Petition — Lomas Santa Fe, Inc. v. Commissioner

8 z £43 1 2 Yd 0 Office-Supreme Court, U.S. F

No. 83- . eB D

JAN 28 1983

IN THE DER L. STEVAS,

Supreme Court of the United, States-r

October Term, 1983

LOMAS SANTA FE, INC., AND SUBSIDIARY

COMPANIES; LOMAS SANTA FE COUNTRY

CLUB, NORCO LANDSCAPE & MAINTENANCE

CO.,

Petitioners,

vs. .

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

David R. Clark, Esq.

Aylward, Kintz, Stiska,

Wassenaar & Shannahan

2100 Central Federal Tower

225 Broadway

San Diego, California 92101

Telephone: (619) 234-1966

Counsel for Petitioners

INTERIM PRINTING & MAILING COMPANY

1105 West MORENA BOULEVARD, SAN DiEGO, CALIFORNIA 92110 — 275-3050

QUESTION PRESENTED

Whether this Court should settle an

important question of Federal income tax law

involving a depreciation deduction generated

from a transaction found by both Courts

below to have been structured for valid

business purposes, particularly when

disallowance of the deduction here would

result in conflicting decisions among the

circuits, and when it is necessary that this

Court determine whether compliance with the

Internal Revenue Code is sufficient to

override proffered considerations of tax

policy.

(ii)

TABLE OF CONTENTS

Question Presented..........eeeeeeees

Opinions Below.......- SUVETEULURELE EL

DUSAMGASCAOR: cc dc iic ce ccccscdesscesecs

Statutes and Regulations Involved....

Statement of the Case..........eeeeee

Where, as here, a Taxpayer Structures

a Transaction for Valid Business

Purposes and in a Manner Which

Renders it Eligible for a Favorable

Tax Deduction, it Transcends the

Judicial Function to Rewrite the

Plain Requirements of a Tax Statute

to Avoid Achieving an "Unsettling"”

POBULGs ac ve civccccseesesccesccccees

Appendix A

Appendix B

(iii)

TABLE OF AUTHORITIES

CASES

Bell v. Harrison, 212 F.2d 253

C7ER Civ. 1954). cccccvvcccscvees

Century Electric Co. v.

Commissioner, 15 T.C. 581 (1950)

(1950), aff'd 192 F.2d 155 (8th

Cir. 1951), cert. denied, 342

U.B. DEG. vw ccccvavccvesscesseswerve

W. N. Fry, 283 F.2d 869 (6th

5c vege |” SRS AE ne oi a AE Se

Lomas Santa Fe, Inc., et al., v.

Commissioner of Internal Revenue

74 T.C. 662 (1980), 693 F.2d 71

OSS, MONEE ove s beet bah ees 10%

Manufacturer Hanovers Trust v.

Commissioner, 431 F.2d 664

(2NG@ Cir. 1970). cccccvvccscseeces

Triangle Publications v.

Commissioner, 54 T.C. 138 (1970)

United States v. Georgia

Railroad & Banking Co., 348

F.2d 278 (5th Cir. 1965), cert.

denied, 382 U.S. 973 (1966).....

STATUTES

26 U.S.C. 167....... Terrerre reer ee

28 U.S.C. 1254(1).. ccc ecneccccvees

26 C.F.R. 1.167... c eee ecccccee

10

1

OPINIONS BELOW

The opinion of the Ninth Circuit Court

of Appeals is reported at 693 F.2d 71, and

is reproduced in Appendix A. The opinion of

the United States Tax Court is reported at

74 T.C. 662 (1980), and is reproduced in

Appendix B. i

JURISDICTION

The Ninth Circuit opinion was filed on

November 1, 1982, and this application for a

Writ of Certiorari is therefore timely.

Jurisdiction of this Court is invoked under

28 U.S.C. Section 1254(1).

STATUTES AND REGULATIONS INVOLVED

Section 167 of the Internal Revenue Code

of 1954, as amended, provides as follows:

"(a) General Rule.--There shall be

allowed as a depreciation deduction a

reasonable allowance for the exhaustion,

wear and tear (including a reasonable

allowance for obsolescence)--(1) of

property used in a trade or business, or

(2) of property held for the production

of income." 26 U.S.C. §167.

Similarly, Treasury Regulation Section

1.167(a)-1l(a) states:

"Section 1.167(a) provides that a

reasonable allowance for the exhaustion,

wear and tear, and obsolescence of

property used in the trade or business

or of property held by the taxpayer for

the production of income shall be

allowed as a depreciation deduction.

The allowance is that amount which

should be set aside for the taxable year

in accordance with a reasonably

consistent plan (not necessarily at a

2

uniform rate), so that the aggregate of

the amounts set aside, plus the salvage

value, at the end of the estimated

useful life of the depreciable property,

equal the cost or other basis of the

property as provided in Section 167(g)

ane 61.167(¢g)-1... . .” 26 C.F.R.

§1.167(a)-1

Treasury Regulation Section 1.167(a)-3

states further that:

"If an intangible asset is known from

experience or other factors to be of use

in the business or in the production of

income for only a limited period, the

length of which can be estimated with

reasonably accuracy, such an intangible

asset may be the subject of a

depreciation allowance. ..." 26

C.F.R. §1.167(a)-3.

STATEMENT OF THE CASE

The facts of the case are fully set

forth in the written decision of the Tax

Court entered following trial. Lomas Santa

Fe, Inc. v. Commissioner, 74 T.C. 662,

663-70 (1980), see Appendix B, infra.

Since the factual determinations made by the

Tax Court were accepted by Petitioners on

their appeal, and because the Ninth Circuit

found accordingly, a brief description will

suffice here.

Petitioner Lomas Santa Fe, Inc.

(hereafter "Lomas"), as the first step in

the development of a luxury residential

community, purchased vacant land and built a

championship golf course and country club.

The golf course and country club were viewed

as an essential part of the planned

community from the inception of the project,

principally because dedicating the acreage

for the golf course for open space use eased

3

the density restrictions imposed by the

local county government, and the facilities

served as a marketing tool to promote the

sale of the adjacent residential properties.

Following completion of the golf course

and country club, Petitioner Lomas Santa Fe

Country Club (hereafter "Country Club") was

organized as a California corporation. In

exchange for all of the issued and

outstanding shares of stock in Country Club,

Lomas sold to Country Club the parking lot,

tennis court, and swimming pool outright,

and the golf course, pro shop and clubhouse

subject to a reserved estate for 40 years.

Both the Tax Court and the Ninth Circuit

held below that the creation of Country Club

as a separate corporate entity to own the

fee title to the golf course and related

facilities, the transfer by Lomas of those

assets to Country Club and the retention of

an estate for 40 years were all motivated by

valid business purposes and had economic

reality. Both Courts below rejected

Respondent's argument that the transfer of

assets by Lomas to Country Club and Lomas'

simultaneous acquisition by reservation of

an estate for 40 years in the golf course

property should have been disregarded for

tax purposes, since those transactions

eliminated potential real estate title

problems and insulated Lomas and its

development of the project from membership

in the country club, thereby foreclosing the

possibility that the latter might be deemed

to constitute an equity interest in Lomas,

under California law.

Several years later, Lomas for the first

time claimed a depreciation deduction due to

the amortization of the portion of the

estate for years which represented an

interest in the land and landscaping of the

golf course. The amount of the annual

deduction was arrived at simply by taking

straight-line depreciation of the

4

agreed-upon cost basis which Lomas had in

the estate for years over its 40-year term.

Section 167(a) of the Internal Revenue Code

provides that there shall be allowed as a

depreciation deduction a reasonable

allowance for the exhaustion of property

used in a trade or business, or held for the

production of income. Treasury Regulation

§1.167(a)-3, in turn, provides that an

intangible asset may be depreciated if it is

known from experience or other factors to be

of use in the business or in the production

of income for only a limited period of time,

the length of which can be estimated with

reasonable accuracy. The estate for years

owned by Lomas clearly meets the statutory

criteria, as the Tax Court ruled below:

"Thus, the estate for years exhibits all

of the characteristics of an asset which

is subject to an allowance for

depreciation pursuant to Section 167 and

the regulations thereunder.” Lomas

Santa Fe, Inc. v. Commissioner, 74 T.C.

662, 679-80 (1980), Appendix B at page

B-26.

"We [decide] that the estate for years

held by Lomas was property, was held by

Lomas for use in its trade or business,

had a determinable basis, and had a

useful life of 40 years. Thus,

Petitioners have made out a prima facie

case for the allowance of a depreciation

deduction in respect of the estate for

Ho yaa Id., at 683, Appendix B at

B- Te

The Tax Court, however, proceeded to

disallow the depreciation deduction, relying

exclusively on one case to reach that

result, United States v. Georgia Railroad &

Banking Co., 348 F.2d 278 (Sth Cir. 1965),

cert. denied, 382 U.S. 973 (1966). The

Ninth Circuit below affirmed on the same

ground, which has caused a conflict to arise

among the Federal Courts of Appeal since

this case, Petitioners urge, falls squarely

within the holding and reasoning of the

opinion by the Eighth Circuit in Century

Electric Co. v. Commissioner, 15 T.C. 581

(1950), aff'd. 192 F.2d 155 (8th Cir.

1951), cert. denied, 342 U.S. 954 (1952).

In addition, this Court should decide the

important question of Federal income tax law

presented by this case.

