Vaughn v. Comm'r of Internal Revenue

• Decision Date: 30 November 1983
• Docket Number: Docket No. 916–78.
• Parties: CHARLES L. VAUGHN AND DOROTHY B. VAUGHN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

81 T.C. 893

81 T.C. No. 55

CHARLES L. VAUGHN AND DOROTHY B. VAUGHN, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 916–78.

United States Tax Court

Filed November 30, 1983.

Petitioner-husband's corporation owned a large portion of an apartment complex, as well as some other assets. Petitioners were the sole partners in a partnership that owned the remainder of the apartment complex. Petitioners sold their partnership interests, and petitioner-husband sold all the stock of his corporation, to petitioner-wife's son under installment contracts. The contract for the sale of the stock included an escrow agreement under which the son was required to place any proceeds from the resale of the assets of the corporation into an escrow account. The escrow agreement did not impose any restriction on petitioner-husband's right to receive the proceeds, except for the passage of time. The son immediately liquidated the corporation and resold the entire apartment complex. The son reinvested the proceeds in commercial paper, stocks, bonds, U.S. Treasury Notes, and savings accounts. The escrow account was never established. The son used the proceeds to make the installment sale payments.

Held: (1) The sales by petitioners to petitioner-wife's son were bona fide transactions that are recognizable for Federal income tax purposes.

(2) Petitioners are entitled to use the installment method (sec. 453, I.R.C. 1954) to report their gains from the sales of their interests in the partnership.

(3) As a result of the escrow agreement, petitioner-husband had constructive receipt of the proceeds of petitioner-wife's son's sale of the corporate assets. The 30-percent rule of former section 453(b)(1)(A), I.R.C. 1954, is applied to petitioner-husband's sale of the corporation's stock. James H. Morgan, Jr., Rex M. Lamb, III, and Thomas B. Wells, for petitioners.

Charles B. Hanfman, for respondent.

CHABOT, Judge:

Respondent determined a deficiency in Federal individual income tax against petitioners for 1973 in the amount of $289,338, and an addition to tax under section 6653(a)¹ (negligence, etc.) in the amount of $14,467. After concessions,² the issues for decision are (1) whether the sales of an apartment complex and stock by petitioners to petitioner-wife's son were bona fide transactions entitled to recognition for Federal income tax purposes, and (2) whether petitioners are entitled to report these sales using the installment method of reporting income under section 453.

FINDINGS OF FACT

Some of the facts have been stipulated; the stipulations and the stipulated exhibits are incorporated herein by this reference.

When the petition in the instant case was filed, petitioners Charles L. Vaughn (hereinafter sometimes referred to as “Charles”) and Dorothy B. Vaughn (hereinafter sometimes referred to as “Dorothy”), husband and wife, resided in Marietta, Georgia.

On June 20, 1963, Perry-Vaughn, Inc. (hereinafter sometimes referred to as “Perry”) was incorporated in Georgia. On or about June 20, 1963, Charles acquired ownership of 50 percent of Perry's issued and outstanding stock. On March 26, 1965, Charles became the owner of 100 percent of Perry's issued and outstanding stock.

In 1963, Perry acquired 20.5 acres of land in Cobb County, Georgia (hereinafter sometimes referred to as “the Cobb land”).

Perry subsequently constructed two apartment complexes, known as the Netherlands I Apartments and Netherlands II Apartments, on approximately seven acres of this land. In 1963, Perry acquired another tract of land in Cobb County, Georgia, on which it constructed an apartment complex consisting of 48 apartment units known as the Riviera Apartments. In 1964, Perry acquired a tract of land in Fulton County, Georgia, on which it constructed an apartment complex consisting of 16 apartment units known as the Boulevard Apartments. The Riviera and Boulevard Apartments were not located within or adjacent to the land on which Perry constructed the Netherlands I and Netherlands II Apartments.

In 1967 Perry leased to petitioners 8.6 acres of the Cobb land which was not improved by the construction of the Netherlands I and Netherlands II Apartments (hereinafter sometimes referred to as “the leased land”). During 1967 petitioners constructed another apartment complex known as the Netherlands III Apartments on the leased land. There were then three apartment complexes adjacent to each other known as the Netherlands I, Netherlands II, and Netherlands III Apartments (hereinafter sometimes referred to collectively as “the Netherlands Apartments”), consisting of 52, 78, and 126 apartment units, respectively. Petitioners operated the Netherlands III Apartments through a two-member partnership known as Netherlands III Apartments (hereinafter sometimes referred to as “the Netherlands Partnership”) in which each petitioner owned an equal interest in the capital and profits. Petitioners lived in and managed the Netherlands Apartments from the time the Netherlands I Apartments were built in 1964 until some time in 1973.

