Norwest Corporation and Subsidiaries, Successor in Interest to United Banks of Colorado, Inc., and Subsidiaries v. Commissioner ( 1998 )

111 T.C. No. 5UNITED STATES TAX COURT
NORWEST CORPORATION AND SUBSIDIARIES, SUCCESSOR IN INTEREST TO
UNITED BANKS OF COLORADO, INC., AND SUBSIDIARIES, ET AL.,1
Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 26499-93, 3723-95, Filed August 10, 1998.
3724-95, 3725-95.
I.
P is the successor in interest to an affiliated
group of corporations whose parent corporation is
United Banks of Colorado, Inc. (the UBC affiliated
group and UBC, respectively). UBC and certain other
members of the UBC affiliated group (collectively, the
Bank) built a structure called the Atrium. P seeks to
allocate the cost of constructing the Atrium to the
bases of adjoining properties that were held by the
Bank. Alternatively, P seeks to deduct the cost of
1
The cases of the following petitioners are consolidated
herewith: Norwest Corp., Successor in Interest to United Banks
of Colorado, Inc., and Subs., docket No. 3723-95; Norwest Corp.,
Successor in Interest to Intrawest Financial Corp. and Subs.,
docket No. 3724-95; Norwest Corp., Successor in Interest to Lorin
Investment Co., Inc. and Subs., docket No. 3725-95.
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constructing the Atrium under sec. 165(a), I.R.C.
Held: P may not allocate the cost of constructing the
Atrium to the bases of the adjoining properties because
the basic purpose of the Atrium was not the enhancement
of the adjoining properties so as to induce sales of
those properties. The basic purpose test enunciated in
Estate of Collins v. Commissioner, 31 T.C. 238 (1958),
and subsequent cases, is applicable, but the Atrium
does not qualify under that test. Held, further, P has
failed to establish a loss equal to the cost of
constructing the Atrium pursuant to sec. 1.165-1(b) and
(d)(1), Income Tax Regs., and, therefore, is not
entitled to a deduction under sec. 165(a), I.R.C.
II.
Pursuant to various agreements (the 1988 Atrium
Transaction), a member of the UBC affiliated group
(LBC) sold an undivided 48-percent interest in the
Atrium and certain related property, and another member
of the UBC affiliated group (UBD) agreed to lease the
Atrium and certain related property from LBC and
another party. The UBC affiliated group reported the
1988 Atrium Transaction as a sale and leaseback for
Federal income tax purposes. Held: P may not disavow
the form of the 1988 Atrium Transaction.
III.
P claims that it is entitled to calculate the
corporate minimum tax for the UBC affiliated group's
1977, 1980, 1984, and 1985 taxable years on a separate
return basis and claims refunds for those years on that
basis. Held: The regular tax deduction under sec.
56(c), I.R.C., for an affiliated group of corporations
is limited to the amount of tax imposed on the group
under chapter one of subtitle A (without regard to the
corporate minimum tax and certain other provisions and
reduced by the sum of certain credits) and, therefore,
P's refund claim is denied.
IV.
P claims that certain furniture and fixtures
placed in service by various members of the UBC
affiliated group during the group’s 1987 through 1989
taxable years, which are described in both asset
guideline classes 57.0 (Distributive Trades and
Services) and 00.11 (Office Furniture, Fixtures, and
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Equipment) of Rev. Proc. 87-56, 1987-2 C.B. 674, should
be classified as class 57.0 property. Held: Rev.
Proc. 87-56 carries forward the pattern established in
Rev. Proc. 62-21, 1962-2 C.B. 418; the priority rule of
Rev. Proc. 62-21 is implicit in Rev. Proc. 87-56:
Asset guideline class 00.11 takes precedence over asset
guideline class 57.0.
V.
P claims that, in determining the portion of the
UBC affiliated group’s consolidated net operating loss
(NOL) that is attributable to bad debt deductions of
bank members, and is, thus, subject to the special
10-year carryback rule of sec. 172(b)(1)(L), I.R.C., it
can apply the special loss ordering rule of sec.
172(l)(1), I.R.C., to the consolidated NOL of both bank
and nonbank members. Held: The consolidated return
regulations contemplate that the consolidated NOL is
comprised of the separate taxable income, including
separate NOL, of each member, and the special ordering
rules of sec. 172(l)(1), I.R.C., apply to a bank not
between a bank member and a nonbank member of an
affiliated group.
Walter A. Pickhardt, Mark Hager, and Scott G. Husaby for
petitioners.
Jack Forsberg, Tracy Martinez, Robert M. Ratchford, and
David L. Zoss, for respondent.
OPINION
HALPERN, Judge: Norwest Corp. (Norwest), a Delaware
corporation, is the petitioner in each of these consolidated
cases. Norwest is the petitioner by virtue of being the
successor in interest to various other corporations. When
necessary for clarity, we shall refer by name to Norwest or one
or the other of those predecessor corporations. Otherwise, we
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shall use the term “petitioner” to refer without distinction to
Norwest or one or more of the predecessor corporations.
These consolidated cases involve determinations by
respondent of deficiencies in petitioner's Federal income taxes
and claims by petitioner of overpayments, as follows:
Norwest Corp. & Subs., Successor in Interest
Docket No. 26499-93 to United Banks of Colorado Inc., & Subs.
Taxable
Year Ending Deficiency Overpayment
Dec. 31, 1988 $1,375,108 $1,655,377
Dec. 31, 1989 1,220,465 1,073,562
Dec. 31, 1990 11,709 641,481
Apr. 19, 1991 20,390 200,417
Norwest Corp., Successor in Interest to
Docket No. 3723-95 United Banks of Colorado, Inc., and Subs.
Taxable
Year Ending Deficiency Overpayment
Dec. 31, 1977 $169,807 $2,266,944
Dec. 31, 1978 390,485 3,625,304
Dec. 31, 1979 123,996 5,931,559
Dec. 31, 1980 2,778 467,598
Dec. 31, 1984 648,163 3,374,964
Dec. 31, 1985 4,637,602 1,596,738
Norwest Corp., Successor in Interest to
Docket No. 3724-95 Intrawest Financial Corp. and Subs.
Taxable
Year Ending Deficiency
Dec. 31, 1980 $34,413
Apr. 30, 1987 1,010
Norwest Corp., Successor in Interest in
Docket No. 3725-95 Lorin Investment Co., Inc., and Subs.
Taxable
Year Ending Deficiency
Dec. 31, 1980 $20,491
Dec. 31, 1981 10,371
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After concessions by the parties, the issues remaining for
decision are (1) whether petitioner may allocate the cost of
certain property to the bases of other properties, (2) whether
petitioner is entitled to a loss deduction under section 165(a)
for the cost of certain property, (3) whether petitioner may
disavow the form of a transaction relating to certain property,
(4) whether petitioner is entitled to refunds of tax paid
pursuant to section 56(a), (5) the applicable recovery period for
determining depreciation deductions with respect to certain
furniture and fixtures, and (6) the appropriate method for
determining that portion of a consolidated net operating loss
attributable to the bad debt deductions of the bank members of an
affiliated group. Some of the facts have been stipulated and are
so found. The stipulations of facts filed by the parties, with
accompanying exhibits, are incorporated herein by this reference.
The parties have made 150 separate stipulations of fact,
occupying more than 40 pages, and there are 174 accompanying
exhibits. We shall set forth only those stipulated facts that
are necessary to understand our report, along with other facts
that we find.
Unless otherwise noted, 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.