WHERE, AS HERE, A TAXPAYER STRUCTURES A

TRANSACTION FOR VALID BUSINESS PURPOSES AND

IN A MANNER WHICH RENDERS IT ELIGIBLE FOR A

FAVORABLE TAX DEDUCTION, IT TRANSCENDS THE

JUDICIAL FUNCTION TO REWRITE THE PLAIN

REQUIREMENTS OF A TAX STATUTE TO AVOID

ACHIEVING AN "UNSETTLING" RESULT.

It was recognized by both Courts below

that Lomas' acquisition by reservation of an

estate for years in the golf course property

met the statutory requirements for a

depreciation deduction under Section 167 of

the Internal Revenue Code. However, both

Courts were disturbed by "the unsettling

fact that Lomas apparently converted a

patently non-depreciable asset [raw land] to

one which is depreciable [a leasehold

interest] by simply relinquishing part of

its interest in that property." Appendix A

at page A-5; Appendix B at page B-26.

Similarly, both Courts below relied

exclusively on the singular precedent of

Georgia Railroad, a case which, if not

distinguishable from this one, is in

conflict with the decision of the Court of

Appeal in Century Electric. In any event,

it is respectfully submitted that it is

incumbent upon this Court to exercise its

role as the final arbiter of this important

question of Federal income tax law.

In Century Electric, the taxpayer owned

a foundry and the underlying land. The

taxpayer sold the land to a "friendly"

landlord, who simultaneously agreed to lease

the property back to Century Electric.

Despite finding that there was never any

intention on the part of the taxpayer to

discontinue its foundry operations, the

Court ruled that the sale/leaseback was

undertaken for legitimate business reasons.

Further, the Court héld that the taxpayer

was entitled to depreciate the leasehold

which it had acquired in exchange for the

sale of the same foundry property that it

had formerly owned in fee. Century Electric

Co. v. Commissioner, 15 T.C. 581, 595

(1950), 192 F.2d 155, 160.

The transactions in Century Electric

are nearly identical to those which occurred

here. Just like Century Electric, Lomas

sold land (a non-depreciable asset) used in

its business for reasons found to have been

legitimate, and which could not be

disregarded for tax purposes, to a party who

had agreed in advance not to take possession

until the expiration of a leasehold interest

which was created as a part of the same

sales transaction. The interim term

interest obtained by Century Electric was a

long-term lease, whereas Lomas acquired a

40-year estate by "reservation." However,

that is a distinction without a difference,

inasmuch as the legal effect of a sale/

reservation is the same that results from a

sale/leaseback. In either instance, the

underlying fee interest is transferred

outright to the purchaser, the former owner

by separate investment acquires a leasehold

interest for a specified amount of time, and

the new owner automatically becomes vested

in possession at the expiration of the

long-term lease, or the estate for years, as

the case may be. The tenant, therefore, has

no interest in the property when the term of

his leasehold interest expires, whether it

be a long-term lease or an estate for

years. It was for those reasons that an

allowance for depreciation was given to

7

Century Electric, since the leasehold

interest was truly a "wasting" asset, the

gradually disappearing value of which could

not be replaced but for periodic

depreciation adjustments. Lomas is

therefore entitled to a similar deduction.

Further, the fact that Century

Electric's sale/leaseback took place with a

"friendly" landlord, whereas Lomas'

sale/reservation was transacted with a

wholly-owned subsidiary, is of no

consequence. That discrepancy again

furnishes only a distinction without a

difference, because in both cases, the Court

specifically found that the transaction was

bona fide, and entered into for substantial

business reasons which were not to be

disregarded for tax purposes. In any event,

were it even to be assumed that a

wholly-owned subsidiary is a more "related

entity" than is a friendly landlord, the law

is uniform that the unrecovered cost of an

interim interest acquired from a

wholly-owned subsidiary may be recovered

through amortization though it may

ultimately be "merged" with the remainder.

That was the holding of Triangle

Publications v. Commissioner, 54 T.C. 138

(1970), where the taxpayer had originally

sold a TV Guide franchise, an intangible

asset not unlike an estate for years. The

taxpayer's wholly-owned subsidiary

eventually purchased that franchise, and was

ultimately liquidated into the taxpayer

prior to the time the franchise expired.

The Court permitted Triangle to amortize its

subsidiary's cost basis in the franchise

over the remaining term, rejecting the

government's argument of merger (i.e.,

since the franchise owned by the subsidiary

had originally been granted by the taxpayer,

when the taxpayer acquired the subsidiary,

the "franchise" ceased to exist). Here, in

fact, Country Club was not even liquidated

into Lomas and, thus, the wholly-owned

subsidiary remains the sole owner of the fee

interest in the golf course property and

Lomas holds only the estate for years, an

interest which will expire as a matter of

law at the end of its term. Since the

business substance of the transactions in

this case was affirmed by the Courts below,

it follows that Lomas is equally entitled to

the depreciation deduction. In accord, see

Bell v. Harrison, 212 F.2d 253 (7th Cir.

1954), and W. N. Fry, 283 F.2d 869 (6th

Cir. 1960), both cases allowing a

depreciation deduction to be taken where a

remainderman acquired the intervening life

estate, and holding against the government's

contention that the remainderman's purchase

had effected a merger leaving no life estate

to amortize.

Georgia Railroad, supra, does not

command a different result and, in any

event, the Fifth Circuit opinion is in

conflict with that of the Eighth Circuit in

Century Electric. The taxpayer in Georgia

Railroad owned stock of two railroad

companies, which it leased to an unrelated

third party for a term of 99 years. The

taxpayer eventually distributed its

"reversionary interest" in the leased stock

to its own shareholders as a dividend in

kind, giving each shareholder the right to

receive his proportionate number of shares

when the lease finally expired. However,

Georgia Railroad retained all present

interest in the stock, including the right

to receive the annual lease payments. The

taxpayer then sought to depreciate that

portion of its basis in the stock which

represented the fair market value of the

right to receive rental income for the years

remaining on the lease term, on the theory

that such right constituted property held

for production of income which would be

fully exhausted by the end of the lease.

The Fifth Circuit disallowed the deduction,

reasoning that the right the taxpayer had

retained after having distributed its

reversionary interest was not a depreciable

asset, since Georgia Railroad had not

thereby obtained any property interest that

it did not already have in the first place.

In this case, on ‘the other hand, Lomas

had formerly owned the golf course property,

transferred the entire fee interest to

Country Club, and acquired a new and

different asset, which required the

allocation of a ceparate cost basis. Lomas

had a separate and independent investment in

the 40-year estate which it obtained, a

property interest which Lomas never

previously had, which distinguishes it from

Georgia Railroad, who at all times owned all

of the stock "subject to the lease" prior to

distributing the reversionary interest to

its shareholders. After that, Georgia

Railroad had only the right to receive

rental income for the remaining term of the

lease, and that interest had no cost basis,

either before or after the distribution,

inasmuch as nothing then was acquired, the

"fee" interest in the stock subject to the

lease simply was given up. If that

fundamental difference does not distinguish

this case from Georgia Railroad, then it

and the coinion below by the Ninth Circuit

are in direct conflict with the Eighth

Circuit decision in Century Electric.

Here, in a bona fide transaction with

Country Club, Lomas acquired by separate

investment an interest which it had not ever

had before, an estate for 40 years in the

golf course property. The estate for 40

years, determined below to be an intangible

property interest, used in Lomas' business,

having an expiring and determinable useful

life equal to its 40-year term, meets the

requirements for a depreciation deduction

under Section 167 of the Internal Revenue

Code. The apparent conflict among the

10

circuits on that question should be resolved

in favor of the allowance of a depreciation

deduction in this case. Moreover, the

deduction is mandated because the

requirements of the tax statute have been

met, and it transcends the judicial function

to rewrite a plain statute, such as Section

167, to conform to proferred considerations

of tax policy. See, Manufacturer Hanovers

Trust v. Commissioner, 431 F.2d 664, 678

(2nd Cir. 1970), and see also the dissenting

opinion below of Justice Pregerson, at

Appendix A-7.

CONCLUSION

The writ should issue so that taxpayers

may rely on structuring their transactions

for valid business purposes, whether or not

it may be "unsettling" that such

transactions are eligible for favorable tax

treatment.

Respectfully submitted,

mC Lak

AYLWARD, KINTZ, STISKA,

WASSENAAR & SHANNAHAN

2100 Central Federal Tower

225 Broadway

San Diego, CA 92101

Counsel for the Petitioners*

*There are no parent, subsidiary or

affiliate companies in addition to the named

parties.

A-1

LOMAS SANTA FE, INC., and Subsidiary

Companies; Lomas Santa Fe Country

Club, Norco Landscape & Maintenance

Co., Petitioners and Appellants,

Vv.

COMMISSIONER OF INTERNAL REVENUE,

Respondent and Appellee.

No. 81-7092.

United States Court of Appeals,

Ninth Circuit.

Argued and Submitted March 1, 1982,

Decided Nov. 1, 1982.

Taxpayer appealed from an order of the

United States Tax Court, 74 T.C. 662, in

favor of Internal Revenue Commissioner. The

Court of Appeals, Tang, Circuit Judge, held

that taxpayer could not claim depreciation

deduction for amortization of an estate for

years in real property where the estate was

created by taxpayer splitting its fee simple

interest into two parts and conveying the

remainder to a wholly owned subsidiary.

Affirmed.

Pregerson, Circuit Judge, dissented and

filed opinion.

1. Internal Revenue 3480

A taxpayer may not claim depreciation

deduction for unimproved real property held

in fee simple. 26 U.S.C.A. § 167.

