Rendina v. Commissioner
| Decision Date | 21 August 1996 |
| Docket Number | Docket No. 19223-93. |
| Citation | 72 T.C.M. 474 |
| Parties | Paul A. Rendina and Janet Mae Rendina v. Commissioner. |
| Court | U.S. Tax Court |
Joseph P. Alexander, J. Timothy Bender, and David G. Lambert, Cleveland, Ohio, for the petitioners. Jeffrey J. Erney, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined a deficiency of $35,934 in petitioners' 1988 Federal income tax, and additions to tax of $1,797 and $8,984, under sections 6653(a)(1) and 6661(a), respectively.1 The deficiency arose from respondent's determination that the distribution to petitioner2 of two condominium units by Wood Street Apartments, Inc. (WSAI) was a dividend.
We hold that petitioner received the condominium units as a distribution in de facto liquidation of his shares of WSAI, thereby reducing his realized gain by the amount of his basis in the shares and by the amount of certain liabilities to third parties that he assumed, resulting in a lesser deficiency than respondent determined. We also hold petitioner liable for the additions to tax for negligence under section 6653 and substantial understatement under section 6661, computed on the reduced deficiency.
Some of the facts have been stipulated, and are so found. The stipulation of facts and attached exhibits are incorporated herein.
When petitioners filed their petition, they resided in Willoughby Hills, Ohio.
Petitioner is a certified public accountant. During the year at issue, he was an owner-shareholder in a certified public accounting firm, Rendina & Vitantonio, Inc.
Wood Street Apartments, Inc.
In 1986, petitioner and Thomas J. Ackerman (Ackerman), a construction contractor, formed WSAI as a general business corporation under Ohio law, for the purposes of constructing and selling 18 condominium units in Willoughby, Ohio. WSAI was operated as a C corporation. Petitioner and Ackerman each paid WSAI approximately $250 for an equal number of common shares of WSAI.
In 1987 and 1988, WSAI constructed the 18 condominium units, known as "South Wood Condominiums" (South Wood). South Wood consists of two-story townhouses, built in clusters of six units in each of three buildings.
WSAI financed the construction of South Wood primarily with borrowed funds. The funds used by WSAI consisted of a loan from Security Federal Savings and Loan of approximately $740,000, petitioner's deposits in WSAI's checking account of approximately $41,200,3 and approximately $68,000 in loans from three of petitioner's accounting clients: William and Mary Foss (the Fosses), Vito and Adella Navar (the Navars), and Frank and Benette Posa (the Posas). The principal amounts of the loans from the Fosses, Navars, and Posas were $53,000, $10,000, and $5,000, respectively. The loan checks were made to WSAI, and deposited in WSAI's checking account at National City Bank. WSAI issued promissory notes to the lenders, providing that interest would be paid at a rate of 12 percent per year. The maturity date of each of the notes was approximately 1 year after issuance.
On March 9, 1987, the Posas lent $5,000 to WSAI, and received notes as follows:
Entity Date Amount
WSAI ..................... 2/17/87 $5,000
WSAI ..................... 3/01/88 5,000
WSAI4 .................... 3/01/89 5,000
On May 5, 1987, June 8, 1987, and June 29, 1987, the Fosses lent $18,000, $10,000, and $25,000, respectively, to WSAI, and received notes as follows:
Entity Date Amount
WSAI .................... 4/06/87 $28,000
WSAI .................... 6/29/87 25,000
WSAI5 ................... 4/06/89 53,000
On February 27, 1987, the Navars lent $10,000 to WSAI, and received the following note:
Entity Date Amount
WSAI .................... 2/26/87 $10,000
With the exception of one of the Foss notes, each new note reflected a rollover of the obligation on the prior note. For the months of January, February, March, and April 1989, all interest payments due on the notes to the Fosses, Navars, and Posas were made in the name of WSAI.6
In 1988, 16 of the 18 units were sold, two of which were purchased by Ackerman. The stated purchase prices and dates of purchase for the 16 units were as follows:
Ackerman and petitioner expected a net profit of approximately $5,000 to $10,000 on each condominium unit sold, based on a cost estimate of approximately $50,100 per unit. However, WSAI incurred approximately $3,500 to $4,000 in commissions and settlement costs for each condominium. In addition, rebates or building allowances were given to prospective buyers in amounts ranging from $1,500 to $3,500. WSAI also incurred financing costs, unanticipated zoning costs, development fees, $25,000 paid in settlement of a lawsuit by South Wood Condominium Association related to alleged construction defects in South Wood and various misrepresentations, nondisclosures, and failures to perform, and WSAI's actual construction costs.
Toward the end of 1988, two of the 18 units remained unsold. Petitioner and Ackerman orally agreed that WSAI would transfer title to the two remaining condominium units to petitioner in consideration of petitioner's assumption of the Foss, Navar, and Posa notes, and petitioner's discharge of WSAI's "debt" owed to him.
In December 1988, WSAI transferred South Wood's two remaining condominium units to petitioner. Petitioner did not report any income or gain from the receipt of the two condominium units on his 1988 Federal income tax return, but did report a taxable dividend from WSAI in the amount of $90. Although WSAI had filed U.S. corporation income tax returns for the tax years 1986 and 1987, employing the completed contract method of accounting, and showing no gross receipts, sales, or other income, WSAI filed no U.S. corporation income tax return for 1988, the tax year in which all the condominium units were sold or transferred.
With the transfer of the last two condominium units to petitioner in 1988, WSAI no longer held business assets, and ceased to be a going concern. Upon transfer of all 18 condominium units in 1988, WSAI ceased doing business, but did not formally dissolve. Its charter was revoked in 1990 for nonpayment and nonfiling of Ohio franchise tax returns.
In April 1989, petitioner sold one of the units for $67,900.
Transfer of notes from WSAI to Canterbury Construction Co.
Following his receipt of the last two South Wood condominium units, petitioner gave the Fosses, Navars, and Posas the option of either having their loans repaid, or of having the loan obligations taken over by Canterbury Construction Co. (Canterbury), an S corporation wholly owned by petitioner that is in the business of real estate construction and development. The note holders chose to have Canterbury take over the loan obligations and to continue receiving interest payments. While petitioner did not, in his individual capacity, issue promissory notes to any of the note holders, Canterbury issued new notes to the Fosses, Navars, and Posas sometime after April 1989, and began making interest payments on the notes.
The loans to the Posas and Navars, in the principal amounts of $15,000 and $10,000, respectively, have been paid. As of the date of filing of the petition, the Fosses still held a note issued by Canterbury on which they were receiving interest payments.
As a result of the earlier lawsuit, WSAI turned its books and records over to the South Wood Estates Condominium Association. Petitioner has not recovered the books and records of WSAI from the Association.
Corporation tax and transferee issues
On or around March 1, 1994, respondent sent petitioner, as transferee of WSAI, a 30-day letter, with a report of income tax examination and explanation of items, asserting for the taxable year 1988 that WSAI had taxable income of $272,320, resulting from gross receipts of $1,068,000 from the sale of the South Wood condominium units,8 based on the retail sales prices as determined by the transfer taxes paid, less costs and expenses of $795,680.9 The report took the position that WSAI owed 1988 U.S. corporation income tax of $89,455, and an addition of $22,364 for failure to file its corporation income tax return. WSAI's liability for 1988 U.S. corporation income tax and the failure to file addition remains unresolved; respo...
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