Wilkerson v. Comm'r of Internal Revenue
| Decision Date | 17 May 1978 |
| Docket Number | 9658-75,10925-75—-10930-75.,Docket Nos. 9565-75—-9567-75 |
| Parties | DONALD L. WILKERSON and MARY A. WILKERSON, et al.,1 PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
1. A portion of the 2-percent initial service charges or finance fees paid to mortgage bankers who loaned the construction money in FHA take-out loans was compensation for the use of money, or interest. The balance was payment for services.
2. The initial service charges or finance fees were “paid” in the year the borrowers delivered checks in amounts thereof to the lenders although most of the funds were obtained from advances on the mortgage loans. The advances were deposited in the borrowers' separate bank accounts over which the borrowers alone had control.
3. The portions of the initial service charges or finance fees attributable to interest were deductible by cash basis borrowers in the year paid. The portions attributable to services must be capitalized and deducted over the life of the permanent loan. Ernest J. Maupin III and Fred L. Oats, for the petitioners.
Nicholas G. Stucky and Rebecca T. Hill, for the respondent.
Respondent determined deficiencies in the Federal income taxes of petitioners as follows:
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¦Docket No. ¦Petitioner ¦Year ¦Deficiency ¦
+------------+-----------------------------------------+------+------------¦
¦ ¦ ¦ ¦ ¦
+------------+-----------------------------------------+------+------------¦
¦9565—75 ¦Donald L. Wilkerson and Mary A. Wilkerson¦1972 ¦$12,489.00 ¦
+------------+-----------------------------------------+------+------------¦
¦9566—75 ¦Nick L. Lusich and Jacqueline E. Lusich ¦1972 ¦5,065.00 ¦
+------------+-----------------------------------------+------+------------¦
¦9567—75 ¦Lawrence F. Devincenzi ¦1972 ¦15,781.27 ¦
+------------+-----------------------------------------+------+------------¦
¦9658—75 ¦F. Albert Kuckoff and Jean M. Kuckhoff ¦1972 ¦1,545.00 ¦
+------------+-----------------------------------------+------+------------¦
¦10925—75 ¦Ben Caramella and Cecile Caramella ¦1971 ¦2,515.00 ¦
+------------+-----------------------------------------+------+------------¦
¦10926—75 ¦Donald L. Wilkerson and Mary A. Wilkerson¦1971 ¦5,821.00 ¦
+------------+-----------------------------------------+------+------------¦
¦10927—75 ¦Maurice J. Nespor and Anita M. Nespor ¦1971 ¦1,105.00 ¦
+------------+-----------------------------------------+------+------------¦
¦10928—75 ¦Theodore E. Selden and Lonnie A. Selden ¦1971 ¦5,200.00 ¦
+------------+-----------------------------------------+------+------------¦
¦10929—75 ¦Joseph F. McDonald and Mary G. McDonald ¦1971 ¦8,574.93 ¦
+------------+-----------------------------------------+------+------------¦
¦10930—75 ¦John T. Hargrove and Ruth D. Hargrove ¦1971 ¦3,172.50 ¦
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Various concessions have reduced the issues for our decision to these:
(1) What portion, if any, of “initial service charges” or “finance fees” incurred in connection with certain FHA-insured housing projects constitutes interest under section 163(a), I.R.C. 1954?2
(2) To the extent a portion constitutes interest, was it “paid” in the taxable years in issue within the meaning of section 163(a) of the Code?
(3) If all or a portion of the charge/fee is determined to be a service charge rather than interest, over what period of time must the service charge be amortized and deducted?
Petitioners are all individuals who, at the time the petitions were filed, resided in Washoe County, Nev.
Petitioner Joseph F. McDonald was, at all times relevant hereto, the general partner of Willowbrook Apartments with a 25-percent interest in the capital and profits and losses of the partnership. Petitioners Ben Caramella, Donald L. Wilkerson, Maurice J. Nespor, Theodore E. Selden, and John T. Hargrove were, at all times relevant hereto, limited partners with the following percentage interests in the capital and profits and losses of the limited partnership:
+--------------------------------+
¦Partner's name ¦Percentage ¦
+-------------------+------------¦
¦ ¦ ¦
+-------------------+------------¦
¦Ben Caramella ¦3.75 ¦
+-------------------+------------¦
¦Donald L. Wilkerson¦10.00 ¦
+-------------------+------------¦
¦Maurice J. Nespor ¦4.00 ¦
+-------------------+------------¦
¦Theodore E. Selden ¦12.00 ¦
+-------------------+------------¦
¦John T. Hargrove ¦10.00 ¦
+--------------------------------+
Petitioners Cecile Caramella, Mary A. Wilkerson, Anita M. Nespor, Lonnie A. Selden, Mary G. McDonald, and Ruth D. Hargrove are the wives of the foregoing petitioners and are joined in this action as petitioners as a result of the joint Federal income tax returns they filed with their respective husbands for the calendar year 1971.