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CONTENTS
I. Background ...............................................7
II. Atrium Issues..............................................8
A. Findings of Fact......................................8
1. Background........................................8
2. Events Preceding the 1981 Transactions. ...........11
a. Introduction................................11
b. The Committee Meeting of August 24, 1979....12
c. The Harrison Price Report...................13
d. The Planning Dynamics Report................14
e. The Committee Meeting of August 25, 1980....15
f. Approval of the Facilities Master Plan......16
3. The 1981 Transactions............................16
a. The 1700 Partnership........................16
b. The Ground Lease............................16
c. The Atrium Project Agreement................17
d. The Skyway Agreement, the 1981 Easement
Agreement, and the Space Lease..............18
4. The Ross and Eastdil Reports.....................19
5. The Committee Meeting of October 24, 1984........22
6. Construction and Operation of the Atrium.........22
7. The Atrium Assets: Cost Bases and Depreciation...24
8. The 2UBC Transaction.............................26
a. The Various Agreements......................26
b. Tax Treatment of the 2UBC Transaction.......27
9. The 3UBC Transaction.............................28
a. The Various Agreements......................28
b. Tax Treatment of the 3UBC Transaction.......30
10. The 1UBC Land Transaction........................30
11. The 1988 Atrium Transaction......................31
a. Background..................................31
b. The Atrium Sale Agreement...................31
c. Tax Treatment by UBC of the
1988 Atrium Transaction.....................33
d. UBC's Financial Statements..................34
e. Petitioner's Responses to Information
Document Requests Regarding the Atrium......34
B. The Atrium Assets: Allocation of the Costs...........35
1. Issue............................................35
2. Arguments of the Parties.........................36
3. Analysis.........................................38
a. Developer Line of Cases......................38
b. The Principles of the Developer
Line of Cases................................42
c. Application of the Basic Purpose Test........44
4. Conclusion.......................................49
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C. The Atrium Assets: Loss Deduction
Under Section 165(a).................................51
D. The 1988 Atrium Transaction: Disavowal of Form.......52
1. Issue............................................52
2. Arguments of the Parties.........................52
3. Analysis.........................................53
a. Introduction.................................53
b. The Danielson Rule Does Not Apply............54
c. Respondent’s Weinert Rule....................55
d. Estate of Durkin v. Commissioner.............58
e. Petitioner May Not Disavow the Form of the
1988 Atrium Transaction......................59
4. Conclusion.......................................62
III. Corporate Minimum Tax Issue...............................62
A. Introduction.........................................62
B. The Corporate Minimum Tax Provisions.................63
C. The Two Methods......................................64
1. UBC's Method.....................................64
2. Petitioner's Method..............................64
D. Analysis.............................................67
1. Issue............................................67
2. Arguments of the Parties.........................67
3. Discussion.......................................69
E. Conclusion...........................................75
IV. Furniture and Fixtures Recovery Period Issue.............75
A. Introduction.........................................75
B. Applicable Recovery Period; Class Life...............78
C. Arguments of the Parties.............................80
D. Discussion...........................................81
E. Conclusion...........................................87
V. Net Operating Loss Issue.................................87
A. Introduction.........................................87
B. Facts................................................89
C. Petitioner’s Position................................93
D. Discussion...........................................94
E. Conclusion...........................................97
I. Background
On the date that the petition in each of these cases was
filed, Norwest’s principal place of business was in Minneapolis,
Minnesota. Norwest is a bank holding company whose affiliates
provide banking and other financial services.
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On April 19, 1991, United Banks of Colorado, Inc. (UBC), a
Colorado corporation, was merged with and into Norwest pursuant
to section 368(a)(1)(A). At all relevant times prior to its
merger with Norwest, UBC was the common parent corporation of an
affiliated group of corporations making a consolidated return of
income (the UBC affiliated group). UBC was a calendar-year
taxpayer. Petitioner is the successor in interest to the UBC
affiliated group as it existed during the years in issue.
On May 1, 1987, Intrawest Financial Corp. (Intrawest), a
Colorado corporation, was merged with and into UBC pursuant to
section 368(a)(1)(A). At all relevant times prior to its merger
with UBC, Intrawest was the common parent corporation of an
affiliated group of corporations making a consolidated return of
income (the Intrawest affiliated group). Petitioner is the
successor in interest to the Intrawest affiliated group for its
taxable year 1980 and its short taxable year ended April 30,
1987.
On April 1, 1982, UBC purchased for cash the stock of Lorin
Investment Co., Inc. (Lorin), a Colorado corporation. At all
relevant times prior to being acquired by UBC, Lorin was the
common parent corporation of an affiliated group of corporations
making a consolidated return of income (the Lorin affiliated
group). Petitioner is the successor in interest to the Lorin
consolidated group for its taxable years 1980 and 1981.
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II. Atrium Issues
A. Findings of Fact
1. Background
During the years in issue, UBC owned in excess of 99 percent
of the stock of United Bank of Denver (UBD), a national bank with
its principal place of business in Denver, Colorado. UBD was the
sole shareholder of Lincoln Building Corp. (LBC), a Colorado
corporation. LBC was the real estate holding company for UBD.
(In the papers filed in this case, the convention of the parties
has been to use the term “the Bank” to refer to UBC, UBD, or LBC,
individually or collectively, in cases where those corporations
acted in concert or where separate identification would not be
material. We shall adopt that convention.)
During the 1970s, LBC owned a portion of a block in downtown
Denver, Colorado, which is bounded by 17th Avenue to the south,
by 18th Avenue to the north, by Broadway to the west, and by
Lincoln Street to the east (the Broadway-Lincoln block). During
the 1970s and throughout some of the years in issue, LBC owned
two buildings located on the Broadway-Lincoln block, namely, Two
United Bank Center Building, located at 1700 Broadway (2UBC) and
Three United Bank Center Building, located at 1740 Broadway
(3UBC). A sketch of the Broadway-Lincoln block, the two
buildings, and certain other features is attached hereto as an
appendix.
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2UBC is a 22-story office building, which was constructed in
1954 and has approximately 390,000 square feet of rentable space.
2UBC is considered a notable building in Denver because it was
the first modern highrise built in the city and was the first
highrise designed by I.M. Pei. 3UBC is a four-story office
building, which was constructed in 1958 and has approximately
115,000 square feet of rentable space. Throughout the 1970s,
2UBC was primarily leased to non-Bank tenants, and 3UBC was
wholly occupied by the Bank. 3UBC served as the Bank's
headquarters prior to completion in 1983 of One United Bank
Center Building (1UBC). See infra sec. II.A.3.b.
During the 1970s, LBC also owned land on the Broadway-
Lincoln block between 2UBC and 3UBC and east of 2UBC extending to
Lincoln Street. There were improvements on that land
constituting an enclosed courtyard. On the corner of Lincoln
Street and 17th Avenue of the Broadway-Lincoln block were a
glass-enclosed restaurant and a small office building, both of
which were owned by LBC.
During the 1970s, LBC owned a portion of a block in downtown
Denver, Colorado, that is bounded by 17th Avenue to the south, by
18th Avenue to the north, by Lincoln Street to the west, and by
Sherman Street to the east (the Lincoln-Sherman block). That
block is directly to the east of and across Lincoln Street from
the Broadway-Lincoln block. During the 1970s and throughout some
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of the years in issue, LBC owned land and improvements on the
Lincoln-Sherman block directly across from 3UBC, including a
structure named Motorbank I. That structure consisted of three
underground levels, two of which contained office space and one
of which contained mechanicals, a ground level that contained
office space, and 10 floors of above-ground parking space.
Motorbank I had approximately 1,000 square feet of office space
and approximately 103,000 square feet of parking space. 3UBC was
connected to the Motorbank I parking garage by an elevated,
enclosed pedestrian walkway and was connected to the Motorbank I
office space by a passage under Lincoln Street. Motorbank I also
had facilities to accommodate drive-up banking through about
1987.
During the 1970s, LBC owned a portion of a block in downtown
Denver, Colorado, that is bounded by 17th Avenue to the south, by
18th Avenue to the north, by Sherman Street to the west, and
Grant Street to the east (the Sherman-Grant block). That block
is directly to the east of and across Sherman Street from the
Lincoln-Sherman block. In the late 1970s, LBC purchased property
on the Sherman-Grant block.
2. Events Preceding the 1981 Transactions
a. Introduction
In the late 1970s, the Bank was in need of additional office
space and was planning the development of a new office tower.
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Unable to acquire a site on Broadway (the intersection of
Broadway and 17th Avenue, where 2UBC was located, was considered
the “100 percent corner” in the central business district of
Denver), the Bank decided to pursue the development of an office
tower on the Lincoln-Sherman block. At that time, the Lincoln-
Sherman block was on the fringe of the central business district
and was considered to be a substantially less preferable location
than the Broadway-Lincoln block. In the late 1970s, LBC acquired
land on the Lincoln-Sherman block adjacent to Motorbank I and
fronting on the corner of Lincoln Street and 17th Avenue in
contemplation of the construction of a new headquarters building
on the site.
The Board of Directors of UBD had a working committee called
the Directors' Facility Planning Committee (the Committee), which
initiated or approved all major decisions regarding the Bank's
real estate holdings. The Committee was closely involved in the
planning of the new office tower project (the Project).
In the late 1970s, Planning Dynamics Corp. (Planning
Dynamics), was retained by the Bank as a consultant for the
Project and was closely involved in the Project through 1986.
In 1979, the Gerald D. Hines Interests (the Developer) was
selected by the Bank as the developer for the Project.
In 1979, the Bank and the Developer selected the firm of
Johnson-Burgee (the Architects) to be the architects for the
Project.
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b. The Committee Meeting of August 24, 1979
Architectural plans for the Project prepared by the
Architects were presented to the Committee on August 24, 1979.
The Architects proposed that a glass atrium be constructed on the
Broadway-Lincoln block enclosing the area between 2UBC and 3UBC
(and east of 2UBC) and that the atrium be connected to the new
office tower on the Lincoln-Sherman block by an elevated,
enclosed pedestrian walkway across Lincoln Street. The minutes
of the Committee meeting on August 24, 1979, in part, provide:
Mr. Hershner presented an architectural scale
model of the project as designed by Philip Johnson &
John Burgee for review by the Committee, and explained
the impact to the existing bank block. The
architectural scheme as shown resolves two major design
issues: how to tie the new tower to 17th Avenue and
Broadway and how to achieve identity of the new tower
and existing bank facilities as a “center” even though
the properties are separated by Lincoln Street.
