# Estate of Thomas v. Commissioner > United States Tax Court · March 14, 1985 · 84 T.C. 412 URL: https://www.frixlaw.com/law-library/cases/4485319 ## Case - **Full name:** Estate of Jerry Thomas (Deceased), Imogene Thomas, Administratrix, and Imogene Thomas, 1 v. Commissioner of Internal Revenue - **Court:** United States Tax Court - **Decided:** March 14, 1985 - **Citations:** 84 T.C. 412; 84 T.C. No. 32; 1985 U.S. Tax Ct. LEXIS 106 - **Precedential status:** Published - **Opinion:** Opinion of the court by Whitaker - **Judges:** Whitaker - **Cited by:** 100 later opinions in the Frix Law Library ## Citator (automated) - No negative treatment found by the automated citator. That is not the same as a confirmation that the case is good law; read the citing cases. - Full citator and citing cases: https://www.frixlaw.com/law-library/cases/4485319 ## How later opinions describe it (automated extraction) - finding a residual value equal to the stipulated residual value of at least 14 percent, rather than equal to the maximum of a range of 20 to 30 percent projected by the taxpayer's experts ## Opinion text Whitaker, Judge: This case was submitted fully stipulated pursuant to Rule 122; 2 the stipulation of facts and exhibits attached thereto are incorporated herein by this reference. However, many of the facts set forth herein are based upon our examination of the exhibits and were not set out in the stipulation. Respondent determined the following Federal income tax deficiencies: Docket No. Petitioner Year(s) Deficiency 17715-81 Estate of Jerry Thomas (deceased) 1976 $20,449.99 Imogene Thomas, administratrix, 1977 35,831.08 and Imogene Thomas 1978 23,117.88 (The years 1978 and 1979 do not involve the issues here tried.) 1979 8,761.27 16415-82 Raymond and Nettie Leven 1976 37,874.77 1977 25,995.20 512-83 Robert P. and Janice K. Kuhn 1976 4,570.62 1466-83 Henry F. and Margaret K. Goller 1976 9,141.00 1977 4,925.00 1978 2,325.00 1472-83 Robert C. and Jeanne T. Baesel 1976 4,570.62 1475-83 Warren J. and Alice M. Welling 1976 2,072.90 1496-83 George E. and Irene L. Schultz 1976 4,570.80 1497-83 Roy B. and Dorothy P. Culler 1976 19,042.33 1977 10,913.36 1978 4,504.82 1498-83 Neil C. and Marilyn M. Schauf 1976 28,509.00 1499-83 James W. and Annie J. Powell 1976 19,862.73 1977 10,123.14 1978 5,611.00 1500-83 Elbert W. and Elizabeth C. Phillips 1976 9,142.00 1977 5,549.00 1978 2,374.00 1502-83 William L. and Mary S. Albritton 1976 41,978.00 1977 26,505.00 1978 11,678.00 5073-83 Edward and Jane C. Waters 1976 428.00 9698-83 Bayard C. and Teresa Tullar 1976 19,792.00 1977 10,417.00 1978 4,029.00 The petitioners in this consolidated proceeding are among the 32 limited partners in a partnership known as 1975 Equipment Investors (Partnership), a limited partnership formed to acquire equipment for lease and/or sale. The pretrial order, dated May 26, 1983, severed for trial, in this proceeding solely all tax issues arising out of the investment by petitioners in the Partnership. By stipulation, the parties submitted for our consideration only the following: (1) Whether the Partnership is the owner of various items of computer equipment for Federal income tax purposes; and (2) whether amounts paid by the Partnership to E.F. Hutton & Co., Inc. (E.F. Hutton), as an equity placement fee may be amortized over the life of the Partnership. FINDINGS OF FACT In Appendix A at the end of this opinion, we set forth the residences of the various petitioners in this proceeding when their petitions were filed and the number of Partnership units owned by them at all material times. Petitioners all were partners in the Partnership, which was formed by the well-known investment firm E.F. Hutton, a subsidiary of the E.F. Hutton Group, Inc. Prior to the activities at issue herein, E.F. Hutton had organized three other limited partnerships which had purchased IBM Systems 370 and 360 computer equipment for lease to a number of corporate lessees and had organized one limited partnership which had purchased a McDonnell Douglas DC-9 aircraft for lease to a commercial airline. E.F. Hutton also had participated as a broker in bringing together prospective lessors and lessees of computer equipment. Creation of the Partnership On January 15, 1975, E.F. Hutton formed 1975 Equipment Manager, Inc. (Equipment Manager or the general partner), a Delaware corporation, the sole function of which was to act as general partner of the Partnership. During all material times, Equipment Manager was a wholly owned subsidiary of E.F. Hutton. The Partnership, a New York limited partnership, also was formed on January 15, 1975, pursuant to article 8 of the New York Partnership Law. As set forth in the amended and restated articles of limited partnership (Partnership agreement), the Partnership was to acquire computer central processing units and related equipment (collectively referred to as equipment), to lease or sell the equipment to others and to perform any acts to accomplish those purposes. 