Regents Park Partners v. Commissioner
| Decision Date | 11 June 1992 |
| Docket Number | Docket No. 10395-90.,Docket No. 3545-90. |
| Citation | 63 T.C.M. 3131 |
| Parties | Regents Park Partners, The Clinton Company of Illinois, Tax Matters Partner v. Commissioner. |
| Court | U.S. Tax Court |
Scott Greiner and Theodore Gelt, 303 E. 17th Ave., Denver, Colo., for the petitioner. Steven S. Brown, for participants Harvey M. Silets and Royal B. Martin, Jr. Harvey M. Silets, pro se. Bruce Anderson, for the respondent.
Memorandum Findings of Fact and Opinion
By Notices of Final Partnership Administrative Adjustment (FPAA) dated November 30, 1989, December 20, 1989, and May 11, 1990, respondent increased Regents Park Partners' (the partnership) ordinary income for 1984, 1985, and 1986 in the amounts of $2,833,078, $2,318,212, and $1,616,806, respectively. In addition, respondent disallowed certain other deductions and credits.
Following concessions, the remaining issues for decision are: (1) Whether the acquisition of certain real property by the partnership constituted a sham transaction; (2) whether the partnership acquired the benefits and burdens of ownership of the real property, located in Chicago, Illinois, in January 1981, and therefore is entitled to ordinary losses arising from the operation of the improvements situated thereon; (3) whether the nonrecourse debt, to which the property was subject at the time of acquisition, unreasonably exceeded the fair market value of the property, and must be excluded in determining the partnership's basis in the property; (4) whether, if the partnership had acquired the property, for purposes of Federal income taxation, the partnership was allowed to increase the basis of the real property by $828,361, which represented the amount the mortgagee of the property paid in 1981 for the 1980 real estate taxes on the property; (5) whether the partners' bases in their interests in the partnership are overstated; and (6) whether we have jurisdiction to determine that a partner, upon the sale or exchange of an interest in the partnership, must treat as ordinary income that portion of the gain derived from the excess depreciation attributable to the property's overvaluation.
The stipulation of facts, supplemental stipulation of facts, and their accompanying exhibits, to the extent the stipulations and exhibits were not excluded at trial, are incorporated herein by this reference.
Regents Park Partners is a limited partnership organized under the law of the State of Illinois and has its principal place of business in Chicago, Illinois.
The following chart shows the partners of the partnership and their respective interests therein:
The Summit ............ 71.5% (Limited Partner)
Frank DiMaria ......... 5.0% (Limited Partner)
Harvey M. Silets ...... 4.5% (Limited Partner)
Royal B. Martin, Jr. .. .5% (Limited Partner)
The Clinton Company
of Delaware ......... 7.0% (Limited Partner)
Bruce E. Clinton ...... 3.0% (Limited Partner)
The Holding
Company ............. 7.5% (Limited Partner)
The Clinton Company
of Illinois ......... 1.0% (Limited Partner)
The Clinton Company of Illinois, petitioner, is an Illinois corporation, is the partnership's tax matters partner, and had its principal office in Chicago, Illinois, at the time the petitions in this case were filed.
The partnership maintained its books and records according to the accrual method of accounting; and filed its Federal income tax returns on the basis of the calendar year.
This case involves the tax aspects arising out of the partnership's acquisition of two interconnected high-rise residential towers and the land upon which they stand, one located at 5050 South Lake Shore Drive, Chicago, Illinois (South Property), and the second located at 5020 South Lake Shore Drive, Chicago, Illinois (North Property). The South Property and North Property shall be referred to collectively as the property.
The property consists of approximately 3.135 acres (136,582 square feet) of land, and is located in an area of Chicago commonly known as Hyde Park. On the North Property is a 35-story apartment building with 528 units, and on the South Property a similar building of 36 stories and 510 units. A four-level underground garage with space for approximately 750 cars is also located beneath the apartment buildings. The buildings were constructed in the early 1970s.
