Nalle v. C.I.R., 92-4954

• Decision Date: 16 August 1993
• Docket Number: No. 92-4954,92-4954
• Citation: 997 F.2d 1134
• Parties: -5705, 62 USLW 2127, 93-2 USTC P 50,468 George S. NALLE, III, and Carole Nalle, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. Charles A. BETTS and Sylvia I. Betts, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 1134

997 F.2d 1134

72 A.F.T.R.2d 93-5705, 62 USLW 2127,

93-2 USTC P 50,468

George S. NALLE, III, and Carole Nalle, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Charles A. BETTS and Sylvia I. Betts, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 92-4954.

United States Court of Appeals, Fifth Circuit.

Aug. 16, 1993.

Michael L. Cook, Carolyn M. Beckett, Jenkens & Gilchrist, Austin, TX, for petitioners-appellants.

Abraham N.M. Shashy, Jr., Chief Counsel, I.R.S., Linda E. Mosakowski, Gilbert S. Rothenberg, Gary R. Allen, Chief, Appellate Section, Tax Div., Dept. of Justice, Washington, DC, for respondent-appellee.

Appeal from a Decision of the United States Tax Court.

Before SMITH, DUHE, and WIENER, Circuit Judges.

JERRY E. SMITH, Circuit Judge:

George and Carole Nalle and Charles and Sylvia Betts (collectively, the "taxpayers") appeal a decision of the Tax Court upholding the assessment of an income tax deficiency against them by the Commissioner of Internal Revenue (the "Commissioner"). Because we find the treasury regulation pursuant to which the Commissioner assessed the deficiency to be an invalid interpretation of the statute, we reverse.

I.

George Nalle ("Nalle") owns a fifty-percent interest in the Heritage Square Joint Venture, which, between 1982 and 1984, identified eight buildings in and around Austin that were appropriate for rehabilitation and relocation, five of which were slated for demolition in order to accommodate the expanding campus of the University of Texas at Austin. All eight houses were purchased and moved to the Heritage Square office subdivision in suburban Rollingwood, where they were restored to substantially the same style and condition as originally constructed. ¹

Because each house was more than forty years old on the date rehabilitative work commenced, Nalle claimed an investment tax credit for over $500,000 of the rehabilitation performed in tax years 1983-86, pursuant to section 48(g) of the Internal Revenue Code (the "Code"), 26 U.S.C. § 48(g). Heritage did not claim the tax credit for expenditures incurred in refurbishing one of its properties, the Julia Harris house, but passed the credit on to the purchasers, appellants Charles and Sylvia Betts, who reported a credit for $35,934 on their joint 1983 federal tax return, $14,322 of which was carried back to their 1980 return.

On June 28, 1985, the Internal Revenue Service ("IRS") published proposed treasury regulation 26 C.F.R. § 1.48-12, subsection (b)(5) of which set forth a requirement that "qualified rehabilitated buildings" such as were eligible for the section 48(g) tax credit not have been relocated within either thirty or forty years of the date on which rehabilitation was begun. The regulation was adopted in final form on October 7, 1988, and was applied retroactively to rehabilitation expenditures incurred after December 31, 1981. The IRS audited the taxpayers' returns for 1983-86, and on June 9, 1989, issued a statutory notice of deficiency disallowing the credits.

In the Tax Court, it was stipulated that the houses qualified for the rehabilitation tax credit but for the exclusion of relocated properties contained in section 1.48-12(b)(5). The taxpayers argued that the new regulation was invalid because it added a requirement to the statute that had not previously existed, yet was passed pursuant to the Commissioner's interpretive authority under 26 U.S.C. § 7805(a) and not pursuant to any legislative authority conferred by Congress with respect to section 48(g). The Commissioner countered that the regulation was not inconsistent with the statutory text and vindicated a central policy goal of the original legislation (as revealed by the legislative history)--the revitalization of decayed and deteriorating areas. The Tax Court ruled in favor of the Commissioner, citing the support for his position contained in the legislative history of the tax credit.

II.

