UNITED STATES TAX COURT

T.C. Memo. 1999-7

UNITED STATES TAX COURT

CORBIN WEST LIMITED PARTNERSHIP, CDC EQUITY

CORPORATION, TAX MATTERS PARTNER, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2203-97.

Filed January 15, 1999.

Robert J. Percy, for petitioner.

Andrew R. Ceccherini, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

VASQUEZ, Judge:

Respondent issued notices of final

partnership administrative adjustment (FPAA's) to Corbin West

Limited Partnership (Corbin West) for 1990, 1991, 1992, and

1993.1

1

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.

- 2 The issues for our decision are:

(1) Whether a note

executed by Corbin West should be included in the basis of

certain acquired property for purposes of computing depreciation

deductions and low-income housing credits, (2) whether Corbin

West is entitled to interest deductions for the accrued interest

on that note, (3) whether Corbin West is entitled to include an

"acquisition fee", a "developer's fee", or a "tax credit

guarantee fee" in the basis of certain acquired property or,

alternatively, whether Corbin West may currently deduct any of

those fees, and (4) whether Corbin West is entitled to

amortization expense for a "no negative cash flow guarantee fee"

paid.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.

Corbin West is a TEFRA partnership.

At the time of the

filing of the petition, its principal place of business was

located in Farmington, Connecticut.

Corbin West consists of one

general partner, CDC Equity Corp. (CDC), and 29 limited partners.

CDC is the wholly owned subsidiary of CDC Financial Corp.

(Financial).

CDC is the tax matters partner of Corbin West.

Pursuant to

Rule 240(c), CDC filed a petition requesting a redetermination of

respondent's adjustments to partnership items.

- 3 I.

Acquisition of the Property

Corbin West was formed to purchase, manage, and syndicate

the Corbin West Apartments (the property).

From approximately

March 17, 1970, until December 23, 1988, Norman Associates

(Norman) owned the property.

On December 8, 1987, Corbin West entered into an option

agreement (the first option) with Norman to purchase the property

for $1,760,000.

On or about December 9, 1987, CDC, acting on

behalf of Corbin West, applied for a reservation of a Federal

low-income housing tax credit relating to the property with the

Connecticut Housing Finance Authority (CHFA application).

The

CHFA application reflected a total acquisition cost of $1,760,000

plus estimated development and/or rehabilitation costs of

$1,698,315.

Corbin West was unable to obtain the financing

required for rehabilitation of the property and allowed the first

option to lapse on April 1, 1988.

Corbin West remained interested in obtaining the property.

With the help of its attorneys, Corbin West devised a new plan to

acquire the property.

Under the plan, Norman would sell the

property to a charitable organization for a price below an

alleged fair market value and take a charitable contribution

deduction for the difference between the sale price and the

alleged fair market value.

The charitable organization in turn

would sell the property to Corbin West.

Corbin West would

reimburse the charitable organization for the cash paid to Norman

to acquire the property and execute a promissory note for the

- 4 difference between the alleged fair market value and the cash

paid (the same amount as Norman's charitable contribution

deduction).

The so-called bargain sale would be advantageous to

Norman because it would provide Norman with a large charitable

contribution deduction.

The bargain sale would also provide

Corbin West a high basis in the property.

On or about November 30, 1988, Financial approached the New

Britain Housing Authority (NBHA) and asked if the NBHA would

participate in Corbin West's bargain sale plan.

The NBHA

officials believed this was a strange request but nonetheless

agreed to participate.

At the NBHA's request, Financial

indemnified the NBHA against any and all loss, cost, claim,

demand, or damage arising out of or in connection with the NBHA's

purchase of the property (hold harmless agreement).

On or about December 23, 1988, the NBHA entered into a

purchase and sale agreement with Norman whereby the NBHA was

granted the right to acquire the property for $1,808,500.

Norman

took a charitable contribution deduction for the difference

between the alleged fair market value of $3,150,000 and the sale

price of $1,808,500 (i.e., $1,341,500).

Respondent denied

Norman's charitable contribution deduction, and Norman never

challenged respondent's determination in court.

On or about December 23, 1988, the NBHA entered into an

option agreement (the second option) with Corbin West under which

Corbin West acquired the right of the NBHA to purchase the

property.

Corbin West exercised the second option and purchased

- 5 the property from Norman pursuant to the option with the NBHA for

$1,808,500.

Corbin West paid the $1,808,500 by assuming the

existing first mortgage of $873,000, obtaining a second mortgage

of $920,000, and paying the balance from the limited partners'

contributions.

Corbin West also gave the NBHA a promissory note

(the note) for $1,341,500 (the difference between the alleged

fair market value of $3,150,000 and the amount already paid of

$1,808,500).

