Owen v. Commissioner
| Decision Date | 28 July 1987 |
| Docket Number | Docket No. 26790-84,26791-84. |
| Parties | William F. Owen, Jr., and Gretchen K. Owen v. Commissioner. Stephen B. McEachron and Mary Jane McEachron v. Commissioner. |
| Court | U.S. Tax Court |
John S. Jagiela and Mark A. Kimball, 4824 IDS Center, Minneapolis, Minn., for the petitioners. Genelle Forsberg, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in Federal income taxes in these consolidated cases1 as follows:
The parties have stipulated some of the facts and their stipulation of facts and attached exhibits are incorporated herein by this reference. William F. and Gretchen K. Owen, husband and wife at all times relevant to this case, resided in Los Angeles, California, at the time their petition was filed. They timely filed joint Federal income tax returns for the years 1980 and 1981. Stephen B. and Mary Jane McEachron, husband and wife at all times relevant to this case, resided in Long Lake, Minnesota, at the time their petition was filed. They timely filed joint Federal income tax returns for the years 1980 and 1981.4 For convenience, we sometimes refer to petitioner, William F. Owen, as "Owen," and to petitioner, Stephen B. McEachron, as "McEachron;" and collectively, we sometimes refer to Owen and McEachron as petitioners.
Owen and McEachron have been involved in several business ventures. In 1977, they organized McO Investment (McO) as a general partnership, of which they each held a 50-percent interest. McO's principal business was investing in real estate ventures.
Sometime around 1980, petitioners decided to enter the seismic drilling operation business.5 Petitioners first attempted to purchase an ongoing concern and eventually decided to start their own seismic drilling business. Petitioners consulted Nick Hay (Hay), a tax specialist, seeking advice on how to structure the business. Petitioners structured the seismic drilling business by placing the equipment in McO and causing Western Exploration, Inc. (Western), to conduct operations. Western (which was owned equally by petitioners) was organized January 1, 1980, under the laws of Minnesota, and during 1980 and 1981, was a Subchapter C corporation.6 Petitioners chose to have McO own the equipment and Western conduct the operations because (1) petitioners would be entitled to the investment tax credit and the depreciation associated therewith, and (2) the corporation would provide some measure of insulation in case of a catastrophe. Pursuant to this arrangement, McO and Western entered into several lease agreements. Generally, the leases were either on a month-to-month basis, or for indefinite terms, and provided that either party could cancel by giving advance notice.7 McO financed the purchase of the equipment8 largely by obtaining loans from Wayzata Bank and Trust Co. (Wayzata Bank).9 In some of the loan proposals, petitioners presented McO's and Western's consolidated income and cash-flow statements to Wayzata Bank.
In addition to the equipment, in which Wayzata Bank had a security interest10 in connection with a loan agreement dated May 26, 1981,11 petitioners pledged a $100,000 certificate of deposit as additional collateral on the indebtedness.12 Petitioners, in connection with the same loan agreement, personally guaranteed the entire indebtedness.
The oil boom of the late 1970's began faltering around 1981 and petitioners experienced problems servicing their debt. At about the same time, the equipment began to decline in value. In order to abate the potential for substantial McO losses, petitioners decided to sell their seismic drilling business. Sometime around November or December 1981, petitioners met with Hay to discuss disposition of the business. Petitioners decided that transferring McO's assets to Western and then selling the business as a single entity offered the most attractive way to dispose of the business. Petitioners realized, however, that McO's outstanding indebtedness exceeded McO's adjusted basis in the property. In order to avoid a potential Federal income tax problem, petitioners met with bank officials and discussed the possibility of the bank reducing its security interest in the equipment.
On December 31 1981, petitioners transferred substantially all of the equipment to Western. There was no contemporaneously written documentation regarding this transfer. A "Third Party Pledge Agreement," dated December 30, 1981, between Western and Wayzata Bank, apparently granted the latter a security interest in the equipment transferred.13
At the time of transfer, the aggregate unpaid principal balance on the consolidated loans payable to Wayzata Bank was $988,008.48. McO's books reflected an adjusted basis in the equipment of $781,862.23. In his notice of deficiency, respondent determined an adjusted basis in the equipment of $763,354.23.