The solution proposed by Johnson/Burgee shows a
strong skyline identity and unique visual image created
by the curvilinear roof line of the new tower.
Identity of the project as a “center” from a
pedestrian scale at the street level is achieved by the
skylight enclosure bridging Lincoln Street, then
wrapping around the existing Tower Building and
connecting with the Main Bank.
Circulation patterns to the new tower through the
proposed enclosed mall in the existing bank block
effectively places the “front door” of the new tower on
17th and Broadway. * * *
c. The Harrison Price Report
In 1980, the Bank retained the Harrison Price Co. (Harrison
Price) as an outside consultant to address a number of issues
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regarding the Project, including whether the proposed atrium
should remain a part of the Project. Harrison Price prepared a
report dated August 20, 1980, entitled “Economic Contribution of
the Glass Pavilion to the United Bank of Denver”, setting forth
its opinion regarding the proposed atrium (the Harrison Price
Report). The Harrison Price Report assumed that the proposed
atrium would cost $16 million and estimated that it would
generate a net operating deficit of $100,000 a year, based on
revenues and operating expenses of $500,000 and $600,000,
respectively. The Harrison Price Report concluded that the
proposed atrium “is a rational and constructive commitment which
will return a positive benefit to the stockholders” of the Bank.
That opinion was based on three factors: (1) the proposed atrium
would increase the rental rates for 2UBC and 3UBC to generate a
value addition of $9 million, (2) the proposed atrium “provides a
means to counteract any adverse perception of Number 1 United
Bank Center associated with an off-Broadway location”, and
(3) the proposed atrium “will in all liklihood [sic] add power,
presence, and image to the Bank's operation which will be
reflected in greater market share.”
d. The Planning Dynamics Report
In a letter dated August 25, 1980, Richard R. Holtz,
president of Planning Dynamics, addressed the economics,
aesthetics, and functionality of the proposed atrium (the
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Planning Dynamics report). Planning Dynamics estimated the
incremental cost of building the proposed atrium to be
approximately $9 million. Planning Dynamics estimated that
constructing the proposed atrium would increase the rental rate
for 2UBC by $2 a square foot, thereby increasing the value of
2UBC by approximately $7 million. Planning Dynamics estimated an
increased rental rate for the new office tower of $1 a square
foot, thereby increasing its value by approximately
$12.3 million, $3.5 million of which would inure to the benefit
of the Bank. Although Mr. Holtz believed that the proposed
atrium would enhance the value of 3UBC, he did not project any
increase in value to 3UBC in the Planning Dynamics report because
3UBC was wholly occupied by the Bank and was not considered as a
sale property for the Bank. Planning Dynamics calculated a value
over cost figure for constructing the proposed atrium of
approximately $1.5 million. Planning Dynamics also estimated a
net annual operating deficit of $100,000 a year, based on
projected revenues and expenses of $500,000 and $600,000,
respectively. In addition, the Planning Dynamics report stated:
As you know the design problem from the beginning
has been to “bring” the Lincoln Street site to
Broadway. This will allow the One United Bank Center
building to gain the benefits of a 100% corner location
in lieu of a secondary location. The main benefit is
higher rents as previously mentioned.
The unique architectural design of the Atrium
sensitively embraces Two United Bank Center and
continues to present this fine building to the 17th and
Broadway location. At the same time the Atrium creates
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a powerful “memory shape” impression which gives unity
to four different buildings and creates the “Center”.
In seeing this shape again at the top of One United
Bank Center viewers will visually identify with the
“Center” from vantage points all over Denver. When one
sees the top ones [sic] mind will automatically recall
the shape at the Atrium level.
This design will give the Bank great visual and
location identity as did the designs for Pennzoil in
Houston and Transamerica in San Francisco and should be
very helpful in marketing and staying unique among
tough competitors.
e. The Committee Meeting of August 25, 1980
On August 25, 1980, the Committee considered the issue of
whether the proposed atrium should be retained as part of the
Project. The Committee reviewed the Harrison Price Report, the
Planning Dynamics report, and financial projections showing the
impact that construction of the proposed atrium could have on
earnings by increasing the Bank's market share. The minutes of
the Committee meeting on August 25, 1980, in part, provide:
Bank management feels very positive about the project.
The general feeling of the Bank is in favor of the
enclosed atrium to allow the Bank to achieve a larger
market share. The atrium should create a major center,
making United Bank Center a nationally notable building
complex.
f. Approval of the Facilities Master Plan
On September 8, 1980, the Committee approved the Facilities
Master Plan, which included construction of the proposed atrium.
On September 10, 1980, that plan was approved at a joint meeting
of the boards of directors of UBC and UBD.
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3. The 1981 Transactions
a. The 1700 Partnership
1700 Lincoln Limited (the 1700 Partnership) was a Colorado
limited partnership. Hines Colorado Ltd. (Hines Colorado), a
Colorado limited partnership, was the sole general partner of the
1700 Partnership, and ARICO America Realestate Investment Co.
(ARICO), a Nevada corporation operating as a real estate
investment trust, was the sole limited partner of the 1700
Partnership.
b. The Ground Lease
By a lease agreement dated February 5, 1981, LBC leased to
the 1700 Partnership for a term of 70 years (1) land on the south
end of the Lincoln-Sherman block (between Motorbank I and 17th
Avenue) and (2) land on the south end of the Sherman-Grant block
(together, the 1UBC land) (the Ground Lease). The Ground Lease
provided that the 1700 Partnership would, at its own expense,
construct an office tower on the Lincoln-Sherman block (1UBC) and
a parking garage on the Sherman-Grant block (the Parking Garage),
according to the plans and specifications appended to the Ground
Lease. The Ground Lease provided for the payment to LBC of both
a fixed rent and a rent based on the net cash flow generated by
1UBC and the Parking Garage.
Following the execution of the Ground Lease and related
documents, the 1700 Partnership commenced construction of 1UBC,
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which is a 52-story office tower with approximately 1,174,200
square feet of rentable space, and of the Parking Garage;
construction was completed in the second half of 1983.
c. The Atrium Project Agreement
Concurrently with the execution of the Ground Lease, the
Bank and the 1700 Partnership entered into an agreement dated
February 5, 1981, whereby the Bank, at its sole expense, would
construct a glass atrium (the Atrium) on the Broadway-Lincoln
block, enclosing the area between 2UBC and 3UBC (and east of
2UBC) (the Atrium Project Agreement). The Atrium Project
Agreement stated that the Atrium and the Skyway, see infra sec.
II.A.3.d., were being constructed “in order to accomplish the
appropriate integration of the New Project [1UBC] with the
Principal Bank Property [2UBC and 3UBC].” The Developer and the
1700 Partnership would not have made the commitment to build 1UBC
had the Bank not made a commitment to build the Atrium. In 1984,
at the request of the Bank, the architectural plans for the
Atrium were modified to reduce the scale of the Atrium and to
address certain safety concerns.
d. The Skyway Agreement, The 1981 Easement Agreement,
and The Space Lease
Concurrently with the execution of the Ground Lease and the
Atrium Project Agreement, the Bank and the 1700 Partnership
entered into an agreement dated February 5, 1981, whereby the
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1700 Partnership would construct an elevated, enclosed pedestrian
walkway (the Skyway) connecting 1UBC with the Atrium, and the
costs of construction and maintenance of the Skyway would be
shared equally by the 1700 Partnership and the Bank (the Skyway
Agreement).
Concurrently with the execution of the Ground Lease, the
Atrium Project Agreement, and the Skyway Agreement, the Bank and
the 1700 Partnership entered into an agreement dated February 5,
1981, whereby the Bank granted to the 1700 Partnership, its
successors and assigns, and to the current and future fee owners
of the 1UBC land and improvements thereon, an easement for
pedestrian access in, on, over, and through the common areas of
the Bank's property on the Broadway-Lincoln and Lincoln-Sherman
blocks, including the Atrium (the 1981 Easement Agreement). In
addition, under the 1981 Easement Agreement, the 1700 Partnership
granted to the Bank an easement for pedestrian access in, on,
over, and through the common areas of 1UBC.
Concurrently with the execution of the Ground Lease, the
Atrium Project Agreement, the Skyway Agreement, and the 1981
Easement Agreement, the Bank and the 1700 Partnership entered
into an agreement dated February 5, 1981, whereby the Bank agreed
to lease (approximately 500,000 square feet of) space in 1UBC.
4. The Ross and Eastdil Reports
In 1984, prior to construction of the Atrium, the Bank
retained two real estate consulting firms, Ross Consulting and
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Eastdil Realty, Inc. (Eastdil Realty), to evaluate the Bank's
real estate holdings and to make recommendations regarding the
possible sale of properties held by the Bank. Ross Consulting
prepared a report dated February 6, 1984, entitled “Working
Outline--Real Estate Sale Considerations” (the Ross report),
which was reviewed by the Committee at its meeting of
February 17, 1984. The Ross report's recommendations regarding
the Atrium were, in part, as follows:
Our recommendations flow from the assumption that
UBC will construct the Atrium. Examination of benefits
therefrom (either higher rents or higher purchase
price) suggest that UBC should build only if legally or
“morally” bound to.