An interpretive regulation promulgated pursuant to the Commissioner's authority under section 7805(a) is generally "entitled to substantial weight." Lykes v. United States, 343 U.S. 118, 127, 72 S.Ct. 585, 590, 96 L.Ed. 791 (1952). ² The Supreme Court has provided us with substantial guidance in reviewing the propriety of such regulations:

In determining whether a particular regulation carries out the congressional mandate in a proper manner, we look to see whether the regulation harmonizes with the plain language of the statute, its origin, and its purpose. A regulation may have particular force if it is a substantially contemporaneous construction of the statute by those presumed to have been aware of congressional intent. If the regulation dates from a later period, the manner in which it evolved merits inquiry. Other relevant considerations are the length of time the regulation has been in effect, the reliance placed on it, the consistency of the Commissioner's interpretation, and the degree of scrutiny Congress has devoted to the regulation during subsequent re-enactments of the statute.

National Muffler Dealers' Ass'n v. United States, 440 U.S. 472, 477, 99 S.Ct. 1304, 1307, 59 L.Ed.2d 519 (1979).

III.

The dispute here is the interpretation of one subsection of the Code provided by a regulation issued more than five years after the subsection it purports to interpret. The key subsection is section 48(g)(1)(A), which, as it existed for the tax years in question, ³ set out a three-part test governing eligibility for the rehabilitative investment tax credit:

(A) In general.--The term "qualified rehabilitated building" means any building (and its structural components)--

(i) which has been rehabilitated,

(ii) which was placed in service before the beginning of the rehabilitation, and

(iii) 75 percent or more of the existing external walls of which are retained in place as external walls in the rehabilitation process.

Only the last of these requirements, referred to by the parties as the "external wall test," concerns us. It is the taxpayers' contention that the external wall test means more or less what it says--that a building may qualify for the tax credit only if its structure remains substantially the same as before rehabilitation. The test, they say, simply serves to distinguish new construction, for which no credit is allowed, from rehabilitation, for which the credit is available. The Commissioner, relying largely upon a deferential review of agency determinations, argues that section 1.48-12(b)(5), which divines in the external wall test a restriction on relocation of non-historic rehabilitated buildings, is not inconsistent with the origin and purpose of the statute. ⁴

As previously noted, the Tax Court upheld the regulation on the basis that it "harmonized" with congressional intent, at least as revealed by selected passages from the credit's legislative history:

The legislative history of section 48 reveals that it is not, as petitioners contend, solely a device to promote the rehabilitation of older buildings. From its inception, the tax credit for rehabilitation expenditures was intended to provide an economic stimulus for those areas susceptible to economic decline and abandonment, particularly the "central cities and neighborhoods of all communities."

Nalle v. Commissioner, 99 T.C. 187, 195, 1992 WL 184967 (quoting H.R.REP. No. 1445, 95th Cong., 2d Sess. 86, reprinted in 1978 U.S.C.C.A.N. 7046, 7121).

We are mindful, at the outset, of Justice Scalia's recent reference to the use of legislative history as oftentimes being "the equivalent of entering a crowded cocktail party and looking over the heads of the guests for one's friends." Conroy v. Aniskoff, --- U.S. ----, ----, 113 S.Ct. 1562, 1567, 123 L.Ed.2d 229 (1993) (Scalia, J., concurring). Our reading of the scant legislative history surrounding the 1978 adoption and 1981 amendment of section 48(g) suggests that, in this case, the Tax Court picked its few friends from an otherwise indifferent crowd.

Foremost among those friends is the above-quoted House report on the Revenue Act of 1978, which first extended the investment tax credit--previously restricted to equipment and machinery--to non-historical, non-residential buildings. According to the report, among the reasons for the change was as follows:

Presently, there is a similar concern [to that which gave rise to the investment tax credit for machinery and equipment] about the declining usefulness of existing, older buildings throughout the country, primarily in central cities and older neighborhoods of all communities....

The committee believes that it is appropriate now to extend the initial policy objective of the investment credit to enable business to rehabilitate and modernize existing structures. This change in the investment credit should promote greater stability in the economic vitality of areas that have been developing into decaying areas.

1978 U.S.C.C.A.N. at 7121.

In 1981, Congress imposed a three-tiered structure upon the tax credit: Rehabilitated historic structures would receive a 25% credit, structures at least forty years old a 20% credit, and thirty-year-old structures, 15%. The Tax Court also cited the legislative history of this amendment to validate the Commissioner's regulation. The Senate Report states as follows:

The tax incentives for capital formation provided in other sections of this bill might have the unintended and undesirable effect of reducing the relative attractiveness of the existing incentives to rehabilitate and modernize older business structures. Investments in new structures and new locations, however, do not necessarily promote economic recovery if they are at the expense of older structures, neighborhoods, and regions. A new structure with new equipment may add little to capital formation or productivity if it simply replaces an existing plant in an older structure in which the new...