Sutton v. Comm'r of Internal Revenue , Docket Nos. 22131-81
| Decision Date | 13 February 1985 |
| Docket Number | Docket Nos. 22131-81,3114-83.,18891-82,22639-81 (Nitrol Issues),28537-81,13350-82 |
| Citation | 84 T.C. 210,84 T.C. No. 17 |
| Parties | WILLIAM F. SUTTON and HELEN C. SUTTON, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Ps claimed losses in connection with the ownership of specially equipped refrigerated highway freight trailers. HELD, Ps may not deduct the claimed losses since they did not engage in the activities for profit within the meaning of section 183, I.R.C. 1954. ANDREW M. WINKLER, for the respondent.
B. GRAY GIBBS, for the petitioners.
In these consolidated cases, respondent determined the following deficiencies in petitioners' Federal income taxes:
+-------------------------------------------------+
¦Docket No.¦Petitioner ¦Year¦Deficiency¦
+----------+----------------------+----+----------¦
¦22131-81 ¦William F. Sutton ¦1977¦$62,616.00¦
+----------+----------------------+----+----------¦
¦ ¦and Helen C. Sutton ¦1978¦60,127.00 ¦
+----------+----------------------+----+----------¦
¦22639-81 ¦John F. Knowlton ¦1977¦61,924.00 ¦
+----------+----------------------+----+----------¦
¦ ¦and Betty W. Knowlton ¦1978¦63,281.00 ¦
+----------+----------------------+----+----------¦
¦28537-81 ¦Joseph W. Fleece, Jr.,¦1975¦13,784.00 ¦
+----------+----------------------+----+----------¦
¦ ¦and Joanne M. Fleece ¦1976¦9,200.00 ¦
+----------+----------------------+----+----------¦
¦ ¦ ¦1977¦108,792.00¦
+----------+----------------------+----+----------¦
¦ ¦ ¦1978¦69,457.00 ¦
+----------+----------------------+----+----------¦
¦ ¦ ¦1979¦97,811.00 ¦
+----------+----------------------+----+----------¦
¦13350-82 ¦John C. Pruitt ¦1976¦44,301.10 ¦
+----------+----------------------+----+----------¦
¦ ¦and Frances M. Pruitt ¦1977¦101,453.70¦
+----------+----------------------+----+----------¦
¦ ¦ ¦1978¦74,268.70 ¦
+----------+----------------------+----+----------¦
¦ ¦ ¦1979¦17,446.18 ¦
+----------+----------------------+----+----------¦
¦18891-82 ¦Jules Dressler ¦1978¦2,084.00 ¦
+----------+----------------------+----+----------¦
¦ ¦and Muriel Dressler ¦ ¦ ¦
+----------+----------------------+----+----------¦
¦3114-83 ¦R. Huston Babcock ¦1977¦52,247.00 ¦
+----------+----------------------+----+----------¦
¦ ¦and Suzanne Babcock ¦1978¦39,366.00 ¦
+----------+----------------------+----+----------¦
¦ ¦ ¦1979¦45,787.00 ¦
+-------------------------------------------------+
One of the issues in docket No. 22639-81 was severed from this consolidated case and is the subject of a separate opinion by Judge Tannenwald reported at 84 T.C. No. 11 filed February 6, 1985. Judge Nims did not participate in the trial or opinion with regard to the severed issue. Judge Tannenwald's disposition of the severed issue will be incorporated into the Rule 155 computation required in docket No. 22639-81.
Due to concessions, the issues for decision are: 1) whether petitioners' Nitrol Program activities were engaged in for profit within the meaning of section 183; and 2) whether certain nonrecourse notes may be included in the basis of the specially equipped refrigerated highway freight trailers acquired by petitioners.
Some of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
Petitioners Joseph W., Jr. and Joanne M. Fleece, husband and wife, John C. and Frances M. Pruitt, husband and wife, John F. and Betty W. Knowlton, husband and wife, and R. Huston and Suzanne Babcock, husband and wife, resided at St. Petersburg, Florida, at the time their respective petitions were filed. Petitioners William F. and Helen C. Sutton, husband and wife, resided at Tampa, Florida, at the time their petition was filed. Petitioners Jules and Muriel Dressler, husband and wife, resided at Ft. Lauderdale, Florida, at the time their petition was filed.
For convenience, William F. Sutton, Betty W. Knowlton, Joseph W. Fleece, John C. Pruitt, R. Huston Babcock and Jules Dressler will sometimes hereinafter be referred to as petitioners.