2. Internal Revenue 3480

Taxpayer may claim depreciation

deduction on amortized value of purchased

A-2

leasehold, even if property underlying

leasehold is nondepreciable. 26 U.S.C.A.

§ 167.

3. Internal Revenue 3480

Taxpayer could not claim depreciation

deduction for amortization of an estate for

years in real property where the estate was

created by taxpayer splitting its fee simple

interest into two parts and conveying the

remainder to a whol'y owned subsidiary. 26

U.S.C.A. § 167.

David R. Clark, Aylward, Kintz &

Stiska, San Diego, Cal., for petitioners

and appellants.

Libero Marinelli, Jr., Washington,

D.C., argued, for respondent and appellee;

Daniel F. Ross, Washington, D.C., on brief.

Appeal from the United States Tax Court.

Before HUG, TANG and PREGERSON, Circuit

Judges.

TANG, Circuit Judge:

This is an appeal from a Tax Court

judgment in favor of the Commissioner. The

issue presented is whether a taxpayer may

claim a depreciation deduction under I.R.C.

§ 167[1] for the amortization of an estate

{1} I.R.C. § 167(a) provides in pertinent part:

There shall be allowed as a depreciation

deduction a reasonable allowance for the

exhaustion, wear and tear (including a reasonable

allowance for obsolescence) --

(1) of property used in the trade or business, or

(2) of property held for the production of income.

A-3

for years in real property if the estate was

created by the taxpayer splitting its fee

simple interest into two parts and conveying

the remainder to a wholly owned subsidiary.

We conclude that this estate for years is

not depreciable for tax purposes and affirm

the Tax Court.

The facts are carefully detailed in the

Tax Court opinion. See Lomas Santa Fe,

Inc. v. Commissioner, 74 T.C. 662, 663-70

(1980). To summarize, taxpayer Lomas Santa

Fe, Inc., as the first step in the

development of a luxury residential

community, purchased land in fee simple and

built a golf course and country club. The

golf course and country club were to serve

as a marketing tool to promote the sale of

adjacent residential properties.

To solve real estate title problems and

to insulate the taxpayer and its operation

from the membership of the country club, the

taxpayer formed Lomas Santa Fe Country Club

as a wholly owned subsidiary and transferred

the assets of the golf course and country

club to the subsidiary. Some assets were

transferred outright, but some were

transferred subject to a retained estate for

forty years in the taxpayer.

The taxpayer claimed in tax year 1973 a

depreciation deduction under I.R.C. § 167

due to the amortization of the estate for

years. The Commissioner disallowed the

deduction on the theory that both the

creation of the subsidiary and the

conveyance of assets to the subsidiary were

not transacted for legitimate business

purposes. On review, the Tax Court

disagreed with the Commissioner's reasoning

and held that the subsidiary's creation and

the conveyance of assets to the subsidiary

were legitimate business transactions and

could not be disregarded for tax purposes.

See id. at 670-79. The court nonetheless

A-4

upheld the Commissioner's disallowance,

ruling that an estate for years is

nondepreciable for tax purposes if it is

created by the taxpayer splitting its fee

simple interest into two parts and conveying

the remainder to a third party. Id. at

680-84.

DISCUSSION

[1,2] This appeal presents a fact

pattern that falls between the cracks of two

well-settled tax rules. It is fundamental

that a taxpayer may not claim a depreciation

deduction for unimproved real property held

in fee simple. See, e.g., Edinboro Co.

v. United States, 224 F.Supp. 301, 302-03

(W.D.Pa.1963) (cost of acquiring golf course

in fee simple not depreciable). It is

equally clear, however, that a taxpayer may

claim a depreciation deduction on the

amortized value of a purchased leasehold,

even if the property underlying the

leasehold is non-depreciable. See, e.g.,

1220 Realty Co. v. Commissioner, 322 F.2d

495, 498 (6th Cir. 1963) (lease on vacant

land is depreciable over unexpired term).

The taxpayer here claims a depreciation

deduction for an estate for years; the

estate, however, was created by the taxpayer

retaining the estate as part of the

taxpayer's sale of the underlying

nondepreciable property to a third party.

{3} The Tax Court, relying upon the

reasoning of United States v. Georgia

Railroad and Banking Co., 348 F.2d 278 (Sth

Cir. 1965), cert. denied, 382 U.S. 973, 86

S.Ct. 538, 15 L.Ed.2d 465 (1966), ruled that

a taxpayer who holds nondepreciable real

property in fee simple may not create a

depreciable asset by carving out an estate

for years for itself and conveying the

remainder to a third party. See Lomas

Santa Fe, Inc., 74 T.C. at 683-84.

A-5

The taxpayer argues that its ownership

of the property in fee simple prior to the

creation of its terminable interest should

not affect the deductibility of the

terminable interest's depreciation. We

disagree. We, like the Tax Court, are

disturbed by "the unsettling fact that Lomas

apparently converted ‘a patently

non-depreciable asset to one which is

depreciable by simply relinquishing part of

its interest in that property." Id. at

680. We are persuaded that a taxpayer in

such a situation has done nothing more than

fragment its bundle of property rights at no

expense to itself, and thus it has no added

investment in the terminable interest to

amortize or depreciate. See id. at 682-83;

see also Georgia Railroad, 348 F.2d at

288-89. (2)

Past precedent does not compel

otherwise. For tax purposes, this

transaction's key feature is that the

taxpayer obtained nothing that it did not

already possess and paid no additional

2. ##The taxpayer argues that Georgia Railroad

does not apply here because, first, the only right

reserved there was a right to receive lease income,

which is a nondepreciable right, and, second, the

taxpayer there could not establish a cost basis for

its interest. The first distinction overlooks that

the Georgia Railroad taxpayer sought to depreciate

its terminable interest in the stock and not the

underlying right to receive income. 348 F.2d at

286-87. Depreciation on the terminable interest

would have been presumably deductible had the

taxpayer purchased only the terminable interest from

a third party, despite the nondepreciability of the

asset underlying the interest. The second

distinction is equally meritless. Both here and in

Georgia Railroad, the taxpayer's basis in the

terminable interest was calculated as a function of

the basis in the underlying asset before it was

divided. Id.

A-6

consideration for the terminable interest it

created. The absence of an additional

investment distinguishes this case from the

line of authority permitting a taxpayer to

depreciate a terminable interest that is

purchased subsequent to the taxpayer's

acquisition of the remainder. See, e.g.,

Bell v. Harrison, 212 F.2d 253, 256 (7th

Cir. 1954); Triange Publications, Inc. v.

Commissioner, 54 T.C. 138 (1970); Fry v.

Commissioner, 31 T.C. 522, 527 (1958),

aff'd, 283 F.2d 869 (6th Cir. 1960).

We also reject the taxpayer's argument

that this transaction is comparable to the

sales-leaseback transaction considered by

the Tax Court in Century Electric Co. v.

Commissioner, 15 T.C. 581 (1950), aff'd,

192 F.2d 155 (8th Cir. 1951), cert. denied,

342 U.S. 954, 72 S.Ct. 625, 96 L.Ed. 708

(1952). The taxpayer there sold land in fee

simple to a college in exchange for cash and

a 95-year lease on the property. Despite

the taxpayer's prior outright ownership of

the property, the Tax Court held that the

taxpayer was entitled to a depreciation

deduction on the amortized value of the

lease. Id. at 595-96.

While facially similar to the situation

here, Century Electric's result turned on

the Tax Court's characterization of the

transaction as a like-kind exchange where a

fee simple interest was exchanged for cash

and leasehold interest. Id. at 595. This

analogy to a like-kind exchange does not

extend to the transaction here. Nothing

akin to a like-kind exchange has occurred;

the taxpayer has acquired its terminable

interest not from another party, as in

Century Electric, but by reserving the

interest in a sale of the property.

Nor is it relevant that the transaction

here could have been easily restructured to

A-7

conform with the sales-leaseback transaction

approved in Century Electric. While we are

not insensitive to the need to tax like

transactions alike, see, e.g., Bercy

Industries, Inc. v. Commissioner, 640 F.2d

1058, 1062 (9th Cir. 1981), it is ultimately

up to the taxpayer and not the courts to

structure transactions in a manner eligible

for favorable tax treatment, see, e.g.,

Commissioner v. National Alfalfa

Dehydrating & Milling Co., 417 U.S. 134,

148-49, 94 S.Ct. 2129, 2136-2137, 40 L.Ed.2d

717 (1974).

AFFIRMED.

PREGERSON, Circuit Judge, dissenting.

I dissent. The transaction described in

the Majority's Opinion was structured by the

taxpayer for valid business purposes. I am

of the view that the estate for years

retained by taxpayer satisfies the

requirements for a depreciation deduction

under I.R.C. § 167. I do not find this

result to be unsettling, but if it is, then

Congress should take the appropriate

corrective action to amend the statute.

B-1

LOMAS SANTA FE, INC., AND SUBSIDIARY

COMPANIES: LOMAS SANTA FE COUNTRY CLUB,

NORCO LANDSCAPE & MAINTENANCE CO.,

PETITIONERS v. COMMISSIONER OF

INTERNAL REVENUE, RESPONDENT

Docket No. 6578-77 Filed July 9, 1980.