3 The Partnership agreement provided for a general partner, one class B limited partner, 4 and for the issuance of up to 52 class A limited partnership units. The general partner was to receive a commencement fee of $25,000 in consideration for its services, in addition to a management fee of 2.1 percent of Partnership gross income. 5 The overhead of the general partner was not considered to be an expense of the Partnership. Under the terms of the Partnership agreement, all items of income or loss were to be allocated, and all distributions of cash made, in accordance with each partner’s pro rata share. All net cash-flow of the Partnership was to be distributed, first to the general partner to the extent of outstanding advances (plus interest), and thereafter to all partners in accordance with their pro rata shares at the time of distribution. The Partnership life was to commence on the day on which its. certificate was filed and to end no later than December 31, 1983. Offering and Sale of Partnership Interests In July and August 1975, the Partnership prepared a private placement memorandum (memorandum) to be used for offering limited Partnership interests to selected E.F. Hutton customers. As described in the memorandum, the instant transaction was to be structured as follows: Upon receipt of sufficient capital from prospective investors, the Partnership was to purchase IBM System 370 computers for approximately $9 million by borrowing a substantial portion of the cost of each computer, and immediately thereafter it was to lease the computers to financially sound lessees for a period of time sufficient to repay fully the borrowings. In order to borrow funds at commercially reasonable interest rates, the Partnership was to pledge both the equipment and the leases as security to the lenders. The memorandum indicated that the Partnership tentatively had arranged to purchase three IBM System 370 computers and lease them to three separate lessees: Sterling Drug Co. (Sterling), Borg-Warner Corp. (Borg-Warner), and Exxon Corp. (Exxon). All of these purchases and leases were arranged through the efforts of equipment brokers, who specialized in IBM computer equipment. The parties have stipulated that, at the time the memorandum was prepared, the Partnership anticipated purchasing and leasing a fourth IBM 370 System, depending on the degree of success of the offering, and the memorandum so indicated. According .to the memorandum, during the terms of the initial leases, the Partnership was expected to realize sufficient cash-flow to cover Partnership expenses and to permit modest cash distributions to the limited partners beginning in 1976. It further indicated that, upon expiration of the initial lease terms, the Partnership planned either to re-lease or sell the computers on a basis which would result in the largest possible gain to the Partnership. Concerning the economic feasibility of investing in the Partnership, each investor was advised in the memorandum to consult his own counsel as to the legal and economic risks and benefits of the investment. It indicated that the investment objectives of the Partnership were: To provide an investment opportunity, including (a) Maximum use of tax benefits applicable to the Partnership’s business, and (b) Modest cash distributions to the Limited Partners beginning in 1976, and (c) Realization of net cash proceeds upon sale or re-leasing of the computer equipment at the end of the initial leases. On its face, the memorandum made it clear that investment in the Partnership was only for certain types of investors — those who were able to commit capital for a long-term investment of limited liquidity, who were able to bear the risk of losing their investment, and who were in a position to benefit from the expected tax benefits of the Partnership. Numerous references are made in the memorandum to taxpayers in the 50-, 60-, and 70-percent brackets, and to the general tax consequences to them of investment in the Partnership. With regard to tax benefits, however, the memorandum cautioned: Although the tax benefits anticipated from the Partnership could be said to have the effect of providing a return on investment in the earlier years, tax obligations will arise in later years; the ultimate success of the Partnership will therefor depend upon the profitability of its business and the residual value of the equipment in the later