The note was recourse against Corbin West but not against

the general partner or any of the limited partners.

not secured by the property.

The note was

Interest and principal on the note

were not payable until the earlier of the sale of the property or

January 1, 2011.

The note was subordinated to repayment of the

first and second mortgages, repayment of loans from the general

partner plus interest, and repayment of the limited partners'

capital contributions and loans plus 8 percent interest.

The

NBHA did not record the note as an asset on its financial

statements.

On its Federal income tax returns for 1990, 1991, 1992, and

1993, Corbin West included the note in the property's basis for

purposes of determining its depreciation deductions and lowincome housing credits.

On these returns, Corbin West also

claimed accrued interest deductions related to the note of

$135,000, $147,492, $160,719, and $175,323, respectively.

- 6 II.

Fees Paid

Corbin West paid CDC substantial fees related to the

property.

These fees included the following:

(1) An

"acquisition fee" of $157,500, (2) a "developer's fee" of

$87,213, (3) a "tax credit guarantee fee" of $90,000, and (4) a

"no negative cash flow guarantee fee" of $53,000.

Corbin West paid CDC the "tax credit guarantee fee" for

CDC's guaranty that the property would be operated in a manner

which would comply with the requirements of section 42 and ensure

the availability of a low-income housing tax credit.

CDC

guaranteed that if the property failed to qualify for the lowincome housing tax credit, then CDC would advance Corbin West an

amount equal to any loss of credit.

To date, CDC has not made

any payments under this provision.

Corbin West paid CDC the "no negative cash flow guarantee

fee" for CDC's promise to make loans up to $250,000 to Corbin

West to fund any operating deficits that might arise through

December 31, 1995.

On its Federal income tax returns for 1990, 1991, 1992, and

1993, Corbin West included the "acquisition fee", the "developers

fee", and the "tax credit guarantee fee" in the property's basis.

On these returns, Corbin West capitalized the "no negative cash

flow guarantee fee" and claimed amortization deductions related

to that fee of $7,571, $7,571, $7,571, and $7,574, respectively.

- 7 OPINION

I.

Inclusion of the Note in the Property's Basis

It is well established that the economic substance of a

transaction, rather than its form, controls for Federal tax

purposes.

Gregory v. Helvering, 293 U.S. 465 (1935).

Respondent

argues that the note lacks economic substance; therefore, Corbin

West cannot include the note in the property's basis for purposes

of computing depreciation deductions or low-income housing

credits.

Generally, the basis for computing depreciation and the lowincome housing credit is the cost of the underlying property.

See secs. 42, 167(c), 1011, 1012.

"Cost" is the amount paid for

the property in cash or other property.

Tax Regs.

Sec. 1.1012-1(a), Income

A promissory note is generally included in that cost.

Crane v. Commissioner, 331 U.S. 1 (1947); see Commissioner v.

Tufts, 461 U.S. 300 (1983); Estate of Franklin v. Commissioner,

544 F.2d 1045 (9th Cir. 1976), affg. 64 T.C. 752 (1975).

To be

included in the cost of the property, the promissory note must

reflect a genuine debt.

See Estate of Franklin v. Commissioner,

supra at 1049; Odend'hal v. Commissioner, 80 T.C. 588, 604-605

(1983), affd. on this issue and remanded 748 F.2d 908 (4th Cir.

1984).

Recourse notes are normally included in basis because the

taxpayer has a fixed, unconditional obligation to pay, with

interest, a specified sum of money.

See Waddell v. Commissioner,

86 T.C. 848, 898 (1986), affd. per curiam 841 F.2d 264 (9th Cir.

- 8 1988).

In deciding whether a recourse note is included in basis,

the mere fact that the note is recourse on its face, however, is

not determinative.

See Roe v. Commissioner, T.C. Memo. 1986-510,

affd. per order (8th Cir., Apr. 1, 1988), affd. without published

opinion sub nom. Sincleair v. Commissioner, 841 F.2d 394 (5th

Cir. 1988).

When taking economic realities into account, if a

recourse debt has no reasonable likelihood of being paid, then

the recourse note lacks economic substance and should not be

included in basis.

See Rose v. Commissioner, 88 T.C. 386, 421-

422 (1987), affd. 868 F.2d 851 (6th Cir. 1989); Waddell v.

Commissioner, supra; Bridges v. Commissioner, 39 T.C. 1064, 1077

(1963), affd. 325 F.2d 180 (4th Cir. 1963).

In determining

whether there is a likelihood of repayment, we look at the facts

and circumstances of each case.

See Waddell v. Commissioner,

supra at 903.

Where the purchase price greatly exceeds the fair market

value of the property, courts often find the transaction lacks

economic substance.

422.

See Rose v. Commissioner, supra at 419-420,

Corbin West reported the purchase price of the property as

$3,150,000.

