Stephen v. Commissioner
| Decision Date | 23 November 1992 |
| Docket Number | Docket No. 17993-89. |
| Parties | C. Stephen and Betty Boehm Babin v. Commissioner. |
| Court | U.S. Tax Court |
J. Timothy Bender, Aaron H. Bulloff, and Timothy J. O'Shaughnessy, 2112 E. Ohio Bldg., Cleveland, Ohio, for the petitioners. Jeffrey J. Erney, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in petitioners' Federal income taxes as follows:
Year Deficiency
1978 ........................... $130,730
1979 ........................... 173,179
1982 ........................... 76,768
After concessions, we must decide several issues in the instant case. The first issue we must decide arises from the discharge of a recourse mortgage debt of a partnership of which petitioner C. Stephen Babin (hereinafter petitioner) was a general partner. We must decide whether petitioners must recognize income from such discharge and, consequently, whether petitioner was insolvent at the time of such discharge. The second issue we must decide is the amount of capital gain to be recognized by petitioner upon the reduction in his share of partnership liabilities occasioned by such discharge. The third issue we must decide is the amount and character of loss petitioners must recognize upon the dissolution of another partnership in which petitioner held an interest. Lastly, we must decide whether petitioner Betty Boehm Babin is entitled to certain net operating loss carryforwards for 1982.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Certain documents have been stipulated for trial pursuant to Rule 91. When the petition in the instant case was filed, petitioners resided in Fairview Park, Ohio. Immediately before petitioner's marriage to Betty Boehm Babin on January 17, 1976, they executed an antenuptial agreement listing all petitioner's assets.
Petitioner was a general partner in Lakewood Center Medical Construction Associates (LCMCA), an Ohio limited partnership. LCMCA's primary asset was the newly constructed Lakewood Center Professional Building (the medical building), a 7-story, 70,000 square foot office building adjacent to Lakewood Hospital. Petitioner held a 51-percent interest in the income and loss of LCMCA and a 75-percent share of its liabilities. The other general partner of LCMCA was James Carroll, who held a 17 percent profit/loss interest. LCMCA had six limited partners, including Mrs. Babin.
Cleveland Trust Company (CTC) held a first mortgage on the medical building of $3,300,110, a second mortgage of $660,014, and debtor's certificates of $220,782 (hereinafter collectively referred to as the "CTC mortgage"). All of the debt held by CTC was recourse as to the general partners. Because LCMCA was unable to make debt service payments, CTC foreclosed on the medical building and LCMCA filed a Chapter XII bankruptcy petition on April 13, 1977. In late 1977, LCMCA and CTC discussed a settlement of the partnership's debts. The total debt owed CTC by LCMCA was $5,170,019, but CTC offered to cancel the debt for $2,750,000, forgiving $2,420,019 of debt.
On October 31, 1977, petitioner contracted to sell to Howard Schulman all of LCMCA's assets, including the medical building, as well as the partners' interest in LCMCA, for a total of $2,850,000, $64,000 of which represented a cash distribution to the partners. The remainder was used to pay various other creditors of LCMCA and expenses incident to the sale. On January 9, 1978, the bankruptcy court approved the settlement reached by LCMCA and CTC and dismissed the proceedings. LCMCA sustained an ordinary loss of $442,265 on the disposition of the medical building, of which petitioner's share was $225,555.
At the time of the sale, Mr. Schulman entered into a Management and Consulting Agreement with petitioner under which Mr. Schulman agreed to award Marwood, Inc., a property management firm owned by petitioner, a 2-year contract as managing and leasing agent for the medical building. Marwood would be compensated at the rate of 4 percent of gross rentals until "break even" cash flow was attained, and such fee would be increased to 5 percent if the "break even" level were attained for 3 consecutive months. Marwood would also receive a leasing fee of 5 percent of the gross lease amount for leases it negotiated. If the lease rate for the building did not exceed 60 percent within a year of Mr. Schulman's acquisition of the building, Mr. Schulman could cancel the contract. If, however, the lease rate was 80 percent within 18 months, the contract would be automatically extended for a year. Marwood would also receive a supervisory fee of 10 percent of cost for all construction in vacant areas of the building, and a design fee of $1.00 per square foot for design work in areas to be leased up to 2,500 square feet, and a design fee of $.75 per square foot for areas in excess of such size. Marwood was also allowed to bid on construction work to be done in the building.
