Roemer v. Comm'r of Internal Revenue
| Decision Date | 12 December 1977 |
| Docket Number | Docket Nos. 3837-74,3838-74,3915-74. |
| Parties | PAUL F. ROEMER, JR., and MARCIA E. ROEMER, et al.,1 PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
In five separate transactions petitioners paid certain amounts which were designated as prepaid interest. Held, Rev. Rul. 68-643, 1968-2 C.B. 76, by its terms, applies retroactively to an interest prepayment sufficient to pay 3 2/3 years' interest where such amount may be, and is applied, at the sole discretion of the lender, to satisfy interest obligations arising during a period in excess of 5 years from the prepayment date. Held, further, Rev. Rul. 68-643 applies retroactively to the entire amount of an interest prepayment for an indefinite period where there is at least a probability that the period may extend beyond 5 years. Held, further: The amount which petitioners were obligated to pay on a purchase money note was the stated principal amount less the discount for prepayment, and part of the amount designated as prepaid interest was a payment on the purchase price. Petitioners' basis in the purchased property should be adjusted accordingly. Held, further, an amount designated as prepaid interest was not “paid,” for sec. 163(a) purposes, to the extent that it was withheld from the proceeds of a $160,000 note. Held, further: A debt is not a sham where, aside from tax benefits, the debtor realistically anticipates to profit from the transaction. There is no requirement that deductible interest serve a business purpose. Held, further: Interest was prepaid pursuant to a legal obligation incurred prior to November 26, 1968, where the sellers were bound prior to such date to sell a leasehold interest and petitioners were bound to buy it according to terms requiring the prepayment. Rev. Rul. 68-643, by its terms, does not apply to such prepayment. Paul F. Roemer, Jr., pro se.
Robert S. Brickell, pro se.
Julian N. Stern and Robert C. Alexander, for the petitioners in docket No. 3915-74.Lawrence G. Becker, for the respondent.
In these consolidated cases, respondent has determined deficiencies in petitioners' Federal income taxes as follows:
Concessions having been made, there are two issues remaining for our decision: (1) Whether certain amounts designated as interest are deductible by petitioners, pursuant to section 163(a),2 for the years in question, and (2) whether the petitioners' deduction of prepaid interest in the year of payment distorts their income.
Some of the facts have been stipulated and are so found.
Petitioners reside in California at the time they filed their petitions herein. They filed Federal income tax returns for the years in issue with the offices of the Internal Revenue Service at San Francisco, Calif. (for some of the years at issue in docket No. 3915-74), and Ogden, Utah.
Petitioner Harry T. Holgerson, Jr. (Holgerson), was in the business of buying and selling used airplane parts, and there was a substantial increase in his income from that business for the years 1967, 1968, and 1969. Dale Kimbell (Kimbell), a certified public accountant, kept Holgerson's books during the years in issue and advised him of his potential increased income tax liabilities arising from his increased income during those years. Kimbell suggested that one of the means available to Holgerson for reducing his potential tax liability would be prepayment of interest on investments which he made. The ability to characterize a portion of the funds paid by him as prepaid interest was a factor which Holgerson considered favorably when choosing investments, but his prime consideration was that the investment be a good one which would provide income for him during his retirement years.
On December 13, 1967, Holgerson and his wife, Mary (the Holgersons), agreed with Walnut Growers, Inc. (Walgro), Walgro shareholders, and their wives to purchase approximately 631 acres of farmland together with trees and improvements (Walgro property). Such agreement read in part as follows:
D. SALE: WALGRO TO HOLGERSONS
NOW, THEREFORE, Holgersons hereby agree to buy from Walgro, and Walgro hereby agrees to sell to Holgersons, the Property * * * pursuant to the terms and conditions of this General Agreement.
The total purchase price for the Property shall be $1,955,250.00.
Holgersons shall pay this purchase price as follows:
a. Cash. A down payment by Holgersons into the escrow of $25,000 in cash.
b. Assumption of Indebtedness.
(1) Assumption by Holgersons of all of the indebtedness set out * * * above, a total of $957,075.50 principal, plus interest, it being understood that proration of interest on this indebtedness shall be made between Walgro and Holgersons as of the closing date of this sale.
c. Promissory Note. A promissory note from Holgersons to Walgro for the remaining $973,174.50. * * *
Concurrently with this sale, the Holgersons shall pay to Walgro, and Walgro shall accept, the sum of $250,000.00, as prepayment of interest on the note referred to in D4c, above, to be applied to such installments of interest to fall due under that note on or before February 1, 1976, as Walgro may at its option designate.
On or about December 13, 1967, Holgerson made the $25,000 and $250,000 payments and assumed the $957,075.50 indebtedness. On December 13, 1967, the Holgersons executed the $973,174.50 promissory note providing for interest on the unpaid principal balance at a rate of 7 percent from December 13, 1967, until December 13, 1977, and thereafter at a rate of 4 1/2 percent until final payment of the principal. Such interest was payable in installments beginning February 1, 1968, with subsequent interest payments payable annually thereafter on the first day of February, and principal payments were to be made annually beginning on February 1, 1978, in the amount of $48,658.72.
In addition to the prepaid interest, Holgerson made further interest and principal payments on the December 13, 1967, note as follows:
+------------------------------+
¦Year ¦Interest ¦Principal ¦
+------+----------+------------¦
¦ ¦ ¦ ¦
+------+----------+------------¦
¦1968 ¦$9,257.50 ¦0 ¦
+------+----------+------------¦
¦1969 ¦68,122.22 ¦0 ¦
+------+----------+------------¦
¦1970 ¦68,122.22 ¦0 ¦
+------+----------+------------¦
¦1971 ¦68,122.22 ¦0 ¦
+------+----------+------------¦
¦1972 ¦68,122.22 ¦0 ¦
+------+----------+------------¦
¦1973 ¦22,488.88 ¦0 ¦
+------+----------+------------¦
¦1974 ¦0 ¦0 ¦
+------+----------+------------¦
¦1975 ¦0 ¦0 ¦
+------+----------+------------¦
¦1976 ¦0 ¦0 ¦
+------------------------------+
No interest payments were made for 1974-76, and a reduced payment was made in 1973, because Walgro applied the $250,000 interest prepayment to the interest requirements of the note for those years. The Holgersons leased the Walgro property back to Walgro as part of the same transaction in which they purchased it. Such lease provided in part as follows:
5. Schedule of Rentals. Lessee shall pay to Lessor, as rental for the Property, the following sums on the dates indicated:
+-----------------------------------------------------------------------------+
¦Date ¦Amount of rental payment due ¦
+----------------------------------------------+------------------------------¦
¦ ¦ ¦
+----------------------------------------------+------------------------------¦
¦Jan. 31, 1968 ¦$15,000 ¦
+----------------------------------------------+------------------------------¦
¦Oct. 30, 1968 ¦0 ¦
+----------------------------------------------+------------------------------¦
¦Jan. 31, 1969 ¦45,000 ¦
+----------------------------------------------+------------------------------¦
¦Oct. 30, 1969 ¦0 ¦
+----------------------------------------------+------------------------------¦
¦Jan. 31, 1970 [and each Jan. 31 of succeeding ¦55,000 ¦
¦years up to and including 1977] ¦ ¦
+----------------------------------------------+------------------------------¦
¦Oct. 30, 1970 [and each Oct. 30 of succeeding ¦77,500 ¦
¦years up to and including 1977] ¦ ¦
+-----------------------------------------------------------------------------+
6. Duties of Lessee. In addition to the duty to pay the rentals...
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