Ross presumes that the proposed Atrium will be
more valuable, or will add more value to adjacent
properties, once completed. Our analysis has proceeded
from the standpoint of weighing cost of waiting for
completion versus benefit to be gained thereby.
Therefore, wait to sell Atrium until constructed, if
economically possible. Although Atrium adds to Bank
image, it does not yield 1:1 dollars to third party
investor return. Guarantees for construction will
complicate the deal.
To “cleanly” justify Atrium construction, cash
flow must be increased by 2.5 million a year
($25 million cost capitalized by 10%). This amount is
a 100% increase over current annual UBC II rental
income. Whether current leases in UBC II can be
renegotiated and UBC will pay higher rents in III on a
leaseback due to Atrium's presence remains to be seen.
Higher rents are more likely to be negotiated during a
possibly healthier downtown real estate market in 1986-
1988, especially with the new Atrium serving to
“refurbish” the UBD complex, as opposed to
renegotiation of rents in the current “tenant's
market,” pointing at architectural plans for the
Atrium.
Presume that maximum value of Atrium would be
realized by sale of UBC II and III together (to same
- 21 -
investor).
Eastdil Realty prepared a report dated July 16, 1984,
entitled “Report to the United Banks of Colorado on One, Two and
Three United Bank Centers and the Atrium Commitment” (the Eastdil
report), which was reviewed by the Committee at its meeting of
September 24, 1984. An observation made in the Eastdil report
provides:
Construction of the atrium will inhibit the Bank
from selling its Broadway-Lincoln property as one unit.
This may reduce the proceeds from the sale of the
Bank's property on the block. In the discussion of the
Broadway-Lincoln block below, we conclude the Bank may
be able to get more for its Broadway-Lincoln property
if it is sold as one package rather than if Two and
Three United Bank Center are sold separately. If the
entire block is sold as a package, the purchaser can
keep the existing buildings, or replace them with a new
52-story office tower at some future date. This
assumes, however, that the atrium is not built.
If the atrium is built, the remaining ground area
on the Bank's portion of the block is not sufficient to
support a 52-story building. As a result, the block is
no longer as attractive a development site, and as such
will probably not command as high a sales price.
In addition, the Eastdil report estimated that the present
value of the net cash flow that would be generated by the retail
operations planned for the Atrium was $2.7 million. The report
noted that, although optimistic, the present value of the net
cash flow that could be generated from adding 39,000 square feet
of additional retail space “by opening the second and third
floors of Three United Bank Center to retail and building Two
United Bank Center out at the ground level to the sidewalk on all
sides and on the second floor” could be as high as $6.9 million.
- 22 -
The Eastdil report concluded that, under the most likely
scenario, the net present value of the additional income to be
generated by the Atrium, both directly from retail space in the
Atrium and indirectly from increased rents from 1UBC and 2UBC,
was $6.2 million and could not alone justify the $25 million cost
of constructing the Atrium. The Eastdil Report, however,
qualified that conclusion as follows:
Notwithstanding the significant construction risk
associated with building the atrium, there may be
reasons why the Bank should consider proceeding with
the project. Successful completion of the atrium will
enhance the Bank's image in the community and give it
greater recognition in the region. It is not realistic
for us to place a dollar value on these benefits.
Undoubtedly they are substantial and could produce a
direct and positive impact on the Bank's business.
More significantly, if the Bank does not complete
construction of the atrium, its image in the community
may be tarnished. It is clear that the Bank has an
obligation to its partners and to the tenants in One
United Bank Center to complete construction of the
atrium facility, or, if possible substitute another
amenity to be completed at a later date. If the atrium
is not built, the building owners run the substantial
risk that at least some tenants will sue to reduce
their rents or get out of their leases altogether. The
cost of securing a release from the atrium obligation
could tip the balance in favor of completing the atrium
facility.
The Eastdil report recommended “against building the atrium if
the Bank can obtain release from its commitment for less than
$22 million less whatever ``recognition value' the Bank believes
the atrium would produce.”
5. The Committee Meeting of October 24, 1984
At the meeting of the Committee on October 24, 1984, Bank
management proposed to offer 2UBC and the Ground Lease for sale
- 23 -
at an asking price in the range of $33 million each. In its
presentation to the Committee, management cited several reasons
for selling 2UBC at that time, but acknowledged that “[a] sale
now may not fully reflect the value to be added by the Atrium
when it is completed.” The committee approved the proposal to
offer 2UBC and the Ground Lease for sale. In addition,
management recommended that construction of the Atrium proceed.
Considerations for completing the Atrium that were noted in the
presentation to the Committee were as follows:
A. The Atrium retains a great deal of appeal;
architecturally, as an enhancement to the Bank's image,
and in value added to the properties.
B. We think our minimum cost not to build would
be about $16,000,000. It makes more sense to build it
for $25,000,000 than to not build it at a cost of
$16,000,000.
At the meeting, the Committee approved the budget for the Atrium.
6. Construction and Operation of the Atrium
Construction of the Atrium commenced in April 1985 and was
completed in late 1987; however, portions of the Atrium were open
to the public in 1986. The Atrium sits on an irregularly shaped,
30,510 square-foot parcel of land on the Broadway-Lincoln block
and has frontage of 96.40 feet along Broadway, 198.75 feet along
Lincoln Street, and 113.32 feet along 17th Avenue. The Atrium
covers a 24,333 square-foot area, encompasses approximately
4.6 million cubic feet of space, and, at its highest point, is
14 stories tall. The Atrium is constructed of glass, steel, and
stone. The Atrium is physically attached to both 2UBC and 3UBC
- 24 -
and is connected to 1UBC by the Skyway. There are pedestrian
entrances to the Atrium in 2UBC, 3UBC, and the Skyway, and on
Broadway, Lincoln Street, and 17th Avenue.
The Atrium shares its mechanical systems with 2UBC; those
systems are located below ground within 2UBC. The basement area
of the Atrium is used for storage and houses a backup power
generator. The Atrium contains space for one restaurant and
retail space for one tenant.
Beginning about 1988, UBD owned and operated The Atrium
Cafe, which seated approximately 135 people, and UBD paid a fee
to a contractor to manage the restaurant's operations. Beginning
in 1994, UBD discontinued operating The Atrium Cafe and leased
the space for the operation of another restaurant. UBD also
leased space for the operation of “expresso carts”.
Beginning on October 12, 1987, for a 10-year term, the
retail space in the Atrium had been leased for the operation of a
Russell's convenience store (the Russell's lease).
From the time of the Atrium's opening in 1986, the only
operating revenues generated by the Atrium have been derived from
the Russell's lease and from the operations of The Atrium Cafe
and other food operations. Those operating revenues have been
less than overhead expenses (maintenance, utilities, taxes,
etc.), resulting in net operating losses during the period 1989
through 1995, as follows:
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Income Overhead Total Atrium
Year (Loss) Expense Loss
1989 ($13,781) $478,890 $492,671
1990 (21,026) 533,198 554,224
1991 (22,728) 564,120 586,848
1992 992 525,548 524,556
1993 (46,294) 731,558 777,852
1994 24,216 745,909 721,693
1995 98,899 788,724 689,825
The Bank has never maintained teller windows or other
banking facilities in the Atrium and has never solicited new
customers from within the Atrium. The Bank has never held
business meetings in the Atrium and has never leased the Atrium
for events. The Bank, however, allows the use of the Atrium by
community groups an average of once a month.
7. The Atrium Assets: Cost Bases and Depreciation
LBC constructed the Atrium Cafe and installed equipment,
furniture, and fixtures therein.
During the years in issue, LBC installed a security system
and signage in the Atrium (the Atrium Security System and
Signage).
During the years in issue, LBC incurred costs to construct,
equip, and install the Skyway, The Atrium Cafe, the Atrium
Security System and Signage, and the remaining components of the
Atrium (the Atrium Structure) (collectively, the Atrium Assets).
The cost bases of the Atrium Assets placed in service during the
years in issue, as adjusted pursuant to section 48(q) for the
investment tax credits claimed with respect to such assets, were
as follows:
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Cost Bases
Taxable Atrium
Year Placed Atrium Atrium Security System
in Service Structure Skyway Cafe and Signage
1986 $31,805,978 -- -- --
1987 -- $26,195 $1,676,090 $246,453
1989 -- -- 2,058 699
1990 144,261 -- 21,917 10,800
On its Federal income tax returns for the taxable years 1986
through 1991, the UBC affiliated group claimed depreciation
deductions with respect to the Atrium Assets as follows:
Depreciation Claimed
Atrium
Taxable Atrium Atrium Security System
Year Structure Skyway Cafe and Signage
1986 $234,121 -- -- --
1987 2,458,735 $2,009 $134,960 --
1988 2,104,223 938 266,895 $60,381
1989 1,190,409 930 190,190 43,211
1990 1,191,171 930 148,151 31,505
1991 344,402 295 39,458 8,955
The depreciation deductions claimed on the Atrium Assets were
computed on 100 percent of the cost bases of the assets as set
forth above, except that, after 1988, the depreciation deductions
claimed with respect to the Skyway and that portion of the Atrium
Structure placed in service prior to 1989 were computed on
51.5152 percent of the assets' cost bases.