As the first step in the development of a luxury

residential community, X built a golf course and

country club. The golf course and countiy club were

to serve as a marketing tool for adjacent residential

properties. To solve real estate title problems and

to insulate X and its operations from the membership

of the country club, X formed Y as a wholly owned

subsidiary and transferred the assets of the golf

course and country club to Y. Some assets were

transferred outright, but some were transferred

subject to a retained estate for 40 years in X. The

estate for years was retained so that X could operate

the golf course and country club until the

residential properties were sold. Held, Y is to be

respected as an entity separate from X. Held,

further, the transfer of assets to Y by X and the

existence of the estate for 40 years will not be

disregarded for tax purposes.

X claimed a depreciation deduction due to the

amortization of the estate for 40 years, which

deduction was disallowed by respondent. Held, the

retained estate for 40 years is not an interest which

is subject to an allowance for depreciation under

sec. 167(a), I.R.C. 1954. Cf. United States v.

Georgia Railroad & Banking Co., 348 F.2d 278 (5th

Cir. 1965), revg. an unreported case (S.D. Ga. 1963,

11 AFTR 2d 1435, 63-1 USTC par. 9443), cert. denied

382 U.S. 973 (1966).

William P. Shannahan and John S.

Huiskamp, for the petitioners.

Louis A. Boxleitner, for the

respondent.

Goffe, Judge: The Commissioner

determined a deficiency in the Federal

B-2

income tax of petitioners for the taxable

year ended July 31, 1973, in the amount of

$107,460.76. Due to concessions, one issue

remains to be decided: whether an estate

for 40 years retained by petitioner Lomas

Santa Fe, Inc., is an interest subject to an

allowance for depreciation under section

167(a), I.R.C. 1954.[1]

FINDINGS OF FACT

Some of the facts have been stipulated.

The stipulation of facts and the exhibits

attached thereto are incorporated herein by

this reference.

Lomas Santa Fe, Inc. (hereinafter

Lomas), and its two subsidiary corporations,

Lomas Santa Fe Country Club and Norco

Landscape & Maintenance Co., filed their

consolidated Federal income tax return for

the taxable year ended July 31, 1973, with

the Office of the Internal Revenue Service,

Fresno, Calif.{2] Petitioners, all of which

are California corporations, had their

principal offices in Solana Beach, Calif.,

when their petition was filed in this

proceeding.

At all times relevant to this

proceeding, Theodore E. Gildred (hereinafter

Gildred) owned all of the outstanding

capital stock of Lomas, was the chairman of

the board of directors of Lomas[3], and was

the president of Lomas. Thomas E. Kern

[1] All section references are to the Internal

Revenue Code of 1954 as amended.

[2] Norco is a party to these proceedings solely

because it joined in the consolidated Federal income

tax return for the taxable year ended July 31, 1973;

none of the events involved in this proceeding relate

to Norco or its activities.

[3] The board of directors of Lomas was

comprised of three persons.

B-3

(hereinafter Kern) was at all times relevant

to this proceeding a member of the board of

directors of Lomas and was a vice president

of Lomas.

In 1964, Lomas began to formulate a plan

for the development of a high quality

residential community. The community, which

was to be called Lomas Santa Fe, was to be

developed on acreage which had been

purchased in 1959 from the Rancho Santa Fe

Irrigation District. The plan included a

neighborhood shopping center, residential

units (single-family homes, condominiums,

and apartments), and a championship golf

course and country club. The develoment of

the golf course and country club was

contemplated for two major reasons: first,

to enhance the value of the residential

properties; and second, to ease the density

restrictions imposed by the Rancho Santa Fe

Irrigation District.

Gildred had considerable experience as a

developer and, based upon that experience,

he believed that houses which bordered a

golf course would be in greater demand and

would fetch higher prices than those which

did not. Lomas intended that the golf

course would be the hub of the residential

community of Lomas Santa Fe. It was

contemplated that the golf course would

attract the higher income residential market

and would greatly enhance the value of the

lots which would be sold for residential

use. The golf course was needed as an

amenity to attract potential purchasers of

residential properties because Lomas Santa

Fe was some distance from the city of San

Diego. In addition to the obvious

recreational aspects of the golf course, its

cart paths would enable residents of Lomas

Santa Fe to travel from their homes to the

shopping center via electric cart or similar

vehicle.

B-4

The Rancho Santa Fe Irrigation District

imposed strict density limits upon

developments within that district.[4] The

acreage held by Lomas was within that

district, and it accordingly was subject to

deed restrictions upon the density of

residential development thereon. In 1967, a

master plan for the development of Lomas

Santa Fe was submitted to the San Diego

County Board of Supervisors and to the Rancho

Santa Fe Irrigation District, both of which

had control over the development of the

acreage on which Lomas Santa Fe was to be

built. In approving the master plan, the San

Diego County Board of Supervisors and the

Rancho Santa Fe Irrigation District imposed

the condition that an open-space easement on

the acreage used for the golf course be

dedicated in perpetuity to the county of San

Diego.[{5] Such an easement was granted, and

the master plan was approved. Because of the

dedication of acreage for the golf course to

open-space use, the Rancho Santa Fe

Irrigation District raised the density limits

for the remaining acreage, permitting roughly

the same number of dwellings to be built on

the remaining land as would have been

constructed on the total acreage.

The golf course and country club, being a

central and dominant feature of Lomas Santa

Fe, was to be used as an essential marketing

tool and sales vehicle in the offer of resi-

dential properties. Lomas did not intend to

keep the golf course and country club

indefinitely, but rather, intended to dispose

of it when its usefulness as a marketing tool

expired.

[4] Density, as the term is used in this case,

means the number of residential properties permitted

to be built on a given area of land such as an acre.

[5] Specifically, the easement would cause the

area set aside for the golf course to remain

perpetually as open space to i» used exclusively for

golf course, park, and recreational purposes.

B-5

The idea of including a golf course as an

integral part of a development community was

not novel, but residential development

usually preceded the development of the golf

course. As a result, the promises of the

developer were the most tangible assurance

that home buyers would receive concerning the

completion of their development community.

In contrast, Lomas undertook the development

of the golf course in 1967 as the first step

in its project to develop Lomas Santa Fe.

Gildred was convinced that his marketing

approach would produce results superior to

those attainable with only the promise of a

golf course.

Lomas Santa Fe Country Club (hereinafter

Country Club) was organized on November 14,

1968. Country Club was formed to serve as a

vehicle for the refinement of title to the

residential properties and to ensure that

membership in the country club would not

constitute an equity interest in Lomas.

On February 11, 1969, Country Club issued

72,869 shares of its capital stock to Lomas

in exchange for certain property as described

below. The 72,869 shares so exchanged were

all of the issued and outstanding shares of

stock in Country Club. Lomas was the sole

shareholder of Country Club until July 26,

1973, when 21 percent of such shares were

sold by Lomas to Gildred. At all times

relevant to this proceeding, Lomas controlled

the board of directors of Country Club.

On December 2, 1968, at a meeting of the

board of directors of Lomas, several

resolutions were adopted concerning a sale of

the golf course facilities which Lomas had

already developed and which Lomas still

owned. The resolutions were as follows:

RESOLVED that the officers of [Lomas] are hereby

authorized and instructed to offer for sale, and to

B-6

sell, to Lomas Santa Fe Country Club, in return for

shares of capital stock in Lomas Santa Fe Country

Club, as of a date certain for evaluation purposes,

all of the real property set aside, planned and

developed as a Country Club, subject thereto to an

estate for 40 years in the property generally known

as, and containing thereon, the golf professional

shop, the existing clubhduse, the area for the

contemplated future clubhouse, and the golf course

proper.

RESOLVED FURTHER that in order to insure the

control of [Lomas] for future development of real

property in the vicinity of the property on which the

golf course is located that there will be

specifically excluded from the conveyance to Lomas

Santa Fe Country Club, the tenth fairway and the

areas known as the east and west parkways, but the

use of such tenth fairway shall be granted pursuant

to a separate agreement between [Lomas] and Lomas

Santa Fe Country Club, or an easement thereon.

RESOLVED FURTHER that [Lomas] will maintain and

operate the golf course, bar, dining and related

facilities pursuant to its reserved estate for years,

and that this corporation will repair, maintain and

make improvements upon the golf course, bar, dining

and related facilities in consideration for 75% of

the membership dues charged by Lomas Santa Fe Country

Club for the use of all facilities located upon the

subject property.

RESOLVED FURTHER that Lomas Santa Fe Country Club

would have administrative control over all of the

operations and facilities upon the subject real

property hereinabove referred to.

By letter dated December 3, 1968, and

pursuant to the foregoing resolutions, Lomas

submitted its offer to Country Club. Lomas

offered to transfer property valued by Lomas

at $728,680,89 and cash of $9.11 in exchange

for 72,869 shares of capital stock in

Country Club at the par value of $10 per

B-7

share. In addition to a technical

description of the property transferred,

Lomas explained and expanded upon its offer

in the letter as follows:

You will note that the real property over which the

tenth fairway of the golf course is located and those

areas known commonly as the east and west parkways

are specifically excluded from our proposal. Should

you accept the offer herein contained, we will by

separate agreement or easement, insure that the

operation, repair, maintenance and improvement of the

golf course is not hindered by the exclusion of the

tenth fairway, said exclusion being so that Lomas

Santa Fe, Inc. may have a full supervision over the

development of the lands adjacent to said tenth

fairway.

You will note that pursuant to the descriptions

in the Exhibits attached hereto that the parking lot,

tennis court and swimming pool would be granted to

Lomas Santa Fe Country Club outright.

Please note that the golf course proper (subject

to the exclusions and either agreement or easement

described above), as well as the golf professional

shop, the present club house and the parcel of real

property upon which it is contemplated that the

future club house will be constructed have been

reserved by this corporation for a period of forty

years.

