

Marilyn J. Harbur, Assistant Attorney General, Salem, argued the cause for respondent. With her on the brief were James C. Wallace, Assistant Attorney General, and Hardy Myers, Attorney General.

Before CARSON, C.J., and GILLETTE, VAN HOOMISSEN, DURHAM and LEESON, JJ. ^*

LEESON, Justice.

Taxpayers, who are the general partners and the spouses of the general partners in three Oregon limited partnerships, appeal from a judgment of the Oregon Tax Court that assessed additional Oregon income taxes against them for the years 1985, 1986, 1987 and 1988. We review for errors of law, ORS 305.445, ¹ and affirm.

FACTUAL BACKGROUND

The Tax Court made the following findings of fact, none of which the parties challenge:

"In 1984, Robert Loverin and Paul Miller, who are brothers-in-law, were employed by Rockwood Development Corporation (Rockwood), an Oregon Corporation. Rockwood was owned by Miller's parents and other family members. Rockwood engaged in creating, purchasing, and managing low-income housing projects, most of which were owned by limited partnerships. * * * "In 1984, Loverin and Miller decided to start their own business because Rockwood was having financial difficulties. They formed BP Corporation to engage in the same kind of business as Rockwood. Knowing they did not have the level of management experience in low-income housing required by the U.S. Department of Housing and Urban Development (HUD), they obtained the extensive experience of Rockwood through a series of management agreements.

"It was through Rockwood that Loverin and Miller became aware of Edward and Fern Fischer, owners of four low-income housing projects commonly know as Fischer Court I, Fischer Court II, East Ninth Street (Maple Court), and Southfair. In May 1984, Rockwood offered to purchase the four Fischer projects, but the Fischers rejected the offer. In September 1984, BP Corporation made an offer which the Fischers accepted. The offering price was $3,500,000, with $650,000 down and the balance of $2,850,000 in the form of a 15-year nonrecourse wrap-around note bearing nine percent simple interest. The offer acknowledged that the properties were subject to HUD insured mortgages and required the Fischers to pay the mortgage payments out of the note payments they received from the buyers. * * *

"The principals of BP Corporation, Loverin and Miller, * * * formed a limited partnership for each property and thereafter sought investors for the partnerships. Money invested by the limited partners would be used to make the down payments on the apartment projects.

"Only Fischer Court I, Fischer Court II, and East Ninth Street Apartment Projects are involved in this litigation, Southfair being the subject of a separate case. The three projects involved the same process and types of documents. Therefore, for purposes of analysis, the parties and the court have focused upon one project, Fischer Court I.

" * * * * *

"On September 20, 1984, the partnership and the Fischers executed an agreement of sale providing for the purchase of Fischer Court I by the partnership for $1,224,000. In December 1984, this price was amended to $1,185,600 with $188,914 due at closing. The difference between the two amounts is a 'finder's fee' of $38,400 * * *.

"The down payment of $188,914, due at closing, was in the form of a nonrecourse note due January 1, 2000. The note, dated December 11, 1984, provided that an 'installment' of $188,914 was due on June 30, 1985, or upon completion of syndication, whichever occurred first. The note bore interest at nine percent compounded semi-annually. The balance of the purchase price was in the form of a [nonrecourse] 'residual note' in the amount of $996,686. This note wrapped around the unpaid balance of the HUD mortgage on the properties. The balance of the HUD mortgage at the time of the agreement was $363,683. [Neither the partnership nor its partners was liable on the downpayment or the wraparound note.]

" * * * * *

"Loverin and Miller then solicited limited partners through private placement memorandums. Taxpayers were unable to find a copy of the private placement memorandum for Fischer Court I. They did find a copy of the private placement memorandum for Fischer Court II and offered it into evidence as being similar to the one for Fischer Court I. That document projected benefits for limited partners from November 1985 through December 1995. It projected no cash flow but only income tax deductions. The projection assumed investors in the 50 percent tax bracket and showed tax savings exceeding the limited partners' required annual investment (including interest) for every year except 1990. In 1990, the limited partner would be expected to contribute $4,760 in capital plus $583 in interest (total $5,343) while the projected tax savings were $5,104. Loverin and Miller experienced some delays but eventually obtained the limited partners necessary for Fischer Court I.