8. The 2UBC Transaction
a. The Various Agreements
Den-Cal Co. (Den-Cal) was a California limited partnership
whose managing general partner was Emerik Properties Corp.
(Emerik).
By a purchase and sale agreement dated July 16, 1985, LBC
sold 2UBC and the land thereunder and an undivided 50-percent
- 27 -
interest in Motorbank I and the land thereunder to Den-Cal for
$35,500,000 (the 2UBC Sale Agreement).
Concurrently with the execution of the 2UBC Sale Agreement
and other agreements, LBC and Den-Cal entered into an agreement
that required LBC to construct the Atrium and the Skyway and to
make certain improvements to 2UBC (the 2UBC Construction
Agreement). Pursuant to the 2UBC Construction Agreement, LBC and
Den-Cal granted to each other certain reciprocal easements
pertaining to the ingress and egress of pedestrians through
common areas, including the Atrium. In addition, LBC agreed to
maintain its improvements on the Broadway-Lincoln block,
including the Atrium, at its sole cost and expense.
LBC agreed to operate the Atrium in an attractive and
orderly manner and to refrain from substantially modifying the
exterior design of the Atrium for a 35-year period commencing on
November 1, 1986, and running through October 31, 2021, and
thereafter until LBC provides at least 6 months' notice to Den-
Cal of its election to terminate (the Atrium Operating
Covenants). The 2UBC Construction Agreement, however, allowed
LBC to terminate its obligations relating to the Atrium after
June 30, 2001, upon payment to Den-Cal of a termination fee and
the occurrence of certain other conditions. LBC and Den-Cal
acknowledged that LBC's election to terminate the Atrium
Operating Covenants “would result in the diminution in value of
Two United Bank Center in an amount at least as large as the
- 28 -
termination fee”, and, accordingly, LBC granted to Den-Cal a lien
to secure performance under the Atrium Operating Covenants in the
event that the Atrium were razed prior to expiration of the
obligations.
The 2UBC Sale Agreement, the 2UBC Construction Agreement,
and related agreements shall be referred to collectively as the
2UBC Transaction.
b. Tax Treatment of the 2UBC Transaction
As a result of the 2UBC Transaction, LBC realized the
following amounts from the sale of its properties:
Property Amount Realized
2UBC improvements $22,847,841
2UBC land 4,219,181
50-percent interest in
Motorbank I improvements 9,795,022
50-percent interest in
Motorbank I land 2,038,506
On January 26, 1988, the UBC affiliated group filed an
amended corporate income tax return for its 1985 taxable year, on
which the UBC affiliated group reported adjusted bases for
determining gain or loss from the sale of its properties in the
2UBC Transaction as follows:
Property Adjusted Basis
2UBC improvements $15,533,317
2UBC land 664,559
50-percent interest in
Motorbank I improvements 1,816,730
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50-percent interest in
Motorbank I land 321,083
The parties agree that those adjusted bases are correct, except
to the extent, if any, that the cost of the Atrium Assets, see
supra sec. II.A.7., is allocable to the bases of the properties
sold in the 2UBC transaction.
9. The 3UBC Transaction
a. The Various Agreements
By purchase and sale agreement dated December 31, 1987, LBC
sold 3UBC, but not the land underlying 3UBC (the 3UBC land), to
Holme, Roberts & Owen (HRO), a partnership that was engaged in
the practice of law and that served as the Bank's legal counsel
during the years in issue (the 3UBC Sale Agreement). The
purchase price of $15,957,648 was paid by a note that was
nonrecourse to the partners of HRO; however, the note was secured
by a deed of trust to 3UBC and an irrevocable letter of credit in
the amount of $2.4 million.
By an agreement dated December 31, 1987, LBC leased the 3UBC
land to HRO for a term commencing on December 31, 1987, and
running for 34 years and 9 months (the 3UBC Ground Lease). For
the period through September 30, 2012, the annual rent was
$25,000 plus 30 percent of any net rental income generated by
3UBC in excess of $2.5 million. After September 30, 2012, the
rent was to be at fair market value. Pursuant to the 3UBC Ground
Lease, LBC and HRO granted to each other certain reciprocal
easements pertaining to the ingress and egress of pedestrians
- 30 -
through common areas, including the Atrium. Also, LBC agreed to
operate the Atrium in an attractive and orderly manner and to
refrain from substantially modifying the exterior design of the
Atrium. In the event that the Atrium was materially damaged,
destroyed by fire or other casualty, or taken by condemnation,
LBC had the option to rebuild, replace, repair, or raze the
Atrium. If LBC elected to raze the Atrium, LBC was required to
cover the area with an attractive surface until rebuilding (if
any) and to grant HRO a 40-foot setback easement on the south
side of the 3UBC land.
By an agreement dated December 31, 1987, UBD leased back the
entirety of 3UBC from HRO (the 3UBC Space Lease). The 3UBC Space
Lease had an initial term of 9 years and 6 months and
automatically renewed for a second term running until
September 30, 2012, unless UBD elected otherwise. The rent was
$2,070,000 a year during the initial term and $2,333,452 a year
during the second term. The 3UBC Space Lease required that UBD
pay all expenses and taxes, maintain and repair the building,
insure the building, and replace the building if destroyed.
On December 31, 1987, LBC assumed HRO's lease of
approximately 122,000 square feet of space in 2UBC and subleased
to HRO approximately 130,000 square feet of space in 1UBC.
The 3UBC Sale Agreement, the 3UBC Ground Lease, the 3UBC
Space Lease, the agreements relating to HRO's lease in 2UBC and
sublease in 1UBC, and related agreements shall be referred to
- 31 -
collectively as the 3UBC Transaction.
b. Tax Treatment of the 3UBC Transaction
On its Federal income tax return filed for 1988, the UBC
affiliated group reported gain on the installment basis using an
amount realized of $14,201,933 from the sale of 3UBC. The
parties agree that the reported amount is the correct amount
realized for purposes of determining gain or loss from the sale
of 3UBC.
On its Federal income tax return filed for 1988, the UBC
affiliated group reported gain on the installment basis using an
adjusted basis of $5,321,361 for purposes of determining gain or
loss on the sale of 3UBC. The parties agree that the reported
adjusted basis is correct, except to the extent, if any, that the
cost of the Atrium Assets, see supra sec. II.A.7., is allocable
to the basis of 3UBC.
10. The 1UBC Land Transaction
By a purchase and sale agreement dated December 30, 1988,
LBC sold the 1UBC land (together with LBC's interest in the
Ground Lease relating to the 1UBC land) to ARICO (the 1UBC land
transaction). LBC realized $2,900,000 as a result of that
transaction. On its Federal income tax return filed for 1988,
the UBC affiliated group reported the sale of the 1UBC land as a
long-term capital loss using an adjusted basis of $2,953,980.
The parties agree that the reported adjusted basis is correct,
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except to the extent, if any, that the cost of the Atrium Assets,
see supra sec. II.A.7., is allocable to the basis of 3UBC.
11. The 1988 Atrium Transaction
a. Background
On December 29, 1988, LBC and Broadway Atrium Limited (BAL),
a Colorado limited partnership consisting of ARICO and Hines
Colorado, formed Lincoln Atrium Limited (LAL), a Colorado limited
partnership. LBC was the general partner of LAL, with a
1-percent “sharing ratio” based on an initial contribution of a
0.4848-percent undivided interest in the “Atrium” (as described
in the LAL partnership agreement). BAL was the sole limited
partner of LAL, with a 99-percent “sharing ratio” based on an
initial contribution of a 48-percent undivided interest in the
“Atrium”, contributed to BAL by ARICO upon acquisition from LBC,
see infra sec. II.A.11.b.
On December 30, 1988, UBC, UBD, LBC, LAL, BAL, ARICO, the
1700 Partnership, and Hines Colorado entered into a number of
transactions (the 1988 transactions).
b. The Atrium Sale Agreement
The 1988 transactions included an agreement titled “Atrium
Purchase, Sale and Lease Agreement”, dated December 30, 1988,
between UBD, LBC, and ARICO (the Atrium Sale Agreement).
Pursuant to the Atrium Sale Agreement, LBC sold to ARICO an
undivided 48-percent interest in the land underlying the Atrium,
- 33 -
all improvements on that land, all rights and interests
appurtenant to that land (collectively, the Atrium Land), and
certain other property (together, the Atrium Property). In
consideration of LBC's conveyance of the Atrium Property, ARICO
agreed to pay a purchase price of $17,100,000 by means of a
promissory note.