Respectively, the South Property and the North Property were originally owned by Chicago Beach South Towers, an Illinois limited partnership, and Chicago Beach North Towers, also an Illinois limited partnership.1
To finance construction of the properties, Chicago Beach South Towers and Chicago Beach North Towers in June 1970 entered into separate though essentially similar trust agreements, Trust Number 40910 and Trust Number 40920, with LaSalle National Bank (LaSalle), a national banking association. According to the terms of the two trust documents, each of which established an "Illinois Land Trust",2 LaSalle served as sole trustee and each of the limited partnerships was the sole beneficiary of the trust it created. Under the terms of each trust, the trustee was authorized to
execute and deliver such agreements, contracts, notes, mortgages, trust deeds, certificates and other documents, including particularly the Federal Housing Administration ("FHA") Regulatory Agreement relating to the trust property * * * and any amendments thereto * * * and a mortgage on the trust property all as directed in writing by the beneficiary.
On July 1, 1970, to finance construction on the South Property, LaSalle as trustee obtained a $12,644,000 loan ($12.6 million loan) from McElvain-Reynolds Company in exchange for a nonrecourse note in like amount secured by a mortgage on the property. On the same date, the U.S. Department of Housing and Urban Development (HUD) agreed to insure the South Property loan pursuant to section 220 of the National Housing Act, and entered into a Regulatory Agreement for Multi-Family Housing Projects with LaSalle with respect to the South Property.
Financing for construction of a high-rise apartment building on the North Property was obtained on May 1, 1972. LaSalle, as trustee, borrowed $13,472,700 ($13.4 million loan) from McElvain-Reynolds Company for which LaSalle executed a nonrecourse note secured by a mortgage on the North Property. On the same date, HUD insured the mortgage and executed a Regulatory Agreement for Multi-Family Housing Projects regarding the North Property with LaSalle, similar to that respecting the South Property.
The regulatory agreements with HUD provided, in particular, that the owner of the property was required to make all payments due under the note and mortgage; could not, without prior written approval of HUD, assign or transfer any beneficial interest in a trust holding title to the property; and was required to maintain the property in good repair and condition.
The note attributable to the $12.6 million loan accrued interest at the rate of 8.5 percent per annum, with interest only payable for 30 months, and principal and interest of $96,692.42 payable for the next 479 months with final payment due on December 1, 2012. The note could be prepaid. According to the terms of the mortgage, the mortgagor was required to keep the property insured against loss in an amount not less than the lesser of 80 percent of the insurable value of the property or the unpaid balance of the insured mortgage, and was required to pay the mortgagee an amount sufficient to pay all taxes and special assessments levied against the property.
The note for the $13.4 million loan accrued interest at a rate of 7 percent per annum, with interest payable only for 26 months and payment of $83,723.58 for 480 months with any unpaid amount of principal or interest due on July 1, 2014. Otherwise, the terms of the mortgage and note with respect to the $13.4 million loan were essentially the same as the mortgage and note for the $12.6 million loan.
McElvain-Reynolds subsequently sold the two mortgages and mortgage notes. Shortly after the completion of construction of the apartment buildings, the Developer defaulted on the notes. HUD paid off the notes and, as a consequence, became the mortgagee of the property.
On or about October 28, 1975, the Developer surrendered possession of the property to HUD. Pursuant to a bidding process, petitioner was awarded the property's temporary management contract. Petitioner was awarded the permanent management contract for the property in January 1976; its fee was 4.75 percent of the gross rental collections. After winning the management contract, petitioner negotiated with HUD and the Developer to acquire the property.
Occupancy of the apartment buildings in late 1975 was 48 percent of capacity and the property was in an operationally and physically disastrous condition, to the point that the city of Chicago was threatening to raze the structures. The neighborhood and the city of Chicago complained that some of the tenants, in particular drug dealers and prostitutes, had infested the building and affected the reputation of the surrounding community.
Structurally, the buildings suffered from a condition known as "spalling", which caused concrete to peel completely away from the internal framework. Spalling apparently arises from the use of improperly mixed concrete and the addition of excessive salt to the mixture to aid in winter pouring.
The original contractor repaired the concrete in the mid-1970's and was released from liability by HUD, but the spalling later reappeared. In 1979, a report prepared for HUD determined that the problem, after it had reoccurred, could be fixed by a one-time expenditure of around $300,000. In 1985, a structural engineer determined that there was an inherent defect in the concrete, the maintenance of which would require an annual expense of $300,000. Petitioner was not...
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