years. In attempting to provide prospective investors with an assessment of the importance of residual value potential, the memorandum explained that, "on termination of the leases at the end of a projected term of 8 years, unless the computers have a residual value of approximately 14% of the Partnership’s original purchase price, the Partnership will suffer an economic loss on the computers.” The memorandum declined to predict the expected residual value of the computers, cautiously describing the computer leasing industry as very competitive and emphasizing that price changes and technological obsolescence could have a materially adverse effect upon the Partnership’s ability to re-lease or sell the equipment at the end of the lease terms. By the same token, it indicated that risks were minimized, because the models were purchased early in their life cycles. The following schedule copied from the memorandum contains a calculation of the expected cash-flow to the Partnership based upon the projection of total rental income extrapolated from the three tentatively negotiated leases and the expected expenses: SCHEDULE II * * (in thousands) Taxable year 1975 1976 1977 1978 1979 1980 1981 1982 1983 Rental income $262 $1,527 $1,527 $1,527 $1,527 $1,527 $1,527 $1,497 $1,123 Disbursements $62 $1,442 $1,442 $1,442 $1,442 $1,442 $1,442 $1,413 $1,056 Debt service 12 76 76 76 76 76 76 75 60 Fees and expenses 188 00000000 Applied to equity Total disbursements cn OO . Commissioner, supra, where we found that the taxpayer paid more than fair market value for the equipment because he purchased only a 70-percent interest. 81 T.C. at 209 . Even after 5 percent for brokers’ fees is taken out, the Partnership owned 95 percent of residual value here. We note that respondent attempts to demonstrate in charts appended to one of his briefs that, should the leases have been terminated prematurely by the lessees and the debts paid off by means of the termination payments, the Partnership would not have recouped its initial investment and started to build up equity until fairly close to the end of the lease terms. However, we conclude that these charts are unpersuasive in that: the residual values used therein are artificially low because they employ an "averaging of averages” of limited material in evidence; they ignore the fact that termination rights did not arise until well into the lease terms; and the leases clearly were not entered into by the Partnership in order to see them terminated prematurely, but were intended to run their full courses in the absence of some unforeseen circumstances. These charts do not, therefore, show an absence of equity such as was intended by Estate of Franklin v. Commissioner, 544 F.2d 1045 (9th Cir. 1976), affg. 64 T.C. 752 (1975), and its progeny, where the likelihood that the debt would be paid was the fundamental issue. At the Court’s request, the parties have stipulated the extent to which the requirements of Rev. Proc. 75-21,1975- 1 C.B. 715 , have been met. That revenue procedure established guidelines under which an advance ruling on a leveraged lease would be issued. All of the leases, here, satisfy all of the requirements of that revenue procedure, except for Guideline No. 1, which requires that the lessor must have a 20-percent minimum unconditional amount at risk in the property when the lease begins, throughout the entire lease term, and at the end of the lease term. Here, the equipment had sufficient useful life at all times to satisfy Guideline No. 1, and the Partnership had more than 10- but less than 20-percent equity in the equipment initially and during the term of the leases. Given these facts, we are further persuaded that respondent’s position is unsound. The spirit of this "safe haven” revenue procedure — attempting to ascertain "true” ownership of the equipment — certainly has been met. The discrepancy between 10-plus-percent equity, here, and the 20 percent required by the guideline does not justify respondent’s position. An issue not raised or briefed by the parties, but alluded to by some of the witnesses, is whether, in determining the economic viability of the instant transaction, we are required to discount the expected residual value of the equipment back to 1975 dollars. In the absence of statutory mandate, we decline to do so. While we are aware of our footnote 23 in Hilton v. Commissioner, 74 T.C. 305 , 353 n. 23 (1980), affd. per curiam 671 F.2d 316 (9th Cir. 1982), cert. denied 459 U.S. 907 (1982), we note that the method employed therein was dictum in the context of circumstances bordering on the egregious. Moreover, we do not feel competent, in the absence of legislative guidance, to require that a