The Atrium Sale Agreement contained a recital stating as
follows: “Seller [LBC] desires to sell the [Atrium] Property to
Purchaser [ARICO] and Purchaser desires to purchase the Property
from Seller on the terms and conditions set forth in the
Agreement.”
Section 8.13 of the Atrium Sale Agreement states as follows:
The parties hereto hereby acknowledge and agree that
the transaction relating to the Property contemplated
by this Agreement is, for tax purposes, a purchase,
sale, and lease transaction. Furthermore, the parties
hereby agree that following the Closing, each party
shall report the transaction as a purchase, sale, and
lease on their respective income tax returns; and
specifically, that (a) Seller shall report the
transaction as a sale on its income tax return and
shall recognize the gain or loss therefrom either
currently or on an installment basis, and (b) Purchaser
shall report the transaction as a purchase on its
income tax return.
The Atrium Sale Agreement also provided that certain other
agreements would be executed by the parties and related entities
(the Atrium Sale Agreement and related agreements shall hereafter
be referred to collectively as the 1988 Atrium Transaction). One
of those agreements was an agreement titled “Atrium Lease”, dated
December 30, 1988, between LBC and LAL, as landlords, and UBD, as
- 34 -
tenant. Pursuant to the Atrium Lease, UBD agreed to lease the
Atrium Land for a period of 30-1/2 years, commencing December 30,
1988, and ending June 30, 2019. The Atrium Lease provided that
UBD would pay rent to LBC in the amount of $1 a year and to LAL
in the following amounts: $1,893,939.39 annually from January 1,
1989, through December 31, 1998; $1,489,898.99 annually from
January 1, 1999, through June 30, 2009; and $303,030.30 annually
from July 1, 2009, through June 30, 2019.
The Atrium Lease contained a recital stating as follows:
“LBC and LAL desire to lease their undivided interests in the
Atrium to Tenant [UBD] in order to provide unified operation of
the Atrium and Tenant desires to lease such interest from
Landlord for the same purpose.”
c. Tax Treatment by UBC of the 1988 Atrium Transaction
On its Federal income tax return for the taxable year 1988,
the UBC affiliated group reported a gain on the sale of a 48-
percent interest in the Atrium Structure and the Skyway of
$3,803,496, based on an amount realized of $16,964,800, a cost
basis of $15,345,273, and accumulated depreciation of $2,183,969.
The reported amount realized was based on a total sales price for
a 48-percent interest in the Atrium Structure, the Skyway, and
the land underlying the Atrium of $17,100,000 less $135,200
allocated to the underlying land ($17,100,000 - $135,200 =
$16,964,800). The reported cost basis equaled 48 percent of the
cost bases of the Skyway and that part of the Atrium Structure
- 35 -
placed in service prior to 1989, as adjusted under former section
48(q) for the investment credits claimed and investment credits
recaptured with respect to those assets. The reported
accumulated depreciation equaled 48 percent of the depreciation
claimed on the Atrium Structure and the Skyway to the date of the
reported sale. No gain or loss was reported as realized on the
sale of the underlying land because the reported amount realized
($135,000) equaled the cost basis of the land.
On its Federal income tax returns for the taxable years 1989
through 1991, the UBC affiliated group took deductions for rental
expenses on account of the Atrium Lease.
d. UBC's Financial Statements
In the notes to UBC's affiliated financial statements for
1988 and 1989, UBC made disclosures of the Atrium Sale Agreement
and the Atrium Lease as a sale and leaseback.
e. Petitioner's Responses to Information Document
Requests Regarding the Atrium
In a letter dated August 11, 1992, to the St. Paul office of
the Internal Revenue Service (IRS) Appeals Division (Appeals
Division), petitioner first claimed that the cost of the Atrium
Assets should be allocated to the bases of adjoining properties.
The Appeals Division referred petitioner's claim for cost
allocation to the IRS Examination Division.
On January 11, 1993, the IRS agent assigned to review
petitioner's claim (the IRS agent) issued an information document
- 36 -
request (IDR) to petitioner. Question four of that IDR states:
“Who is the owner of the Atrium now? History of the Atrium
ownership from 1985 till 1992?” In response to that question,
petitioner stated, in part:
On December 30, 1988, Lincoln Building Corporation sold
an undivided 48% interest in the Atrium to ARICO
America Real Estate Investment Company (ARICO). ARICO
contributed its undivided 48% interest in the Atrium to
Broadway Atrium Limited (Broadway). Broadway
subsequently contributed the 48% undivided interest in
the Atrium to Lincoln Atrium Limited. Lincoln Building
Corporation contributed an additional .48% undivided
interest in the Atrium to Lincoln Atrium Limited as its
general partner. Consequently, ownership of the Atrium
after the sale on December 30, 1988 was as follows:
51.52% - Lincoln Building Corporation
48.48% - Lincoln Atrium Limited, whose ownership
is:
99% - Broadway Atrium Limited
1% - Lincoln Building Corporation
The ownership of the Atrium did not change during the
period between December 30, 1988 and December 31, 1992.
On April 22, 1993, the IRS agent issued another IDR to
petitioner requesting documentation pertaining to the sale of an
interest in the Atrium referred to in petitioner's response to
the first IDR. Petitioner's response to the second IDR referred
to the transaction as a “sale of the 48% interest in the Atrium”.
B. The Atrium Assets: Allocation of the Costs
1. Issue
The issue is whether petitioner may allocate the cost of the
Atrium Assets to the bases of other properties that were held by
the Bank. If we decide that issue for petitioner, we must decide
- 37 -
the nature and extent of the proper allocation.
2. Arguments of the Parties
Relying on a line of cases that includes Estate of Collins
v. Commissioner, 31 T.C. 238 (1958), and Willow Terrace Dev. Co.
v. Commissioner, 40 T.C. 689 (1963), affd. 345 F.2d 933 (5th Cir.
1965) (the developer line of cases), petitioner argues that it is
entitled under section 1016(a)(1)2 to allocate the cost of the
Atrium Assets to the bases of properties that benefited from the
Atrium. Petitioner claims that “[t]he Bank constructed the
Atrium for the purpose of creating an office building complex
with the expectation that the buildings within the complex would
increase in value” and that the Atrium, as a stand-alone asset,
has negative value. Petitioner asserts that an allocation of the
costs of “the Atrium Assets in proportion to the relative fair
market values of the benefited properties as of December 31,
1987, the close of the year in which the Atrium was completed”,
is “equitable” and would result in a “proper adjustment” under
section 1016(a)(1). Petitioner proposes the following
allocation:
2
As pertinent to this case, sec. 1011 provides that the
adjusted basis for determining gain or loss from the sale or
other disposition of property is the cost of such property, see
sec. 1012, adjusted as provided in sec. 1016. Sec. 1016(a)(1),
in part, provides that proper adjustment is to be made for
expenditures, receipts, losses, or other items, properly
chargeable to capital account. Sec. 1.1016-2(a), Income Tax
Regs., in part, states: “The cost or other basis shall be
properly adjusted for any expenditure, receipt, loss, or other
item, properly chargeable to capital account, including the cost
of improvements and betterments made to the property.”
- 38 -
Property Cost Allocation
1UBC Land $2,161,625
2UBC 18,579,112
3UBC 11,900,811
3UBC Land 1,292,903
Respondent argues that section 1012 provides that the basis
of property is the cost of such property and that “the amount
paid for a given asset becomes the asset's cost basis and cannot
be added to or combined with the basis of other assets.”
Respondent, however, acknowledges the developer line of cases,
but asserts that those cases recognize a narrow exception to the
general rule. Respondent claims that the present case is
factually distinguishable from the developer line of cases and
that the principles of those cases “have never been applied
outside the narrow factual context in which those cases arose.”
In the alternative, respondent argues that, if the developer line
of cases “have relevance beyond their unique facts”, the present
case fails to meet the requirements set forth in those cases.
Lastly, respondent rejects petitioner's proposed allocation of
the cost of the Atrium Assets based on the fair market values of
the adjoining properties because those “values bear no necessary
correlation to the economic benefits” that were anticipated by
the Bank from the construction of the Atrium. According to
respondent, an allocation, if any, “must be based on the bank's
purpose for building the Atrium as of February of 1981 when it
made the initial commitment to build the Atrium, or at the
- 39 -
latest, October of 1984 when it made the final decision to
proceed with the Atrium's construction.”
3. Analysis
a. The Developer Line of Cases
In Country Club Estates, Inc. v. Commissioner, 22 T.C. 1283(1954), the taxpayer transferred approximately 300 acres of land
and certain improvements located thereon to the Tuscon Country
Club (the Club). With the proceeds of a loan from the taxpayer,
the Club agreed to construct on the transferred property a first-
class country club that included an 18-hole golf course, club
house, and recreational facilities. The taxpayer anticipated
that the construction of the country club would enhance the value
of the surrounding property, which the taxpayer subdivided into
lots for sale. Relying on Commissioner v. Laguna Land & Water
Co., 118 F.2d 112, 117 (9th Cir. 1941), affg. in part and revg.
in part a Memorandum Opinion of the Board,3 the taxpayer argued
that the cost of the land transferred to the Club should be added
to the cost of the lots sold. The Court distinguished Biscayne
Bay Islands Co. v. Commissioner, 23 B.T.A. 731 (1931),4 despite
3
In that case, the Court of Appeals for the Ninth Circuit
affirmed the Board of Tax Appeals' determination that a taxpayer
should be allowed to deduct from the sales proceeds of certain
lots expenditures made for streets, drives, curves, and other
improvements, which benefited those lots.