This corporation would, subject to any future

agreements or conveyances, which would act to modify

the plan set forth herein, operate the golf course,

bar, dining and related facilities during the period

of its reserved estate for years, specifically

excluding the parking, tennis, swimming and

administrative facilities and responsibilities. In

light of the enormous costs involved in the

operation, repair, maintenance and improvement of a

golf course facility, we would require that 75% of

the proposed membership dues be collected for our

account for that purpose,

It would be further understood and agreed by this

corporation that your corporation would operate the

parking, tennis and swimming facilities and would

have administrative control over the entire

operations of all the facilities,

It is contemplated that this corporation would

construct at its own cost further improvements and

facilities upon the subject real property and would

be willing, upon completion of same, to negotiate a

value thereon by mutual agreement for which we would

accept payment therefor in cash or shares of stock in

your corporation.

The assets which Lomas offered to

transfer outright to Country Club and the

value of those assets were as follows:

Asset Value

Acreage (7 acres at $8,000/acre) $56,000.00

Skyline Drive widening 35,123.99

Sewer 35,835.73

Tunnel 37,808.03

Tennis court 36,837.13

Playground equipment 718.75

Nursery fence 775.85

Cash 9.11

Total 203,108.59

The assets in which Lomas reserved an

estate for 40 years, their useful lives, and

their value were as follows:

Asset Useful Life Value

Acreage (60 acres

at $8,000/acre) Unlimited $480,000.00

Acreage (61.1 acres

at $8,000/acre) Unlimited 492,800.00

Acreage (1.4 acres

at $8,000/acre) Unlimited 11,200.00

Main clubhouse 40 years 45,148.20

Golf-ball building 40 years 696.57

Pool clubhouse 40 years 39,488.19

Golf course Unlimited 737,692.07

Sprinkler 15 years 152,000.00

Pumphouse 40 years 11,811.52

Maintenance 40 years 40,708.35

Snack bar Not shown 69,368.24

The value of the estate for 40 years in

those assets was computed by multiplying the

value of the assets by a factor of

0.7474275, and the value of the remainder

conveyed to Country Club was computed by

multiplying the value of the assets by a

factor of 0.2525725.[6] Thus, the value of

the estate for 40 years in the foregoing

assets was $1,555,331.73, and the value of

the remainder was $525,581.41. The value of

the assets offered to be transferred

outright ($203,108.59) and the value of the

remainder interest ($525,581.41) combine for

a total offer of $728,690 worth of assets.

On December 17, 1968, at a special

meeting of the board of directors of Country

Club, the three directors of Country Club,

Gildred, Kern, and Kent Staab, unanimously

resolved that the offer of Lomas be

accepted.[7] In accordance with the

agreement between Lomas and Country Club,

two corporation grant deeds were prepared.

Two deeds dated February 11, 1969, were

recorded in the Office of the Recorder of

San Diego County on December 3, 1971. One

deed grants Country Club the property which

was not subject to restriction, and the

other deed grants Country Club a remainder

interest in the property which was subject

to an estate for 40 years.

[6] The factors came from Internal Revenue

Publication No. 11 and are not disputed.

{7} Kent Staab, at that time, was the manager of

the country club as well as a vice president of

Country Club.

B-10

The cost of the golf course and its

landscaping in which Lomas retained an

estate for 40 years was $1,151,244.[8]

Lomas had a basis in those asets equal to

their cost. Petitioners computed the basis

that Lomas had in its estate for 40 years

in the land and landscaping of' the golf

course by applying a‘factor of 0.7474275 to

the basis that Lomas had in those assets. [9]

Thus, petitioners determined that Lomas had

a basis of $855,086 in its estate for 40

years in those assets.

The creation of Country Club solved

practical problems of real estate law.

Attorneys for Lomas wanted to settle all

potential boundary and easement problems

prior to the sale of any residential lots.

By creating a separate entity to hold the

golf course and country club, boundaries

between that transferred property and the

retained residential property were set

accurately. Because the residential

property and golf course property were held

by different entities, easements for

playing rights, cart paths, and open slopes

were negotiated easily and placed on the

residential lots with certainty.

The creation of Country Club helped

Lomas retain control over its development

of Lomas Santa Fe. The opinion of the

Calfornia Supreme Court in Silver Hills

Country Club v. Sobieski, 55 Cal. 2d 811,

361 P.2d 906 (1961), raised the possibility

that memberships sold by Lomas as owner of

the golf course and country club could

constitute «equity interests in Lomas. As

such, the plans for development of Lomas

[8] Of the total amount, $413,552 was

attributable to the cost of land and $737,692 to the

cost of improvements.

[9] This factor came from Internal Revenue

Publication No. 11 and is not disputed.

B-11

Santa Fe could have been influenced by the

members of the country club.

By the time of trial, Lomas had

received three offers for the purchase of

the golf course and country club. One

offer, made in 1974, was an unsolicited

offer from a California corporation owned

by some of the club members. Another

offer, made in 1977, was a solicited offer

from a California corporation owned by some

of the club members. The third offer was

outstanding at the date of trial and was

made by a foreign corporation not linked to

club members.

In 1973, during a financial audit of

petitioners, a certified public accountant

noticed that petitioners had not been

amortizing the estate for years which was

held by Lomas. The assets that are subject

to the estate for years fit into two

categories: (1) those which are

depreciable assets having a useful life

equal to or less than 40 years; and (2)

those which have no determinable useful

life and are not depreciable assets. Lomas

had been claiming depreciation deductions

for the assets in the first category

because their useful lives would expire

prior to or at the same time as the

termination of the estate for 40 years.

Lomas had not been claiming depreciation

deductions for the assets that fit into the

second category (land and landscaping) or

for the estate for 40 years in those assets.

On their consolidated Federal income

tax return for the taxable year ended July

31, 1973, petitioners claimed their usual

depreciation deductions in respect of the

assets which were depreciable assets having

a useful life equal to or less than 40

years, and they also claimed, for the first

B-12

time, a depreciation deduction due to the

amortization of the portion of the estate

for years which represented an interest in

the land and landscaping of the golf

course. The amount of the latter was

$21,377.16.[10] In addition, petitioners

modified the computation of their net

operating loss by including an

"amortization correction" in the amount of

$21,377.16 for the taxable year ended July

31, 1972.

In determining a deficiency in Federal

income tax for the taxable year ended July

31, 1973, the Commissioner disallowed the

depreciation deduction taken in respect of

the estate for years, and he recomputed

peitioners' net operating loss carryover,

eliminating the "amortization correction"

from petitioners’ computation. Those two

adjustments were made "for the reasons that

your investment in the Lomas Santa Fe

Country Club does not represent an

amortizable or depreciable asset."

ULTIMATE FINDING OF FACT

The creation of Country Club by Lomas

and the retention by Lomas of an estate for

40 years in certain assets transferred to

Country Club were motivated by business

purposes and must not be disregarded for

tax purposes.

OPINION

As the first step in the development of

a luxury community to be known as Lomas

Santa Fe, Lomas created a golf course and

country club on part of the land that Lomas

had designated for development. The golf

[10] (Basis - salvage value) + useful life =

(855,086 - 0) : 40 = $21,377.15 (l-cent discrepancy

with amount claimed).

B-13

course and country club were made part of

the community for two reasons: first, to

enhance the value of the residential

properties being developed; and second, to

ease the density restrictions imposed by

the local irrigation district.

A fully operational golf course and

country club having been created, Lomas

decided to form a wholly owned subsidiary,

Country Club, to hold the golf course and

country club property while Lomas developed

the residential community. Lomas formed

Country Club to separate the golf course

and country club from its other assets.

Specifically, Contry Club was to serve as a

vehicle for the refinement of title to the

residential properties and to ensure that

membership in the country club would not

constitute an equity interest in Lomas.

Under the facts of Silver Hills Country

Club v. Sobieski, 55 Cal. 2d 811, 361 P.2d

906 (1961), the California Supreme Court

endowed country club memberships with the

attributes of securities. In the event

that Lomas had not separated the golf

course and country club from its other

assets, memberships in the country club,

which were found to be securities, would

have represented a direct interest in

Lomas. Such interest could have directly

influenced the development of Lomas Santa

Fe. By creating a subsidiary to hold the

assets of the golf course and country club,

any equity interest attributed to members

would be a direct interest in Country Club

ratner than in Lomas. Thus, direct control

over the continued development of Lomas

Santa Fe was preserved by the interposition

of Country Club. Nevertheless, the

potential control of Country Club by

members could have indirectly influenced

the development of Lomas Santa Fe. If

B-14

members controlled the operation of the

golf course and country club through an

equity interest in Country Cub, the

facilities might not have been maintained

in the style required for promotion of a

luxury residential community. Lomas did

not want to jeopardize the value of the

golf course and country club as a marketing

tool. Therefore, Lomas retained an estate

for 40 years in the golf course, bar,

dining and related facilities, enabling

Lomas to operate those facilities and

maintain quality control until the

marketing function had been served. The

parking, tennis, swimming, and

administrative facilities were transferred

outright and were to be operated by Country

Club. Lomas intended to divest itself

entirely of the golf course and country

club after its usefulness as a marketing

tool ceased.