In 1971, petitioners' certified public accountant began to advise them that Perry had or would soon have an unreasonable accumulation of earnings. He also advised Charles that the tax advantage and the tax sheltering effect of the apartment ownership had been fully utilized and that continued ownership of the Netherlands III Apartments and Perry stock would create more taxable income than cash flow. Because of these factors, he advised Charles to consider, among several alternatives, selling the Netherlands III Apartments and Perry stock.

By 1972, Charles had turned all his attention to the development of a major office park project in the Atlanta metropolitan area known as “Circle 75”. Because of Charles' involvement in Circle 75, all or most of the management responsibilities for the Netherlands Apartments, the Boulevard Apartments, and the Riviera Apartments fell upon Dorothy's shoulders. Charles realized that the management problems were too much for her to handle alone. Because of this strain on Dorothy, petitioners' marriage was adversely affected and Charles realized that the sale of the Netherlands Partnership and the Perry stock and the resulting relief from the burdens of apartment management would have a favorable impact upon his marriage. Because the Circle 75 project involved certain risks, Charles also saw the sale of the Netherlands Partnership and the Perry stock as a means of providing steady income and security to him.

When petitioners married each other, in 1953, Dorothy had custody of a son from a previous marriage, which had ended in 1951. The son, born in 1947, was named Steven W. Rogers. When he was enrolled in military school as a young boy, he began to use the name Steven W. Vaughn. (This son is hereinafter sometimes referred to as “Steven”). Charles did not adopt Steven. Petitioners have a daughter of their marriage, Valerie G. Vaughn (hereinafter sometimes referred to as “Valerie”), who was born in 1955.

Steven lived with petitioners from the date of petitioners' marriage until he entered college at the University of Georgia in 1965. Steven then lived with petitioners during the summer of 1966 through 1968. He worked for Perry during the summers of 1965, 1966, 1967, and 1968. In August 1968, Steven got married. He served on active duty with the United States Marine Corps. After Steven returned from this active duty in August 1969, he and his wife lived in Atlanta, Georgia, he was employed full time by Perry, and he attended Georgia State University. In December 1972, Steven received a B.A. degree in Business Administration with a major in real estate.

While Steven was employed by Perry, he participated in the construction of the Netherlands Apartments, did landscaping work, acted as assistant to the construction superintendent, had payroll duties, and later had management responsibilities. Since October 1972, Steven owned and lived in a house in Marietta, Georgia, which is approximately a 15-minute drive from the Netherlands Apartments. Between 1970 and 1973, Steven's gross income from his employment by Perry ranged between $15,000 and $25,000 per year.

In the summer of 1972, Steven and petitioners began discussing the transfer to Steven of the Netherlands Partnership and the Perry stock. Petitioners reached a general agreement with Steven in October 1972 whereby petitioners would transfer the Netherlands Partnership to Steven and Charles would transfer Perry stock to Steven, but they had not agreed to a price at that time. Shortly before December 22, 1972, petitioners and Steven agreed to a price for the Netherlands Partnership and the Perry stock. Although the agreement to transfer was consummated in three separate portions (a December 22, 1972, transfer of Charles' interest in the Netherlands Partnership, a January 29, 1973, transfer of Dorothy's interest in the Netherlands Partnership, and a February 2, 1973, transfer of the Perry stock), it was negotiated and agreed to as a single package.

On December 22, 1972, Charles transferred his one-half undivided interest in the Netherlands Partnership to Steven pursuant to a contract styled “Installment Sales Contract” (hereinafter sometimes referred to as “Contract I”). Pursuant to Contract I, Steven gave Charles a promissory note dated December 22, 1972, and styled “Installment Note” (hereinafter sometimes referred to as “Note I”) in the principal amount of $150,000 (with interest at five percent per year). Steven also assumed one-half of the then outstanding liabilities of the Netherlands Partnership. Note I required 240 monthly payments of $989.93 (of which $625 was to be principal and $364.93 was to be interest), beginning January 5, 1973. Payment on Note I was secured by the property transferred. The liabilities thus assumed amounted to $655,927.

Contract I provides in relevant part, as follows:

2. PURCHASE. * * * The payment of said...