Willowbrook Apartments is a Nevada limited partnership that reports for Federal income tax purposes on the cash basis of accounting. The taxable year of the partnership was the calendar year. All petitioners were, at all times relevant hereto, cash basis taxpayers whose taxable years were the calendar year.
Willowbrook Apartments was formed for the purpose of acquiring, developing, building, and operating a 183-unit apartment project in Reno, Nev., under section 221(d)(4) of the National Housing Act and the regulations thereunder.
During the calendar year 1971, Willowbrook Apartments submitted to the Federal Housing Commissioner and Mason-McDuffie Investment Co. of Nevada an application for a loan in the principal amount of $3,126,300 to be insured by the Federal Housing Administration (FHA) under the provisions of section 221(d)(4) of the National Housing Act.
As part of the loan application, Mason-McDuffie, the proposed lender, represented to the Federal Housing Commissioner when requesting a firm commitment to insure a mortgage covering the subject property as follows:
After examination of the application and the proposed security, (Mason-McDuffie) considers the project desirable and is interested, subject to the issuance of a firm commitment by FHA, in making a loan in the principal amount of $3,126,300, which will bear interest at seven per cent, * * *
issued to Mason-McDuffie and Willowbrook Apartments its commitment to endorse for insurance under the provisions of section 221(d)(4) of the National Housing Act, and the regulations thereunder, a mortgage note in the amount of $3,126,300, to be secured by a mortgage on the property on which the apartment project was to be constructed.
On October 19, 1971, Mason-McDuffie applied with the Government National Mortgage Association (GNMA) for a commitment to purchase the promissory note and deed of trust following the completion of the construction, the final disbursement of the loan proceeds, and the final endorsement of the loan for insurance by FHA. On November 10, 1971, GNMA issued its commitment to so purchase the note and deed of trust. In consideration for the commitment, GNMA required a commitment fee of 1 percent of the face amount of the loan, or $31,263. This amount was paid by Willowbrook Apartments in November of 1971. Although Mason-McDuffie was not obligated to sell the promissory note to GNMA, Mason-McDuffie's practice was to sell the note at final closing pursuant to the terms of the commitment, and Mason-McDuffie certified to FHA that it had a firm commitment from GNMA.
After receiving from the Federal Housing Commissioner the commitment for insurance of advances, and after receiving from GNMA its commitment to purchase the promissory note and deed of trust following final endorsement by the Federal Housing Commissioner, Willowbrook Apartments entered into a building loan agreement with Mason-McDuffie. The proceeds of the loan were to be used for the construction of the 183-unit apartment project and for the payment of various charges and fees to be incurred by Willowbrook, including the $62,526 “initial service charge or financing fee.”
On November 24, 1971, Willowbrook Apartments executed, and the Federal Housing Commissioner endorsed (the “initial endorsement”), a promissory note payable to the order of Mason-McDuffie in the face amount of $3,126,300, together with a deed of trust on the apartment project to secure the promissory note. The note, as originally executed by Willowbrook to Mason-McDuffie, or order, was for a term of 411;2 years at an interest rate of 7 percent per annum. The note provided for “interest only” payments for 11;2 years (until June 1, 1973), and installment payments of principal and interest for the remaining 40 years.
The building loan agreement required Willowbrook Apartments to pay to Mason-McDuffie an “initial service charge” of 2 percent of the face amount of the loan, $62,526. The two parties agreed that the $62,526 initial service charge or financing fee due from Willowbrook to Mason-McDuffie would be advanced by Mason-McDuffie from the loan proceeds if not otherwise paid by Willowbrook. Willowbrook was not, however, obligated to pay the charge or fee solely from the loan proceeds. The charge or fee represented 2 percent of the face amount of the loan; the amount is governed by FHA regulations. The applicable provision, section 221.508 of the FHA regulations, provides as follows:
Maximum fees and charges by mortgagee.
The mortgagee may collect from the mortgagor the amount of the fees provided for in this subpart. The mortgagee may also collect from the mortgagor an...
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