In 1973, during a financial audit of

petitioners, a certified public accountant

noticed that petitioners had not been

amortizing the estate for years which was

held by Lomas. The assets that are subject

to the estate for years fit into two

categories: (1) those which are depreciable

assets having a useful life equal to or

less than 40 years; and (2) those which

have no determinable useful life and are

not depreciable assets. Lomas had been

Claiming depreciation deductions for the

assets in the first category because their

useful lives would expire prior to or at

the same time as the termination of the

estate for 40 years. Lomas had not been

claiming depreciation deductions for the

two assets that fit into the second

category (the land and the landscaping for

the golf course), because those two assets

have no determinable useful lives and thus

are not depreciable assets. Edinboro Co.

v. United States, 224 F.Supp. 301 (W.D.

B-15

Pa. 1963). After some research, however,

it was decided that petitioners would

amortize over 40 years the portion of the

cost of the estate for years that was

allocable to the land and landscaping of

the golf course. On their consolidated

Federal income tax return for the taxable

year ended July 31, 1973, petitioners

claimed their usual depreciation deductions

in respect of the asset included in the

first category described above, and they

also claimed for the first time a

depreciation deduction due to the

amortization of the portion of the estate

for years which represented an interest in

the land and landscaping of the golf

course. In addition, petitioners modified

the computation of their net operating loss

carryover to the taxable year ended July

31, 1973, by including an "amortization

correction" for the taxable year ended July

31, 1972. Thus, petitioners effectively

amended their Federal income tax return for

the taxable year ended July 31, 1972,

because the net operating loss carryover

was computed as if they had claimed a

depreciation deduction due to the amoriti-

zation of the portion of the estate for

years which represented an interest in the

land and landscaping of the golf course.

In determining a deficiency in tax for

the taxable year ended July 31, 1973, the

Commissioner disallowed the depreciation

deduction taken in respect of the estate

for years, and he recomputed petitioners’

net operating loss carryover, eliminating

the "amortization correction" from

petitioners’ computation. Those two

adjustments were made "for the reasons that

your investment in the Lomas Santa Fe

Country Club does not represent an

amortizable or depreciable asset."

B-16

In this proceeding, respondent's chief

argument is that the transfer of assets by

Lomas to Country Club and the retention by

Lomas of an estate for 40 years in some of

those assets should both be disregarded for

tax purposes. Therefore, respondent

reasons that for tax purposes, Lomas still

owns the transferred assets and holds a

direct, nondepreciable fee interest in the

land and landscaping of the golf course.

Petitioners argue that Country Club was

created to fulfill a valid business

purpose, that all transactions between

Lomas and Country Club fulfilled valid

business purposes, that Lomas and Country

Club are separate entities, and that the

form of the initial transaction between

Lomas and Country Club accurately reflected

its substance. Therefore, petitioners

reason that the transfer of assets by Lomas

to Country Club and the retention by Lomas

of an estate for 40 years in some of those

assets should not be disregarded for tax

purposes. Petitioners then conclude that

they properly claimed a depreciation

deduction due to the amortization of the

estate for years which is held by Lomas.

The crux of respondent's argument is

that the manner in which petitioners

structured the transfer of assets and

retention of an estate for years does not

reflect the substance of the transaction.

Respondent contends that petitioners are

attempting to do indirectly what they

cannot do directly, i.e., they are

attempting to depreciate land and

landscaping, which do not have limited

useful lives. Respondent characterizes

Country Club as "little more than a shell"

and describes the transaction between Lomas

and Country Club as a "device." The

100-percent ownership of Country Club by

Lomas initially, and by Lomas and Gildred

eventually, in conjunction with the

B-17

100-percent ownership of Lomas by Gildred,

are seen by Respondent as evidencing

sufficient domination and control by

Gildred to consider the two corporations as

one and the economic interests of Gildred

and the two corporations as inseparable.

Respondent argues by way of analogy to the

doctrine of merger, contending that when

viewed as a whole, Lomas and Country Club

were in the same economic position after

the transaction as before, and Lomas could,

through its control of Country Club, at any

time, convey a fee interest in the property

subject to the estate for years. Respondent

also points out that Country Club had

little or no value to potential buyers

without the assets in which Lomas held an

estate for years. Further, respondent

contends that a fatal flaw in petitioners'

position is the admitted intention of Lomas

to dispose of the golf course and country

club after the residential development of

Lomas Santa Fe had been completed. As

further evidence of the identity of Lomas

and Country Club, respondent points out

that the agreement which granted Lomas a

percentage of membership dues and fees was

later altered to give Lomas a greater share

of those dues and fees. Finally,

respondent argues that the relationship

between Lomas and Country Club regarding

the maintenance and operation of the golf

course and country club is vague and

ill-defined.

At the outset of our discussion of this

iscue, it seems appropriate to note that

this is not an attempt by the Commissioner

to "distribute, apportion, or allocate

gross income, deductions, credits, or

allowances" as he is empowered to dco under

section 482. Instead, the Commissioner has

chosen to ignore the corporate entity of

Country Club for purposes of taxation and

B-18

to disregard entirely the initial

transaction between Lomas and Country Club.

The test that we must use for deciding

whether or not Lomas and Country Club are

separate entities for tax purposes was

enunciated by the Supreme Court in Moline

Properties, Inc. v. Commissioner, 319 U.S.

436 (1943):

The doctrine of corporate entity fills a useful

purpose in business life. Whether the purpose be to

gain an advantage under the law of the state of

incorporation or to avoid or to comply with the

demands of creditors or to serve the creator's

personal or undisclosed convenience, so long as that

purpose is the equivalent of business activity or is

followed by the carrying on of business by the

corporation, the corporation remains a separate

taxable entity.* * *

*% * *In general, in matters relating to the

revenue, the corporate form may be disregarded where

it is a sham or unreal. In such situations the form

is a bald and mischievous fiction. [319 U.S. at

438-439; citations and fn. refs. omitted. ]

The United States Court of Appeals for the

Ninth Circuit, the forum to which this case

would be taken on appeal, has adopted the

foregoing test for use when deciding

whether or not a corporation should be

treated as a separate entity. In O'Neill

v. Commissioner, 271 F.2d 44 (9th Cir.

1959), affg. a Memorandum Opinion of this

Court, the following language was used:

As a general rule, a corporation is to be treated as

an entity separate from the individuals who own it.

Burnet v. Commonwealth Improvement Co., 287 U.S. 415,

419 [(1932)]* * *, Dalton v. Bowers, 287 U.S. 404,

410 [(1932)]}* * *, An exception is recognized and

the corporate structure may be disregarded where (1)

the purpose of its creation was not a business

purpose, and (2) the creation was not followed by any

B-19

business activity. Paymer V. Commissioner, 2d Cir.,

1945, 150 F.2d 334.

On the other hand, where the corporation is

created for a business activity or the creation is

followed by business activity the corporation must be

recognized as a separate entity. National Carbide

Corporation v. Commissiorier, 336 U.S. 422, 428-429

[(1949)]* * *; Skarda v. Commissioner, [250 F.2d 429

(10th Cir. 1957)]* * *; Moline Properties, Inc. v.

Commissioner, 319 U.S. 436, 439 [(1943)]* * * [271

F.2d at 49.]

Both the Supreme Court and the United

States Court of Appeals for the Ninth

Circuit incorporated alternative tests in

the language of their opinions. The

question whether there existed a valid

business purpose for the creation of a

corporation and the question whether that

corporation engaged in business activity

after its creation are questions of fact

which must be answered in light of all of

the facts and circumstances of that case.

Estate of Parshelsky v. Commissioner, 303

F.2d 14, 21 (2d Cir. 1962), revg. 34 T.C.

946 (1960); Van Raden v. Commissioner, 71

T.C. 1083, 1097 (1979), on appeal (9th Cir.,

Sept. 18, 1979); see Commissioner v.

Wilson, 353 F.2d 184, 187 (9th Cir. 1965).

Based upon the entire record in this case,

we have concluded that Country Club was

created for a business purpose, that it

carried on business activity after its

creation, and that its existence as a

separate entity must be respected.

Country Club was formed for two reasons:

first, to serve as a vehicle for the

refinement of title to the residential

properties; and second, to ensure that

membership in the country club that Lomas

had developed would not constitute an equity

interest in Lomas. Both are business

purposes. Respondent has not questioned the

B-20

existence of those motives or their

reasonableness, and we find that Lomas acted

prudently and in its best economic interests.

Country Club was created to solve

practical problems of real estate law.

Attorneys for Lomas wanted to settle all

potential boundary and easement problems

prior to the sale of any residential lots.

By creating a separate entity to hold the

golf course and country club, boundaries

between the transferred property and the

retained residential property would

necessarily be set with accuracy. Because

the residential property and golf course

property were held by different entities,

easements for playing rights, cart paths,

and open slopes could be negotiated easily

and placed on the residential lots with

certainty.

Country Club was created to help Lomas

retain control over the development of Lomas

Santa Fe. Based upon the opinion of the

California Supreme Court in Silver Hills

Country Club v. Sobieski, 55 Cal. 2d 811,

361 P.2d 906 (1961), Lomas was advised by

its legal counsel to form a subsidiary to

hold the golf course and country club. That

case raised the possibility that memberships

sold by Lomas as owner of the golf course

and country club might constitute equity

interests in Lomas. As such, disclosure of

the plans for development of Lomas Santa Fe

would have been required by California

securities law, and the members of the

country club would have had an opportunity

to influence the development of Lomas Santa

Fe.

We also note that Country Club is not a

mere shell; it actively engaged in business

activity after its creation even though

Lomas- operated a portion of the facilities

at the golf course and country club.