"Upon audit, the auditor concluded that the property's sales price significantly exceeded the property's fair market value. The assessed value for property tax purposes in 1985 was land $98,370 and improvement $529,520, for a total of $627,890. The final agreed sales price was $1,185,600. Under the terms of the sale, the only payments to be made under the residual note were the amounts due on the HUD mortgage. The rest of the principal and interest were deferred. When the note becomes due on January 1, 2000, the [taxpayers] will owe $2,718,010.

"The auditor concluded that because the debt was all nonrecourse debt and the amount of the money owing on the property exceeded its fair market value, the partners had no economic interest in the property. Moreover, the payments on the 'down payment note' were delayed until August 1986. Until then, the partners had only been paying the underlying HUD mortgage and were not acquiring any equity in the property. Consequently, the auditor did not believe taxpayers were entitled to depreciation based on their cost basis. The auditor did recognize basis to the extent of fair market value, and separately considered personal property.

"The auditor also increased the estimated life of the property for depreciation purposes from 15 years to 30 years. The auditor explained that the basic Internal Revenue Service life guideline for buildings is 45 years. Therefore, because the subject property was 15 years old at the time of purchase, the auditor reasoned that there should be 30 years left.

"Finally, on their income tax returns, the general partners allocated 99.9 percent of the losses to themselves up to the time the investing limited partners were admitted. The auditor reallocated these losses according to the provisions in the limited partnership agreement, allocating two percent to general partners and 98 percent to limited partners."

Miller v. Dept. of Rev., 13 OTR 488, 490-93, 1996 WL 263240 (1996) (internal footnote omitted).

Taxpayers appealed the notices of assessment that were issued pursuant to the audit. After the administrative hearing, the Department of Revenue (Department) concluded that the sales were not arm's-length transactions and that the best indication of the fair market value of the properties was their assessed value on January 1, 1985. For Fischer Court I, which is the property selected for the purpose of analysis before the Tax Court and this court, the assessed value was $627,890. The Department sustained the auditor's adjustments to depreciation and her adjustments regarding allocation of profits and losses to the general and limited partners. Taxpayers appealed to the Tax Court.

According to the Tax Court, it was "unlikely that the total amount due under the wrap note will ever be paid" and that there was "no economic basis for the numbers involved except tax benefits." The court concluded that the purchase price of Fischer Court I exceeded its fair market value, that taxpayers had failed to establish that the remaining useful life of the property was 15 years and that the limited partnership agreement did not provide for allocation of 99.9 percent of the profits and losses to the general partners. Taxpayers assign error to all three holdings.

LEGAL STANDARDS

Pursuant to ORS 316.007, we apply federal tax laws and federal court interpretations of those laws in resolving the issues raised by taxpayers. ORS 316.007 provides, in part:

"It is the intent of the Legislative Assembly * * * to make the Oregon personal income tax law identical in effect to the provisions of the federal Internal Revenue Code relating to the measurement of taxable income of individuals * * *; to achieve this result by application of the various provisions of the federal Internal Revenue Code relating to the definition of income, exceptions and exclusions therefrom, deductions (business and personal), * * * basis, depreciation and other pertinent provisions relating to gross income as defined therein, modified as provided in this chapter, resulting in a final amount called 'taxable income' * * *."

Additionally, ORS 316.032(2) provides that, insofar as is practicable in the administration of ORS chapter 316, "the department shall apply and follow the administrative and judicial interpretations of the federal income tax law." See also Baisch v. Dept. of Rev., 316 Or. 203, 209, 850 P.2d 1109 (1993) (Oregon courts...