4
In that case, the Board of Tax Appeals rejected the
taxpayer's contention that no part of the cost of construction
and development of an island subdivision should be allocated to a
(continued...)
- 40 -
the possibility that the transferred land could revert to the
taxpayer upon the occurrence of certain contingencies. The
Court, citing Kentucky Land, Gas & Oil Co. v. Commissioner,
2 B.T.A. 838 (1925),5 held that the basis of the lots included
the cost of the property transferred to the Club because “the
basic purpose of petitioner in transferring the land was to bring
about the construction of a country club so as to induce people
to buy nearby lots.” Country Club Estates, Inc. v. Commissioner,
supra at 1293.
In Colony, Inc. v. Commissioner, 26 T.C. 30 (1956), affd.
per curiam 244 F.2d 75 (6th Cir. 1957), a taxpayer in the
business of developing and selling real estate argued that the
cost of a water supply pumping system that provided water service
4
(...continued)
large interior area of the island that was reserved for 10 years
(later extended an additional 3 years) as a playground and
recreational center for the use of lot purchasers:
[The interior] area was not permanently and irrevocably
dedicated to the public, but may later be sold by
petitioner. The possibility of gain has only been
postponed. It is unlike the area used for public
streets, which is permanently beyond the possibility of
sale and gain, the cost of which must be absorbed in
the salable lots. * * * [Biscayne Bay Islands Co. v.
Commissioner, 23 B.T.A. 731, 735 (1931).]
5
In Kentucky Land, Gas & Oil Co. v. Commissioner, 2 B.T.A.
838 (1925), the taxpayer acquired a tract of oil land, which the
taxpayer subdivided into lots. The taxpayer drilled four wells
on the subdivision. The Board of Tax Appeals (the Board) held
that the cost of drilling one well only was an additional cost of
the lots and “a proper charge against the sale price of the lots
sold” because the taxpayer was “bound to drill but one well”
under the covenants in the deeds of conveyance. Id. at 840.
- 41 -
to a subdivision should be added to the cost of the lots in the
subdivision. This Court stated as follows:
The difficulty with petitioner's contention is
that, unlike the taxpayer in Country Club Estates,
Inc., supra, the petitioner has not given up any
property in order to sell its lots. For the funds it
expended, the petitioner acquired a water supply system
which it owned and operated during the taxable years
and thereafter. It is true that the system has not
been operated at a profit, due, perhaps, to the small
number of houses which have been constructed at The
Colony. And it also may be true, as petitioner
contends, that the pumping station may be abandoned at
some time in the future, when the facilities of the
Lexington Water Company reach the subdivision. These
circumstances, however, do not alter the fact that the
petitioner retained full ownership and control of the
water supply system during the taxable years, and that
it did not part with the property for the benefit of
the subdivision lots. Because of this retention of
ownership, Country Club Estates, Inc., supra, is
distinguishable. * * * [Id. at 46.]
This Court in Estate of Collins v. Commissioner, 31 T.C. at
256 (1958), distilled the decisions in Country Club Estates, Inc.
v. Commissioner, supra, and Colony, Inc. v. Commissioner, supra,
and announced the following test:
A careful consideration of the cases above cited
indicates that if a person engaged in the business of
developing and exploiting a real estate subdivision
constructs a facility thereon for the basic purpose of
inducing people to buy lots therein, the cost of such
construction is properly a part of the cost basis of
the lots, even though the subdivider retains tenuous
rights without practical value to the facility
constructed (such as a contingent reversion), but if
the subdivider retains “full ownership and control” of
the facility and does “not part with the property
[i.e., the facility constructed] for the benefit of the
subdivision lots,” then the cost of such facility is
not properly a part of the cost basis of the lots.
The rule of Estate of Collins has been applied in subsequent
- 42 -
cases. In Willow Terrace Dev. Co. v. Commissioner, 40 T.C. at
701,6 this Court stated:
As we read the Collins case, the pivotal consideration
is whether the basic purpose for constructing such
utilities systems in real estate subdivisions is to
induce people to buy lots in such subdivisions. It is
a question of fact, and in resolving it the profit and
loss record of the operating company must, of course,
be considered. But this does not mean that the
presence of some profit will always be fatal to the
taxpayers's case. * * *
In addition, this Court in Noell v. Commissioner, 66 T.C. 718,
725 (1976), stated as follows:
The critical question is whether petitioner
intended to hold the facilities to realize a return on
his capital from business operations, to recover his
capital from a future sale, or some combination of the
6
The Court of Appeals for the Fifth Circuit stated as
follows:
The problem presented by these cases is whether
deduction or capitalization of such costs will more
accurately reflect the economic realities of the
situation from the standpoint of the subdivider. We
cannot accept the rule advocated by the Commissioner,
which in effect allows deduction only when the costs
can be recovered in no other manner. Some relevant
factors to be considered in determining the proper tax
treatment of the costs of such facilities are whether
they were essential to the sale of the lots or houses,
whether the purpose or intent of the subdivider in
constructing them was to sell lots or to make an
independent investment in activity ancillary to the
sale of lots or houses, whether and the extent to which
the facilities are dedicated to the homeowners, what
rights and of what value are retained by the
subdivider, and the likelihood of recovery of the costs
through subsequent sale. These factors were considered
in Collins, and the holding centered on the basic
purpose test as modified by ownership. * * * [Willow
Terrace Dev. Co. v. Commissioner, 345 F.2d 933, 938
(5th Cir. 1965).]
- 43 -
two; or whether, on the other hand, he so encumbered
his property with rights running to the property owners
(regardless of who retained nominal title) that he in
substance disposed of these facilities, intending to
recover his capital, and derive a return of his
investment through the sale of the lots.10 * * *
10
Actually, in most of the cases, the asset
involved is encumbered with rights running to the
property owners which significantly diminish the value
of an asset which nevertheless retains substantial
value. This diminution, resulting from restrictions
benefiting the adjacent lots, represents a pro tanto
disposal with each lot. However, there is no basis in
the decided cases, and certainly none in the record
before us, for making an allocation based on the rights
disposed of and the property retained.
See also Derby Heights, Inc. v. Commissioner, 48 T.C. 900 (1967);
Dahling v. Commissioner, T.C. Memo. 1988-430; Bryce's Mountain
Resort, Inc. v. Commissioner, T.C. Memo. 1985-293; Montclair Dev.
Co. v. Commissioner, T.C. Memo. 1966-200.
b. The Principles of the Developer Line of Cases
The developer line of cases all involve real estate
developers that seek to allocate the cost of certain common
improvements to the bases of residential lots held for sale.
Respondent suggests that the principles of the developer line of
cases are applicable only in that context because, “[i]n that
context, both the purpose for incurring the costs and the
properties benefitted thereby are readily identifiable.” An
examination of the principles underlying the developer line of
cases, however, does not suggest that those principles are
restricted to any particular factual context or that difficulty
in application justifies nonadherence. We need not decide
- 44 -
whether those principles apply in every case; it is sufficient
that we decide today that no rule of law proscribes their
application to the case at bar.
The developer line of cases addresses the basic problem of
what constitutes a proper adjustment to the basis of property in
the context of a common improvement that benefits lots in a
residential subdivision. Those cases focus on the common
improvement and not directly on the lots held for sale. If an
analysis of the common improvement indicates that (1) the basic
purpose of the taxpayer in constructing the common improvement is
to induce sales of the lots and (2) the taxpayer does not retain
too much ownership and control of the common improvement, then
the lots held for sale are deemed to include the allocable share
of the cost of the common improvement. The rationale of the
developer line of cases is that, when the basic purpose of
property is the enhancement of other properties to induce their
sale and such property does not have, in substance, an
independent existence, total cost recovery for such property
should be dependent on sale of the benefited properties. There
is no principled basis here to distinguish between residential
lots and the office buildings in question in the application of
that logic. In sum, we believe that the logic underlying the
developer line of cases is applicable outside the narrow context
of allocating the cost of common improvements to the bases of
residential lots held for sale, and, therefore, we shall
- 45 -
determine whether petitioner has satisfied the requirements set
forth in those cases.
c. Application of the Basic Purpose Test
The requirement that the basic purpose of a taxpayer in
constructing a common improvement be to induce sales of benefited
properties serves the purpose of justifying total cost recovery
of the common improvement based on sales of the benefited
properties. Cf. Noell v. Commissioner, supra at 725 n.10
(1976).7 Petitioner apparently acknowledges that a pivotal
question is whether the basic purpose of the Bank in constructing
the Atrium was to induce sales of the Bank's adjoining
properties. That question is one of fact, which we shall answer
upon consideration of all the facts and circumstances. See
Willow Terrace Dev. Co. v. Commissioner, 40 T.C. 689, 701 (1963).