Respondent argues that the fair market value of the

property at the time of Corbin West's acquisition was only

$1,808,500; therefore, the purchase price greatly exceeds the

fair market value.

In this case, the most significant indicator of the fair

market value of the property is the first option entered into by

Corbin West and Norman 1 year before the acquisition of the

- 9 property through the bargain sale.

The first option allowed

Corbin West to purchase the property for $1,760,000.

The

evidence suggests that this price was negotiated at arm's length.

It, therefore, appears that the purchase price greatly exceeded

the fair market value of the property at the time of Corbin

West's acquisition, and the note was unlikely to be repaid from

its inception.

Furthermore, the repayment of the note was subordinate to

repayment of the following:

(1) The existing first mortgage of

approximately $873,000, (2) the second mortgage of $920,000, (3)

the limited partners' loans of $705,600 plus 8 percent interest,

(4) the limited partners' capital contributions of $258,900, and

(5) the general partners' loans of $500,000 plus interest.

These

amounts total $3,257,500.

The preexisting debt on the property and the obligations to

the partners already exceeded by a large amount the fair market

value of the property at the time of Corbin West's purchase, and,

as noted above, the repayment of the note was subordinate to

repayment of that debt and those partner obligations.

Therefore,

there was no reasonable likelihood that the note would be repaid.

See Estate of Franklin v. Commissioner, supra; Waddell v.

Commissioner, supra.

Additionally, it appears from the record that the property

was the sole asset held by Corbin West; therefore, even if Corbin

West decided to pay off the note, it is unlikely that Corbin West

- 10 would have the financial ability to pay off the note and the

interest thereon when due.2

In determining the likelihood of repayment of the note, we

also focus on the nature of the dealings between the parties.

See Rose v. Commissioner, supra at 415-416, 423.

The NBHA was

chosen by Corbin West to execute its bargain sale plan.

was not a negotiating party in the transaction.

The NBHA

There is no

evidence that the NBHA made any independent analysis concerning

the fair market value of the property or the likelihood of

repayment of the note by Corbin West.

The NBHA had nothing at

risk in the transaction because Financial gave the NBHA a hold

harmless agreement.

The NBHA received the note for allowing

itself to be used by Corbin West and Norman in their attempt to

ensure advantageous tax positions.

Although the subjective intent of the parties to create a

genuine debt is not controlling, we note that the NBHA did not

treat the note as genuine debt.

See Graf v. Commissioner, 80

T.C. 944, 952 (1983); Bridges v. Commissioner, supra at 1077; Roe

2

Petitioner provided expert testimony that the note could

be paid off at the end of its term (22 years) because it

anticipated 6-percent annual appreciation on the property. Barry

J. Cunningham, petitioner's expert, testified that at the end of

the note's term the property would be worth approximately $11

million. He also testified that at that time the first and

second mortgages and the note could be paid off with

approximately $9 million.

Mr. Cunningham, however, did not consider the loans from the

general partner or the loans and capital contributions from the

limited partners. Petitioner has not shown that the amount

remaining after satisfaction of the first and second mortgages

and the obligations to the partners would be sufficient to pay

off the note.

- 11 v. Commissioner, supra.

There is no evidence that the NBHA

considered the credit rating of Corbin West before agreeing to

accept the note.

See Capek v. Commissioner, 86 T.C. 14, 48-49

(1986); Burns v. Commissioner, 78 T.C. 185, 212 (1982); Estate of

Helliwell v. Commissioner, 77 T.C. 964, 976-977, 987-988 (1981).

The NBHA never recorded the note as an asset on its financial

statements.

note.

At the time of trial, the NBHA could not locate the

See Patin v. Commissioner, 88 T.C. 1086 (1987), affd.

without published opinion 865 F.2d 1264 (5th Cir. 1989), affd.

without published opinion sub nom. Hatheway v. Commissioner, 856

F.2d 186 (4th Cir. 1988), affd. sub nom. Gomberg v. Commissioner,

868 F.2d 865 (6th Cir. 1989), affd. sub nom. Skeen v.

Commissioner, 864 F.2d 93 (9th Cir. 1989).

The note was

subordinate to repayment of the preexisting debt and the

obligations to the partners, which greatly exceeded the

property's fair market value at the note's inception.

The facts

in toto indicate that the NBHA did not expect the note to be

repaid and never treated the note as genuine debt.

On the basis of our review of the entire record, we hold

that there was no reasonable likelihood that Corbin West would

pay off the note; therefore, the note lacks economic substance

and is not includable in the property's basis.

Accordingly,

Corbin West is not entitled to depreciation deductions or lowincome housing credits related to the note.

- 12 II.

Deductibility of Accrued Interest on the Note

In general, section 163(a) allows a deduction for interest

paid or accrued.