particular return must be expected before a "profit” is recognizable, the necessary conclusion to be drawn if we were to discount residual value. As stated in sec. 1.183-2(b)(9), Income Tax Regs., in a closely related context, "the availability of other investments which would yield a higher return, or which would be more likely to be profitable, is not evidence that an activity is not engaged in for profit.” Our sole task here is to determine whether a profit was reasonably likely on these facts in order to find that tax avoidance was not the sole motivation for the transaction. Since the potential profit here was more than de minimis, we are satisfied that petitioners should prevail. See Lemmen v. Commissioner, 77 T.C. 1326 , 1342-1347 & nn, 22 & 24 (1981). An argument might be made that these expenses are similar to loan coste, which are capitalized and deducted pro rata over the life of the loan. Detroit Consolidated Theatres, Inc. v. Commissioner, 133 F.2d 200 (6th Cir. 1942), affg. per curiam a Memorandum Opinion of the Board of Tax Appeals; Goodwin v. Commissioner, 75 T.C. 424, 442 (1980), affd. without published opinion 691 F.2d 490 (3d Cir. 1982); Cagle v. Commissioner, 63 T.C. 86, 97 (1974), affd. 539 F.2d 409 (5th Cir. 1976). While this theory might be persuasive if we were writing on a clean slate, we cannot overlook the fact that the law in the corporate context — which clearly provides a closer analogy— is to the contrary. We note that the legislative history of this provision refers to deductions "under the partnership tax provisions (subchapter K of the code),” as contrasted with the broader language in the statute "under this chapter,” which on its face encompasses amortization under sec. 167. S. Rept. 94-938, at 94, 1976-3 C.B. (Vol. 3) 132. See McGuire, "Can the Syndication Costs of a Partnership be Amortized? An Analysis of Authorities,” 59 J. Tax. 208 n. 2 (1983). However, a reference to subch. K also necessarily includes those deductions flowed through to partners by reason of sec. 702(a)(7) (now sec. 702(a)(8)) — such as depreciation and amortization. Thus this inconsistency is of no consequence here. Under sec. 709(b), a partnership may elect to amortize organization fees over a period of not less than 60 months in a manner similar to sec. 248, but — as was true of its corporate counterpart — this amortization provision was clearly not intended to be applied to syndication fees. S. Rept. 94-938, supra at 94, 1976-3 C.B. (Vol. 3) at 132. Sec. 709 (a) is applicable in the case of partnership taxable years beginning after Dec. 31,1975. Consequently, on its face, this provision appears to be applicable to the years at issue here. However, the Conference report states: "The conferees intend that no inferences should be drawn as to the deductibility (when paid) of partnership organization and syndication fees paid or incurred in taxable years beginning before January 1, 1976.” S. Rept. 94-1236, 94th Cong., 2d Sess. 421, 1976-3 C.B. (Vol. 3) 825. Because the conclusion we have reached is consistent with that required by the statute, we need not decide this question. The new U.S. Claims Court more recently addressed the question of amortization of organization and syndication fees in the context of respondent’s argument that Blitzer was wrongly decided. Stating that it had no authority to overrule Blitzer, that court simply held that amortization of syndication fees over the life of one of the partnership’s office buildings ("a tangible asset with a useful life related to the syndication fee”) was appropriate. Sartin v. United States, 5 Cl. Ct. 172, 179 (1984). Thus, there was no discussion concerning the legality of amortization in that opinion either. The supplemental stipulation indicates that Raymond Leven, petitioner in docket No. 16415-82, owned one Partnership unit, but an examination of the Form K-l prepared by the Partnership indicates that Mr. Leven owned two units. To the extent of this inconsistency, we will not follow the supplemental stipulation. 1975 is not a year at issue. Includes fees paid to Alanthus in connection with the Exxon lease, fees paid to the general partner pursuant to the Partnership articles and legal and accounting fees paid to third parties in the course of administrating the leases and the Partnership. 3 Due to higher than projected legal and accounting expenses, cash was actually distributed to the limited partners only in 1976 in the aggregate amount of $8,897.88. It was anticipated that a substantial portion of the 1975 and 1976 net cash-flow would be used to pay startup and acquisition expenses. --- Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/4485319. Public record. Not legal advice.