Moss v. Commissioner, Docket No. 5571-82
| Decision Date | 31 March 1986 |
| Docket Number | Docket No. 5571-82,5572-82,5573-82. |
| Citation | 1986 TC Memo 128,51 TCM (CCH) 742 |
| Parties | Jerome S. Moss and Sandra Moss, et al. v. Commissioner. |
| Court | U.S. Tax Court |
John C. Fossum and Dana E. Miles, for the petitioners. Pamela R. Piland, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in petitioners' Federal income taxes for the taxable year ended December 31, 1976 in these consolidated cases by separate notices of deficiency, each dated December 24, 1981, as follows:
Docket No.Petitioner(s)Deficiency
5571-82 Jerome S. Moss and
Sandra Moss $60,725
5572-82 Sharon M. Alesia 27,785
5573-82 Herb Alpert and
Lani Alpert 26,687
After concessions,2 the sole issue for decision is whether certain expenditures incurred in the 1976 taxable year totaling $270,268 are deductible under section 1623 as ordinary and necessary repairs or must be depreciated under section 263 as capital expenditures pursuant to a general plan of capital improvements.
Some of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference.
Petitioners filed timely Federal income tax returns for the 1976 taxable year with the Internal Revenue Service Center in Fresno, California. Petitioners Jerome S. and Sandra Moss and Herb and Lani Alpert resided in Los Angeles, California, and petitioner Sharon M. Alesia resided in Beverly Hills, California at the time they filed their petitions in these consolidated cases. Petitioners utilized the cash receipts and disbursements method of accounting to report their income for the 1976 taxable year.
On January 1, 1975, Almo Hotel Company, Ltd. (Almo), a California limited partnership, was formed. Petitioners' respective interests in Almo's profits and losses were as follows:
Jerome S. general
Moss partner 50%
Sharon M. limited
Alesia partner 25%
Herb general
Alpert partner4 25%
David A. Alpert, brother of petitioner Herb Alpert, also was a general partner of Almo. Although he did not have any interest in partnership profits or losses, the Almo partnership agreement provided that David A. Alpert had full authority to bind the partnership pursuant to contract.
During the taxable year at issue, Almo was the sole fee owner of a hotel (the hotel) located at 6225 West Century Boulevard, Los Angeles, California, near the Los Angeles International Airport. Prior to Almo's formation, the hotel was owned solely by Almo Enterprises, a California limited partnership, which had purchased the hotel in 1967 at a cost of $12,600,000. The partners of Almo Enterprises were petitioners Jerome S. Moss, Sharon M. Alesia, and Herb Alpert, and their respective partnership interests were identical to their partnership interests in Almo.
The hotel was constructed in 1963 and since it opened has operated as a major business hotel in the Los Angeles International Airport area. The hotel is a 13-story, reinforced, concrete building containing approximately 620 guest rooms, 2 large restaurants, 2 cocktail lounges, a large ballroom with a capacity of more than 1,000 guests, more than a dozen smaller conference rooms, and numerous retail stores, which merchandise such items as men's and women's clothing, jewelry, flowers, newspapers, rental cars and gifts. Other site improvements include a 2-story, reinforced, concrete parking structure, a health club complex and a swimming pool.
During the taxable year at issue and all years relevant to these cases, Almo leased the hotel under a master lease to Ariz, a California limited partnership. Ariz subleased the hotel under an operating lease to Airportel, Inc. (Airportel) for management purposes.5 Prior to August 1975, Airportel, a Florida corporation in the business of hotel management, was a wholly owned subsidiary of International Airport Hotel Systems, Inc. (IAHS). IAHS had agreed to guarantee Airportel's obligations as tenant under the terms of the operating lease, and, prior to 1975, the hotel operated under the name of the International Hotel.