Respondent began his examination in April 1982. On or about June 24, 1982, the Internal Revenue agent conducting the audit requested documentation regarding the December 31, 1981, transfer. During June or July 1982, a "Transfer agreement" purportedly governing the equipment transferred on December 31, 1981, was drafted. That agreement reflected that "as of this 31st day of December, 1981," Western agreed to pay and assume $781,862.23 of the indebtedness incurred by McO to purchase the equipment. Western also agreed to indemnify McO against claims arising out of the agreement, the equipment or use of the equipment. An "Agreement" between McO and Western, also drafted in June or July 1982, purportedly modified the Transfer agreement. This modifying agreement also reflected that it was "as of this 31st day of December, 1981." It further noted that the equipment transferred was "security for certain purchase money indebtedness in an amount in excess of the indebtedness assumed by Western" and that Western would not "assume any of said indebtedness in excess of $781,862.23, it being expressly agreed by and between the parties that any said indebtedness in excess of the amount assumed by Western, shall be the sole obligation of McO." The Internal Revenue agent received the Transfer agreement and modification on July 14, 1982.
The Transfer agreement and the agreement modifying it were executed, apparently, around September 1982. On September 3, 1982, Wayzata Bank released part of its security interest in the equipment. The total outstanding indebtedness to Western was restructured to provide that Owen and McEachron individually assumed personal liability for a portion of the indebtedness. On September 2, 1982, McEachron had reached an agreement to sell his 50-percent interest in Western to Mountain States Seismic Service, Inc., an unrelated party. This agreement appears to have been made with the condition that McEachron's portion of the indebtedness be reduced to reflect the estimated value of the equipment ($750,000).
OpinionThe first issue for our consideration is whether petitioners are entitled to an investment tax credit. The sole dispute concerning this issue is whether petitioners satisfy section 46(e)(3)(B).
Section 38 allows a credit against tax for investments in certain depreciable property in an amount determined under section 46. In pertinent part, section 46(e)(3) provides:
Petitioners bear the burden of proving that the leases were for less than 50 percent of the useful lives of the properties. Welch v. Helvering 3 USTC ¶ 1164, 290 U.S. 111 (1930); Rule 142(a).14
In determining whether the lease is of an indefinite duration for purposes of section 46(e)(3)(B), all pertinent facts and circumstances should be considered. Highland Hills Swimming Club, Inc. v. Wiseman 60 USTC ¶ 9109, 272 F.2d 176 (10th Cir. 1959); Buddy Schoellkopf Products, Inc. v. Commissioner Dec. 33,593, 65 T.C. 640, 656 (1975). The length of a lease term is determined by the "realistic contemplation" of the parties at the time the lease was entered into. Hokanson v. Commissioner 84-1 USTC ¶ 9217, 730 F.2d 1245, 1248 (9th Cir. 1984), affg. Dec. 39,206(M) a Memorandum Opinion of this Court. If there is reasonable certainty that the lessee will continue leasing the property beyond the period stated in the lease, the lease term is considered indefinite. G.W. Van Keppel Co. v. Commissioner 61-2 USTC ¶ 9725, 295 F.2d 767, 770-771 (8th Cir. 1961), affg. Dec. 24,411(M) a Memorandum Opinion of this Court. The actual duration of the lease is not necessarily determinative. Ridder v. Commissioner Dec. 37,944, 76 T.C. 867, 875 (1981); Bloomberg v. Commissioner Dec. 37,285, 74 T.C. 1368, 1371 (1980).
Petitioners contend that they intended to (and in fact did) lease equipment to third parties and, in any event, that they were advised that they must terminate the leases prior to the expiration of 50 percent of the useful life of the equipment, and accordingly planned to (and actually did) transfer the equipment before such time. Respondent maintains, that from the inception of the leases, petitioners did not "realistically...
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