During the years in issue, petitioners were employed as follows:
+-------------------------+
¦Petitioner¦Profession ¦
+----------+--------------¦
¦Sutton ¦Executive ¦
+----------+--------------¦
¦Knowlton ¦Hotel manager ¦
+----------+--------------¦
¦Fleece ¦Attorney ¦
+----------+--------------¦
¦Babcock ¦Physician ¦
+----------+--------------¦
¦Pruitt ¦Physician ¦
+----------+--------------¦
¦Dressler ¦Executive ¦
+-------------------------+
In December, 1977, petitioners invested in a program (the Nitrol Program) offered by two California Corporations, Nitrol Corporation (Nitrol) and Transit Management Company (TMC). Under the program, investors purchased refrigerated highway freight trailers equipped with ‘controlled atmosphere units‘ from Nitrol and entered into a trailer management agreement with TMC. For convenience, we will hereinafter refer to the controlled atmosphere units as the Nitrol Units and the refrigerated highway freight trailers equipped with the Nitrol Units as the Nitrol trailers.
Sutton, Knowlton and Babcock each purchased one Nitrol trailer. Fleece and Pruitt each purchased two Nitrol trailers. Dressler owned a limited partnership interest in Overnite, Ltd., a limited partnership formed to purchase one Nitrol trailer. For purposes of this opinion, reference to the term petitioners for convenience also sometimes refers to Overnite, Ltd., and/or the general partner of that partnership.
David Dixon, a mechanical engineer, designed the Nitrol Unit to produce a low-oxygen environment within the interior compartment of a standard refrigerated highway freight trailer. He worked from 1966 to 1968 developing the Nitrol Unit. In June, 1976, he received a patent (the 477 Patent) for the Nitrol Unit.
The Nitrol Unit consisted of an insulated storage tank filled with liquid oxygen and nitrogen mounted on the chassis of a refrigerated highway freight trailer. As the liquid vaporized, gases entered the trailer compartment through metal tubes leading from the tank to the compartment, producing a low oxygen environment within the interior of the trailer.
Studies conducted during the early l960's by Dixon concluded that perishable commodities shipped in a low-oxygen environment would generally remain fresher than if shipped in a standard refrigerated truck. From the mid-l960's to the mid-l970's, several companies attempted to market trailers designed to transport perishable commodities in a low oxygen environment. The unprofitability of the venture, however, forced each company to abandon the project.
Sometime during early 1977, Dixon, Steven Lewis (Lewis), James Power (Power) and Dorman Dimmitt (Dimmitt) joined together to develop the Nitrol Program to economically exploit the 477 Patent. Power incorporated Nitrol on June 3, 1977, to construct approximately 100 Nitrol trailers. Dimmitt, who had managed several trucking companies prior to his association with the Nitrol Program, incorporated TMC on July 11, 1977, to manage the Nitrol trailers sold by Nitrol. Dimmitt also became the chief operating officer of TMC.
Subsequent to the incorporation of Nitrol, Dixon and Lewis transferred an exclusive license under the 477 Patent to Nitrol. Nitrol agreed to pay Dixon and Lewis 70 percent of the net profits realized from the sale of Nitrol trailers. Power, as Nitrol's sole shareholder and chief operating officer, effectively retained 30 percent of Nitrol's profits.
Following the receipt of the exclusive license, Nitrol purchased 100 refrigerated highway freight trailers from Sierra Truck and Trailer Sales, Inc. (Sierra) for $27,500 per trailer. Nitrol financed the purchase of the trailers with Hobbs Corporation (Hobbs), the manufacturer of the trailers. Hobbs retained a security interest in each trailer sold. Although Nitrol was primarily liable on the installment contracts, all Nitrol Program investors were given the right to cure any default on the installment contracts.
Nitrol also contracted with Gibson Cryogenics to construct approximately 100 Nitrol Units pursuant to Dixon's specifications. Nitrol paid approximately $2,430 for the manufacture and installation of each Nitrol Unit.
Petitioners first learned of the Nitrol Program from their accountants and attorneys in November, 1977. In December, 1977, after reviewing a private placement memorandum detailing the Nitrol Program and discussing the investment with their accountants and attorneys, petitioners invested in the Nitrol Program. Neither petitioners nor their advisors had previous experience in the trucking industry.
Petitioners purchased each Nitrol trailer for $275,000; the consideration consisting of a $27,500 cash downpayment and a nonrecourse promissory note in the amount of $247,500. Agreements executed contemporaneously with the nonrecourse notes provided that the total purchase price of $275,000 was allocable as follows:
$32,500 to the trailer and $242,500 to the Nitrol Unit.
Petitioners entered into ten-year trailer management agreements with TMC contemporaneously with the purchase of the Nitrol trailers. Pursuant to these agreements, TMC agreed to solicit and negotiate freight contracts with shippers on behalf of petitioners. Dimmitt intended to contract with produce growers shipping perishable commodities from the west coast to the east coast. For the return trip from the east coast, however, Dimmitt intended to lease the trailers to a common carrier under a trip leasing agreement.2 Dimmitt anticipated that the common carriers would ship non-perishable commodities and thus...
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