During the early 1970's, IAHS and Airportel suffered financial difficulties, and substantial repair work, maintenance and capital replacements were not performed on the hotel for approximately 2 or 3 years. In 1975, IAHS was released from its guarantee obligations in exchange for the transfer of all of its Airportel stock to Almo and Ariz, 70 percent and 30 percent, respectively, transferred directly to their individual partners, plus $1,950,000 in cash and promissory notes. Almo and Ariz then negotiated with several hotel management concerns, including the Hyatt Corporation (Hyatt), the Hilton Corporation (Hilton), and Mr. Brian Corbell, an independent operator who ran several hotels, with respect to assuming the management of the hotel's daily operations. During their negotiations, both Hyatt and Hilton recommended that approximately $2 million of repair work and capital improvements be made, and Mr. Corbell estimated total expenditures of approximately $600,000 — $700,000. The individual partners of Almo and Ariz chose Hyatt to manage the hotel and thereafter the hotel's name was changed to the Hyatt House Hotel. An agreement (management agreement) was executed on August 13, 1975 between Hyatt and Airportel,6 as lessee under the operating lease. Several amendments to the management agreement were executed between 1975 and 1981.
As a condition to the execution of the management agreement, certain hotel repair work, improvements and capital expenditures were deemed necessary. The structure of the building and its exterior were in very good condition, and one floor, as well as rooms by the pool area, had been remodeled recently. However, although the hotel remained in very good operating condition its "tired" interior condition was plainly visible to Hyatt and petitioners. Specifically, from both a functional and aesthetic standpoint, the hotel's furnishings, fixtures and design were somewhat obsolete and required remodeling. Pursuant to the terms of the management agreement, a program of repairs and improvements was proposed by Hyatt's technical assistance services division. Hyatt bore primary responsibility for deciding the specific work to be performed, subject to the final approval of the lessee, Airportel, referred to in the agreement as "Owner" of the premises. The program of repairs and improvements was incorporated directly within the management agreement, as set forth in the relevant portions of the following provisions:
Agreement
* * *
1.3 Capital Improvements.
(a) Owner agrees, alone or in conjunction with others, to make or cause to be made, with respect to the Existing Hotel, capital improvements (which term, as used in this Section 1.3 and in Section 1.4 and the several subsections thereof, shall refer to (i) the refurbishing of the Existing Hotel, including any work of repair and maintenance, (ii) improvements, additions or alterations to the Existing Hotel, and (iii) the purchase and installation therein of additional personal property, including Operating Equipment and Furnishings and Equipment) at a total cost to Owner of not to exceed the sum of $2,000,000.00 (which sum is herein referred to as the "Limit").
The "total cost" to Owner of any such capital improvements is hereby defined to include *** (ii) the cost of all work involved in the refurbishing, improvements, additions or alterations of or to the Existing Hotel, ***.
(b) As soon as practicable, Hyatt shall submit to Owner for its approval a proposal and budget (the "Improvement Budget") setting forth, in reasonable detail, a program of proposed capital improvements, ***. Upon approval by Owner of the Improvement Budget *** Hyatt, as agent of and for the account of Owner, shall, with reasonable diligence, cause to be prepared detailed plans and specifications designed to implement the capital improvements (the "Budgeted Capital Improvements") embodied in the Approved Improvement Budget, including detailed architectural plans and specifications (the "Architectural Plans") for the proposed capital improvements other than the New FFE and detailed plans and specifications (the "FFE Plans") for the New FFE, and shall furnish copies of each thereof to Owner for its advance approval. Such Architectural Plans and FFE Plans shall be prepared by architects, designers and other specialists selected by Owner with Hyatt's approval.
* * *
The management agreement also provided that Hyatt was to loan to Airportel the funds necessary to finance such repairs, maintenance work and capital improvements, up to a total cost not to exceed the $2 million limit. Due to concerns that the newly acquired Airportel stock might be subject to potential but unknown liabilities, petitioners decided to segregate the money loaned by Hyatt into a separate entity. On September 15, 1975, the individual partners of Almo and Ariz formed a joint venture, Almo/Ariz, a California limited partnership, whose ownership interests were held by Almo and Ariz, 70 percent and 30 percent, respectively. Almo/Ariz was formed for the purpose of making the needed repairs and refurbishments to the hotel, and executed a nonrecourse note whereby Hyatt loaned to the partnership $2 million to finance the improvement program. On October 4, 1975, Almo/Ariz, as lessor, executed a lease agreement (FFE lease) with Alar, as successor in interest to...
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