For the interest to be deductible, however, the

underlying debt must be genuine.

Elliott v. Commissioner, 84

T.C. 227, 244-246 (1985), affd. without published opinion 782

F.2d 1027 (3d Cir. 1986).

When a debt lacks economic reality and

is incurred solely to create an income tax deduction, it does not

support an interest deduction.

Goldstein v. Commissioner, 364

F.2d 734, 740 (2d Cir. 1966), affg. 44 T.C. 284 (1965).

We have already found that the note lacks economic substance

and is not genuine indebtedness.

We therefore conclude that

Corbin West is not entitled to interest deductions associated

with the note.3

III.

The Fees Capitalized Into the Property's Basis

Corbin West paid CDC substantial fees related to the

property.

These fees included the following:

(1) An

"acquisition fee" of $157,500, (2) a "developer's fee" of

$87,213, and (3) a "tax credit guarantee fee" of $90,000.

Corbin

West capitalized these fees into the basis of the property for

purposes of computing depreciation deductions and low-income

housing credits.

In the FPAA's, respondent disallowed the

inclusion of these various fees in the property's basis.

Petitioner argues that (1) these fees are properly includable in

3

The interest deductions claimed by Corbin West were for

accrued interest on the note; no interest was ever paid on the

note during the years in issue.

- 13 the property's basis or, in the alternative, (2) these fees are

deductible expenses.

Neither party disputes that these fees were

actually paid by Corbin West to CDC.

Under section 1.263(a)-2, Income Tax Regs., acquisition

costs of property must be capitalized.

Included as acquisition

costs are expenditures that result in the taxpayer's acquisition

of a capital asset, such as survey fees, attorney's fees for

drafting documents, and real estate commissions.

Godfrey v.

Commissioner, 335 F.2d 82 (6th Cir. 1964), affg. T.C. Memo. 19631; Burman v. Commissioner, 23 B.T.A. 639 (1931).

A.

"Acquisition Fee" and "Developer's Fee"

Corbin West capitalized $157,500 as an "acquisition fee" and

$87,213 as a "developer's fee" into the property's basis.

Petitioner presented two exhibits at trial detailing the services

performed or to be performed by it for both of these fees.

services included, among other things, the following:

The

(1)

Arranging for an option to acquire the property, (2) evaluating

zoning requirements and ensuring compliance, (3) arranging and

evaluating an environmental report relating to the property, and

(4) establishing guidelines for compliance with the low-income

housing tax credits requirements.

We conclude that the "acquisition fee" and "developer's fee"

were incident to Corbin West's acquisition of the property, and

they must be considered part of the property's acquisition cost.

We therefore conclude that Corbin West is entitled to capitalize

- 14 both the "acquisition fee" and "developer's fee" into its basis

in the property.

B.

"Tax Credit Guarantee Fee"

Corbin West also capitalized a "tax credit guarantee fee" of

$90,000 into the basis of the property.

This fee was for CDC's

guaranty that the property would be operated in a manner that

would ensure Corbin West's entitlement to a low-income housing

tax credit for the property.

If Corbin West failed to obtain

such a credit in any year, CDC guaranteed that it would advance

Corbin West an amount equal to the amount of any loss of credit.

Petitioner has failed to demonstrate that this cost is

associated with Corbin West's acquisition of the property.

1.263(a)-2, Income Tax Regs.

Sec.

We therefore conclude that Corbin

West is not entitled to capitalize the "tax credit guarantee fee"

into its basis in the property.

Petitioner alternatively argues that this fee is a

deductible expense.

Deductions are a matter of legislative

grace, and petitioner has the burden of showing that Corbin West

is entitled to any deduction claimed.

Rule 142(a); New Colonial

Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

Petitioner has

failed to cite a Code section or other authority that would

permit a deduction for this cost; therefore, petitioner has

failed to establish that Corbin West is entitled to such a

deduction.

- 15 IV.

"No Negative Cash Flow Guarantee Fee"

Corbin West paid CDC a fee that it labeled a "no negative

cash flow guarantee fee" in the amount of $53,000.

In exchange

for this fee, CDC agreed to make loans to Corbin West in any

amount up to $250,000 to fund any operating deficits through

December 31, 1995.

Corbin West capitalized this fee and deducted

amortization expense related to this fee during the years in

issue.

In the FPAA's, respondent disallowed the amortization

expense deduction related to this fee.

Petitioner provides no explanation for its treatment of this

item and fails to cite any Code section or other authority that

would allow its capitalization and amortization of this fee.

Rule 142(a); New Colonial Ice Co. v. Helvering, supra.

We

therefore conclude that Corbin West is not entitled to any

deductions associated with this fee.

To reflect the foregoing,

Decision will be entered

under Rule 155.