B-21

Moreover, no motive or plan of tax avoidance

is apparent in this instance. The formation

of Country Club resulted from purely

business considerations, and it engaged in

business activity after its formation. Both

of the alternative tests that were spelled

out in Moline Properties,

Inc. v. Commissioner, supra, and O'Neill v.

Commissioner, supra, are met in this case,

and we respect Country Club as an entity

separate from Lomas and from Gildred.

Not only are we convinced that there was

a business purpose for the creation of

Country Club, but also we find that there

was a business purpose for the retention by

Lomas of an estate for years in certain

assets which were transferred to Country

Club in exchange for stock. In essence,

Lomas created the golf course and country

club to serve as a "loss leader" which would

attract home buyers. By its very nature as

a “loss leader,” it was more important that

the golf course and country club enhance the

value of residential properties than operate

at a profit. As long as Lomas could operate

the golf course and country club, that

policy could be carried out. If, however,

the membership of the country club obtained

control over the operation of the golf

course and country club,[11] the membership

certainly might not be disposed toward

operation at a loss, the quality of the golf

course and country club could decline, and

{11} In light of the opinion of the California

Supreme Court in Silver Hills Country Club v.

Sobieski, 55 Cal. 2d 811, 361 P.2d 906 (1961), we

have found that it was prudent for Lomas to

anticipate that memberships in the country club might

be classified as securities representing interests in

the corporation which held the assets of the country

club. It would be inconsistent not to take that same

consideration into account when anlyzing the effect

of transferring those assets to Country Club.

B-22

its value to Lomas as a marketing tool could

evaporate. Therefore, to protect the value

of the golf course and country club as a

marketing tool, it was necessary for Lomas

to retain a modicum of operational control

over those facilities. Although other

methods were considered, retention of an

estate for years was chosen as the vehicle

by which that objective would be attained.

Thus, the transfer of assets by Lomas to

Country Club and the retention by Lomas of

an estate for years was motivated by a

business purpose, and respondent's charac-

terization of the transaction as a "device"

is wholly inappropriate. Therefore, the

transaction must not be disregarded. Cf.

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

We adhere to the foregoing result

despite respondent's arguments that Gildred,

Lomas, and Country Club must be viewed as

one for purposes of this case. Respondent

contends that Lomas and Country Club were

both under the domination and control of

Gildred and, therefore, the transfer of

assets by Lomas to Country Club must be

disregarded. To support that contention,

respondent cites Higgins v. Smith, 308 U.S.

473 (1940); National Lead Co. v.

Commissioner, 40 T.C. 282 (1963), affd. on

this issue, revd. in part on another issue

336 F.2d 134 (2d Cir. 1964), cert. denied

380 U.S. 908 (1965); Investors Diversified

Services, Inc. v. Commissioner, 39 T.C. 294

(1962), affd. 325 F.2d 341 (8th Cir. 1963);

Bank of America v. Commissioner, 15 T.C.

544 (1950), affd. per curiam 193 F.2d 178

(9th Cir. 1951); Crown Cork International

Corp. v. Commissioner, 4 T.C. 19 (1944),

affd. per curiam 149 F.2d 968 (3d Cir.

1945). The underpinnings for this line of

cases are illustrated by the following

language from Higgins v. Smith, supra:

B-23

If * * * the Gregory case is viewed as a precedent

for the disregard of a trans‘er of assets without a

business purpose but solely to reduce tax

liability, it gives support to the natural conclusion

that transactions, which do not vary control or

change the flow of economic benefits, are to be

dismissed from consideration. * * * The purpose here

is to tax earnings and profits less expenses and

losses. If one or the other factor in any

calculation is unreal, it distorts the liability of

the particular taxpayer to the detriment or advantage

of the entire taxpaying group. [308 U.S. at 476-477;

emphasis added. }

We acknowledge and embrace the legal

principle espoused in Higgins v. Smith,

supra, and used in all of the foregoing

cases, but the facts in those cases are

readily distinguishable from the facts

here. The cases cited by respondent all

involved the deductibility of losses

realized by taxpayers on sales of property

to their controlled corporations. All of

the sales were found to be shams, unreal,

or lacking economic significance. The

question whether a transaction is a sham,

is unreal, or lacks economic significance

is one of fact. Shaw Construction Co. v.

United States, 323 F.2d 316 (9th Cir.

1963), affg. 35 T.C. 1102 (1961). Based on

the facts present in this case, we are

convinced that the transaction between

Lomas and Country Club, i.e., the creation

of Country Club and the retention of an

estate for years by Lomas, was not a sham

or unreal or lacking in economic signifi-

cance. Rather, it was bona fide, it had a

business purpose, and it substantively

changed the flow of economic benefits. The

transaction was bona fide because it was

valid for purposes of State law, title to

the property passing from Lomas to Country

Club. As for business purposes, the trans-

action was carried out in order to refine

title to the residential properties, to

B-24

insulate the assets of Lomas from the

country club members, and to protect the

value of the golf course and country club

as a marketing tool. The flow of economic

benefits was changed because the trans-

action isolated and identified the assets

which would be subject to an equity claim

by the members of the country club.

Respondent has also cited Johnson v.

Commissioner, 24 T.C. 107 (1955), affd.

233 F.2d 752 (4th Cir. 1956), cert. denied

352 U.S. 841 (1956), to support his

position. Our opinion in Johnson was

premised upon the same rationale as that of

Higgins v. Smith, supra. As explained

above, that rationale and the facts of this

case combine to dictate that we honor the

transaction in issue and give it full

effect for tax purposes.

Respondent argues further that a fatal

flaw in petitioners’ position is evidenced

by the intention of Lomas to dispose of the

golf course and country club after its

utility as a marketing tool had ceased. We

disagree and view that intent as supportive

of petitioners’ position. First, the

intent to sell confirms our holding that

Country Club was created for a business

purpose because the prospect of sale is

consistent with an intent to settle

potential title problems. Second, the

intent to sell confirms our holding that

the golf course and country club were

marketing tools, and our consequent holding

that Lomas had a legitimate interest in the

quality of those marketing tools and a

business purpose in retaining its estate

for 40 years. Although respondent argues

otherwise, we see no relevance in the fact

that a purchaser of the golf course and

country club would have to purchase both

the estate for years and either the assets

of Country Club or Country Club stock in

B-25

order to obtain a fee interest. That fact

only illustrates the effectiveness of the

mechanism chosen by Lomas to limit the

potential interest of country club members.

Respondent also faults the agreement

between Lomas and Country Club, claiming

that the relationship between those

entities is vague and ill-defined and that

subsequent alteration of the agreement

evidences a lack of independence between

the entities. Based upon the testimony and

evidence in this case, we conclude that

this complaint by respondent is without

foundation. The terms of the agreement

were set forth by Lomas in a letter to

country club dated December 3, 1968, which

is set forth in our findings of fact. The

terms are straightforward, and alteration

of the allocation of dues and fees is

contemplated by the portion of the agree-

ment which acknowledges possible "future

agreements or conveyances, which would act

to modify the plan set forth herein."

Respondent's foregoing arguments were

directed solely toward convincing this

Court that we should disregard Country Club

as an entity separate from Lomas and that

we should ignore both the transfer of

assets by Lomas to Country Club and the

retention by Lomas of an estate for 40

years in certain of those assets. One by

one, we have explained why those arguments

are without merit. We, therefore, have

found as facts that Country Club is an

entity separate from Lomas and that neither

the transfer of assets by Lomas to Country

Club nor the retention by Lomas of an

estate for 40 years in certain of those

assets may be disregarded for tax purposes.

Thus, Lomas holds an estate for 40

years. Under California law, an estate for

years is property. More specifically, an

B-26

estate for years is a chattel real. Cal.

Civ. Code sec. 765 (West 1979). By its own

terms, it is an asset with an expiring and

determinable useful life of 40 years. The

estate for 40 years is held by Lomas for

use in its land development business

because the golf course and country club

constitute the cornerstone of the marketing

strategy which has been adopted by Lomas to

promote the sale of residential property.

Lomas has allocated its basis in the land

and landscaping of the golf course and

country club between the retained estate

for 40 years and the transferred remainder

under the method used for valuing such

interests for purposes of the gift tax.[12]

Thus, the estate for 40 years exhibits all

of the characteristics of an asset which is

subject to an allowance for depreciation

pursuant to section 167 and the regulations

thereunder.

Neither of the parties has cited any

cases which would move our inquiry beyond

the issues which are resolved above.

Nevertheless, we are faced with the

unsettling fact that Lomas apparently has

converted a patently nondepreciable asset

to one which is depreciable by simply

relinquishing part of its interest in that

property. After an exhaustive search of

[12] See sec. 25.2512-5(c), (d), and (f) table

II, Gift Tax Regs. The factors used by petitioners

in this case were taken from an extension of table II

which appears in Internal Revenue Publication No.

11. A similar extension of table II appears at par.

1209.50, [1977] Fed. Est. & Gift Tax Rept. (CCH).

See and compare Georgia Railroad & Banking Co. v.

United States, an unreported case (S.D. Ga. 1963, 11

AFTR 2d 1435, 63-1 USTC par. 9443), revd. 348 F.2d

278 (5th Cir. 1965), cert. denied 382 U.S. 973

(1966); C.G. Sloan & Co. v. Commissioner, 38 T.C.

203, 211 (1962); Hunter v. Commissioner, 44 T.C.

109, 115-117 (1965).