Under the Management Agreement, petitioner was entitled to 30 percent of annual cash flow, after payment of expenses and repayment of advances made by Mr. Schulman. Petitioner also was entitled to 30 percent of net proceeds from refinancing or sale of the property. Petitioner also entered into a purchase option agreement with Mr. Schulman concerning the medical building.
Petitioner's basis in his interest in LCMCA prior to the debt discharge was $2,663,180, which includes a reduction for the distribution of petitioner's share, $32,640, or 51 percent, of the $64,000 cash payment to the partners of LCMCA by Mr. Schulman. Upon the discharge of the CTC mortgage, petitioner's basis was reduced by $3,877,514 (75 percent of $5,170,019).
Marwood, Inc.
Petitioner owned all of the stock of Marwood, Inc. (Marwood), the real estate management company which operated the medical building and other buildings in which petitioner had an interest. The buildings generally were operated under management contracts which could be cancelled on 30 to 60 days notice. Usually, when a building was sold, Marwood was replaced as property manager. Marwood did not seek other properties to manage. Marwood usually received a management fee of between 4 and 5 percent of rental income, a commission on leases it obtained, and fees on construction work for tenants in the buildings. Marwood's assets included office equipment, cash, and receivables. Marwood's expenses exceeded its income in 1977. Marwood's income tax return for the year ended December 31, 1977, shows accounts receivable and assets equalling $143,842 and accounts payable of $137,180. The excess of assets over liabilities totals $6,662.
Petitioner was Marwood's employee, but had no employment contract or noncompetition agreement with Marwood. In 1977, petitioner received a salary of $48,000 from Marwood, as well as a "commission" of $134,358.
14701 Detroit Corp.
Petitioner owned all the stock of 14701 Detroit Corp. (14701 Detroit), the principal assets of which were the INA Building and Annex, a modern 7-story office building, and the Lakewood Center Building, a 3-story office building originally constructed as a department store in the 1920's and extensively remodelled in 1969. The buildings were in average to above-average condition as of January 10, 1978. Both buildings were located on the same block in downtown Lakewood, Ohio, and shared two and three level parking garages, as well as a surface parking lot, which had been constructed on such site for their tenants. The land owned by the corporation had been sold to a real estate investment trust (the REIT), and 14701 Detroit leased the land from the REIT for $175,000 per year at the time in issue. Certain of the land used for parking had been leased from the City of Lakewood in 1973 by Marwood, Inc., a corporate predecessor of 14701 Detroit. The other assets of 14701 Detroit had a value of $83,172 as of January 9, 1978.
The buildings were encumbered by a first mortgage of $4,863,762, held by Broadview Savings and Loan. As of January 9, 1978, 14701 Detroit was in default on such mortgage. The REIT held a second mortgage of $200,000 on the buildings, which was also in default at such time. The mortgages had a higher payment priority than other corporate debts. 14701 Detroit was also in default on its land lease with the REIT at such time. As of the end of 1977, the corporation's cash flow fell $100,000 short of what was needed to service the debt.
Petitioner held a note from 14701 Detroit in the amount of $746,511, which he received when he assumed a debt in such amount on the corporation's behalf. Such debt was included in a $1,000,000 nonrecourse note given by petitioner to CTC on January 9, 1978, which is discussed further below. Petitioner never wrote the 14701 Detroit note off as worthless on his tax returns.
One of the tenants of 14701 Detroit's buildings was Control Data Corp. (Control Data) which, at the beginning of 1978, was considering moving out of the buildings because it wanted more space. In February 1978, petitioner began negotiating in earnest to try to keep Control Data, promising to secure additional space in the buildings. Control Data signed a 12-year lease with 14701 Detroit on March 30, 1978. The lease provided that Control Data would be able to terminate if the additional space were not made available. In order to provide the space, petitioner had to relocate two tenants in the building, who had not agreed to move when the lease was signed. One tenant's space was to be available to Control Data in June 1978 and the other's was to be available in March 1979. Petitioner succeeded in relocating the tenants to the...
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