B-27

case law, we conclude that there are no

cases directly on point. There is,

however, one case which we find to be

persuasive authority for disallowing

petitioners’ claimed deduction.

In Georgia Railroad & Banking Co. v.

United States, an unreported case (S.D.

Ga. 1963, 11 AFTR 2d 1435, 63-1 USTC par.

9443), revd. 348 F.2d 278 (5th Cir. 1965),

cert. denied 382 U.S. 973 (1966), the

United States District Court for the

Southern District of Georgia was faced with

a unique factual situation and a novel

legal issue. In 1881, the taxpayer leased

its railroad properties, which included

assets of and securities issued by two

other railroad corporations, to an

individual for a term of 99 years. In

1954, with the lease amended but still in

force, the taxpayer-lessor distributed to

its own shareholders its reversionary

interest in 19,180 shares of stock which

were among the securities that were covered

by the lease. After that distribution, the

lessee of the securities continued to be

entitled to hold all of the securities

during the term of the lease; the taxpayer,

as lessor of the assets and securities, was

entitled to the lease payments for the

remainder of the term of the lease; and the

shareholders of the taxpayer, as holders of

the remainder interest in 19,180 shares of

stock, were entitled to those securities

upon expiration of the lease. In other

words, the taxpayer had split its bundle of

property rights in the 19,180 shares of

stock into two parts, one being a retained

lessor's interest with its attendant right

to lease payments and the other being a

transferred remainder interest in the

shares of stock themselves.

Having thus split its property rights

in the 19,180 shares of stock, the taxpayer

B-28

allocated its basis in those shares between

the retained lessor's interest and the

transferred remainder interest. Using a

useful life equal to the remaining lease

term, a salvage value of zero, and the

applicable allocation of basis, the

taxpayer calculated an allowance for

depreciation, in respect of its retained

lessor's interest in the 19,180 shares of

stock, and claimed a depreciation deduction

in that amount. The Commissioner

disallowed the deduction and, pursuant to

refund litigation, the question of

deductibility was presented to the United

States District Court for the Southern

District of Georgia.

The facts in the instant case and

those in the Georgia Railroad & Banking Co.

case are quite similar. In each case, the

taxpayer held nondepreciable property,

subsequently divested itself of a remainder

interest in that property, and attempted to

amortize its retained interest in the

property. In each case, the retained

interest was property held for use in the

taxpayer's business, it was assigned a

basis equal to a properly allocated portion

of the taxpayer's basis in the undivided

property, it had a limited and determinable

useful life, and it had no salvage value.

The transaction which accomplished the two

divisions of property were both undertaken

for valid business purposes and with no

tax-avoidance motives.

Nevertheless, the facts in the instant

case are distinguishable from those present

in the Georgia Railroad & Banking Co. case

in two respects. First, in one case, the

underlying property was stock; in the

other, it was land. Second, in one case,

the underlying property was held by a

lessee, and the taxpayer retained a

lessor's interest after the interest was

B-29

split; in the other case, the underlying

property was held by the taxpayer who

retained an estate for years after the

interest was split. On the whole, however,

we find sufficient factual similarities

between the cases to use the Georgia

Railroad & Banking Co. case as

precedential authority on which our

decision may rest. The key fact in both

cases is the division of property into a

retained interest and a transferred

remainder.

The District Court held in favor of

the taxpayer. Georgia Railroad & Banking

Co. v. United States, an unreported case

(S.D. Ga. 1963, 11 AFTR 2d 1435, 63-1 USTC

par. 9443). The decision followed the

reasoning that, had the taxpayer purchased

rather than retained a present interest in

property having a limited useful life, then

its cost unquestionably would be

amortizable over its useful life. See,

e.g., Bell v. Harrison, 212 F.2d 253 (7th

Cir. 1954). Such reasoning followed the

conclusions that the taxpayer's basis in

the stock could be allocated between the

retained lessor's interest and the

transferred remainder, that the retained

interest constituted property held for the

production of income, and that the retained

interest was a wasting asset with a useful

life of 25-3/4 years. In the course of its

opinion, the District Court pointed out

that the taxpayer's interest in the stock

was bifurcated for valid business purposes

and that no motive of tax avoidance was

present.

Rejecting the legal reasoning but not

the findings of fact of the District Court,

the United States Court of Appeals for the

Fifth Circuit reversed the decision of the

District Court. United States v. Georgia

Railroad & Banking Co., 348 F.2d 278 (5th

B-30

Cir. 1965). We find the following

paragraph of the opinion of the Court of

Appeals to be particularly compelling:

By distributing the reversion in 1954, taxpayer did

nothing more than split its bundle of property rights

into two parts. We cannot see how this action on its

part can result in a depreciable asset where none

previously existed, unless it made some additional

investment. The rights which the taxpayer retained

after the distribution are merely a fragment of the

total bundle of nondepreciable property rights which

the taxpayer had before the distribution. The

taxpayer has obtained no asset which it did not have

in 1913. While similar property might constitute a

depreciable asset when acquired separately from the

reversionary interest in the shares themselves and

while a portion of the total tax basis exists on the

taxpayer's books and that the property is exhaustible

does not alone confer depreciability. While there

need not always be a cost to the taxpayer in order

to permit a depreciation deduction, we think in the

present circumstances the taxpayer is required to

show the acquistion of property in which he has some

separate investment before he can claim a

depreciation deduction. See Detroit Edison Co. v.

Commissioner of Internal Revenue, 319 U.S. 98, 63

S.Ct. 902, 87 L.Ed. 1286 (1943). Depreciability

cannot be conferred merely by the voluntary,

gratuitous division of its nondepreciable property

into two segments, one of which becomes, as a result

of the separation, wasting solely by reason of lapse

of time. * * * [348 F.2d at 288-289; fn. refs.

omitted. ]

As we see it, the Court of Appeals has

enunciated a logical and useful rule. It

will be called into play only when a

nondepreciable asset is divided into two

parts, one of which is kept and one of

which is given up. In that case, the

retained interest will not be considered a

depreciable asset even though the purchase

of a similar interest would result in its

depreciability. The foregoing rule does

B-31

not mean that the basis of the underlying

property may not be allocated between the

retained and transferred interests; the

rule simply disallows the depreciation or

amortization of that basis. We have

followed this course in the past. C.G.

Sloan & Co. v. Commissioner, 38 T.C. 203,

211 (1962). The rule does allow for the

depreciation of additional costs which are

incurred in the acquisition of the interest

as distinguishable from the acquisition of

the underlying property. See Commissioner

v. Moore, 207 F.2d 265, 273-276 (9th Cir.

1953), cert. denied 347 U.S. 942 (1954).

At the point where we digressed from

the decision of the instant case to discuss

the Georgia Railroad & Banking Co. case,

we had just decided the estate for years

held by Lomas was property, was held by

Lomas for use in its trade or business, had

a determinable basis, and had a useful life

of 40 years. Thus, petitioners have made

out a prima facie case for the allowance of

a depreciation deduction in respect of the

estate for years.

Had Lomas purchased the estate for

years from a third party rather than

retained it as part of the creation of

Country Club, its depreciability would be

unquestioned.[13] See, e.g., Bell v.

[13] Whether we characterize the creation of the

estate for years as an exception or a reservation

under California law, Lomas did not purchase the

estate for years from Country Club within the meaning

of the cited cases. Pursuant to the teaching of

{[Williard v. First Church of Christ, Scientist,

Pacifica, 7 Cal. 3d 473, 498 P.2d 987 (1972), we are

of the opinion that Lomas never relinquished the part

of its interest which became the estate for years.

Nevertheless, even if Lomas did trensfer its entire

interest in the property to Country Club, and an

estate for years was then vested in Lomas, for

B-32

Harrison, 212 F.2d 253 (7th Cir. 1954),

and Keitel v. Commissioner, 15 B.T.A. 903

(1929) (purchase of life estate); 1220

Realty Co. v. Commissioner, 322 F.2d 495

(6th Cir. 1963), and Atterbury v.

Commissioner, 1 B.T.A. 169 (1924)

(purchase of lease). Nevertheless, we

hold, as did the United States Court of

Appeals for the Fifth Circuit, that the

retention of an interest which was created

by a division of property is

distinguishable from the purchase of

similar interest. Accordingly, the

foregoing cases which were decided on the

basis of purchased interests and other

cases similarly premised do not control the

outcome of this case.

Instead, we will follow the approach

of the United States Court of Appeals for

the Fifth Circuit and examine the property

which was divided to create the retained

estate for years. Cf. Gulfstream Land &

Development v. Commissioner, 71 T.C. 587

(1979). The land and landscaping of the

golf course did not have limited useful

lives when held by Lomas and, therefore,

were nondepreciable assets. The separation

of that property into two interests, namely

a retained estate for 40 years and a trans-

ferred remainder, does not transform either

part of the whole into a depreciable

asset. Lomas is not entitled to amortize

its basis in the estate for 40 years

because the estate for 40 years is not an

asset which is subject to an allowance for

depreciation under section 167(a). United

States v. Georgia Railroad & Banking

purposes of this case, the estate for years would

merely constitute boot to Lomas in the sec. 351

transaction by which Country Club was created.

Neither instance is a purchase within the meaning of

the cited cases.

B-33

Co., 348 F.2d 278 (Sth Cir. 1965), cert.

denied 382 U.S. 973 (1966). Nor has Lomas

proved that it made any separate investment

in the retained estate for 40 years which

may be recouped through depreciation

deductions.

To reflect the foregoing and

concessions by the parties,

Decision will be entered under

Rule 155.