Petitioner asserts: “The Bank constructed the Atrium for
the purpose of creating an office building complex with the
expectation that the buildings within the complex would increase
in value.” That purpose alone, however, without an intention to
7
Such total basis recovery is a decided advantage not
generally enjoyed by a taxpayer who disposes of less than his
complete interest in property. See, e.g., sec. 1.61-6(a), Income
Tax Regs. (“When a part of a larger property is sold, the cost or
other basis of the entire property shall be equitably apportioned
among the several parts, and the gain realized or loss sustained
on the part of the entire property sold is the difference between
the selling price and the cost or other basis allocated to such
part.”). Consider that a lessor of income producing property
must take advance rentals into gross income in the year of
receipt, sec. 1.61-8(b), Income Tax Regs., without any increased
depreciation deduction in that year.
- 46 -
induce sales of the benefited properties, is insufficient under
the developer line of cases. Although the record indicates that
the Bank was aware that construction of the Atrium would enhance
the value of the Bank's adjoining properties, we believe that the
basic purpose of the Bank in constructing the Atrium was not the
enhancement of the adjoining properties so as to induce sales of
those properties, but rather the resolution of certain design
issues and the enhancement of the Bank's image. Value
enhancement of the Bank's adjoining properties was simply a
beneficial consequence of that basic purpose.8
On August 24, 1979, when architectural plans for the Project
were presented to the Committee for the first time, construction
of the Atrium was proposed as a means of resolving two major
design issues: (1) counteracting the off-Broadway location of the
proposed tower and (2) creating a center consisting of the
proposed tower and the existing bank facilities. By September
1980, when construction of the proposed atrium was approved, the
Bank had the benefit of both the Harrison Price and Planning
Dynamics reports. Both reports recommended construction of the
proposed atrium based on three factors: (1) increased rental
8
It appears that petitioner would likely not dispute that
assertion; in its brief, petitioner states: “[A]lthough the
impetus for building the Atrium came from the construction of
1UBC (including the need for a ``front door on Broadway'), the
Bank expected that 2UBC - the largest building to which the
Atrium is physically attached - would be the beneficiary of the
largest value increase.”
- 47 -
rates of adjoining properties, (2) ability to counteract the off-
Broadway location of the proposed tower, and (3) enhancement of
the Bank's image, which would be reflected in a greater market
share. Reflective of those reports, the minutes of the Committee
meeting on August 25, 1980, in part, provide:
Bank management feels very positive about the project.
The general feeling of the Bank is in favor of the
enclosed atrium to allow the Bank to achieve a larger
market share. The atrium should create a major center,
making United Bank Center a nationally notable building
complex.
At that time, however, there were no immediate plans to sell any
of the adjoining properties, and, thus, there is simply no basis
to find that the Bank approved construction of the proposed
atrium so as to induce sales of those properties.9
9
Petitioner proposes the following finding of fact:
During 1978-1979, while the Bank was negotiating and
planning the construction of 1UBC and the Atrium, the
Bank gave consideration to selling some of its
properties in United Bank Center. * * *
Petitioner apparently supports that finding only with the
following testimony of Mr. Richard A. Kirk, president of UBD in
1979:
[Counsel for petitioner]: In the time frame
1978-9 to 1984, before the construction of the Atrium
commenced, did LBC consider selling any of its
properties in United Bank Center?
[Mr. Kirk]: Yes.
[Counsel]: Do you know which properties were
under consideration for sale?
[Mr. Kirk]: We would--we had a lot of real
estate, as is evidenced here, and I think in those days
we were coming to a conclusion that that wasn't
necessarily the best place for us to have our monies.
(continued...)
- 48 -
In addition, when the budget for construction of the
proposed atrium was approved in 1984, the Bank was advised by
both Ross Consulting and Eastdil Realty that the cost of
construction would far exceed any increase in values to the
adjoining properties. Indeed, the Eastdil report noted that
“[c]onstruction of the atrium will inhibit the Bank from selling
its Broadway-Lincoln property as one unit. This may reduce the
proceeds from the sale of the Bank's property on the block."
(Emphasis omitted.) Ross Consulting recommended that “UBC should
build only if legally or ``morally' bound to”, and Eastdil Realty
recommended “against building the atrium if the Bank can obtain
release from its commitment for less than $22 million less
whatever ``recognition value' the Bank believes the atrium would
9
(...continued)
You know, we could put our money to work in lots of
different ways.
And so I think that it is fair to say that around
that time, we started--we were dealing more and more
with real estate, and we were thinking more and more
about it is it logical, do we need it all, should we
move some parcel.
I can't remember exactly which we were talking
about at the time, but it is definitely my recollection
that we were, you know, considering the validity of
holding all of this real estate.
The minutes of the Committee meeting on Sept. 10, 1981,
provide the earliest documentary evidence that the Bank
considered sales of its real estate:
It is the Bank's intention to investigate the
possibility of selling various elements of our real
property as a means of generating additional capital.
* * *
- 49 -
produce.” At the Committee meeting of October 24, 1984, when the
budget for the Atrium was approved, considerations for completing
the Atrium that were noted in the presentation to the Committee
were as follows:
A. The Atrium retains a great deal of appeal;
architecturally, as an enhancement to the Bank's image,
and in value added to the properties.
B. We think our minimum cost not to build would
be about $16,000,000. It makes more sense to build it
for $25,000,000 than to not build it at a cost of
$16,000,000.
We believe that the Bank initially approved construction of
the proposed atrium in 1980 and entered into the commitment to
build in 1981 to address certain design issues and to enhance the
Bank's image; enhancement of value in the adjoining properties
was an ancillary consideration, and we so find. We believe that
the Bank's motivation derived, in significant part, from the fact
that the Developer and the 1700 Partnership would not have made a
commitment to build 1UBC had the Bank not made a commitment to
build the Atrium. When the budget for the Atrium was approved in
1984, enhancement of value of the adjoining properties was simply
one of many considerations that led to the budget's approval.
Lastly, the Bank was aware that any value to be added to the
property by the construction of the Atrium would not be fully
realized in a sale prior to completion of the Atrium;
nevertheless, the Bank sold 2UBC in 1985. In sum, upon
consideration of all the facts and circumstances, we believe that
- 50 -
the basic purpose of the Atrium was not the enhancement of the
adjoining properties so as to induce sales of those properties,
and we so find.10
4. Conclusion
Our finding with respect to the Bank's basic purpose renders
an analysis of the extent of the Bank's retained interest in the
Atrium unnecessary. In any event, we believe that such an
analysis would support our conclusion that cost recovery for the
Atrium should be independent of sales of the adjoining
properties. Although both the easements allowing ingress and
egress of pedestrians and the Bank's obligation to maintain and
operate the Atrium at its sole cost and expense for a period of
years restricted the Bank's ownership and control of the Atrium,
such restrictions did not prevent the Bank from entering into a
10
The fact that the Atrium has consistently generated net
operating losses does not change our conclusion. If the presence
of some profit is not always fatal to a taxpayer's case, we
believe then that the absence of profit is also not dispositive.
See Willow Terrace Dev. Co. v. Commissioner, 40 T.C. 689, 701
(1963), affd. 345 F.2d 933 (5th Cir. 1965); Colony, Inc. v.
Commissioner, 26 T.C. 30, 46 (1956), affd. per curiam 244 F.2d
75 (6th Cir. 1957); Bryce's Mountain Resort, Inc. v.
Commissioner, T.C. Memo. 1985-293; Montclair Dev. Co. v.
Commissioner, T.C. Memo. 1966-200. But more importantly, the
Atrium's operating loss figures do not consider the benefits (if
any) derived by the Bank when it entered into the commitment to
build the Atrium in 1981 as part of an integrated series of
agreements. We are unclear whether any possible benefits derived
by the Bank as part of those agreements, e.g., a favorable lease
agreement in 1UBC or enhanced Bank image derived from a prominent
complex bearing the Bank's name, would skew the significance of
those loss figures. Therefore, we have little confidence in the
import of those figures.
- 51 -
series of transactions that included the sale of an undivided
48-percent interest in the Atrium to ARICO for $17.1 million in
December 1988. Petitioner now challenges the form of that
transaction and claims that the substance of the transaction
constituted a financing arrangement. See infra sec. II.D.
Although the fact that a taxpayer retains a salable interest in a
common improvement is not dispositive of the analysis in the
developer line of cases, see, e.g., Willow Terrace Dev. Co. v.
Commissioner, 40 T.C. 689 (1963), the December 1988 transaction
strongly indicates that the Bank did not intend to recover its
investment in the Atrium through a sale of the adjoining
properties.
Lastly, we note that petitioner's reliance on the developer
line of cases is the sole reason that the basic purpose test was
applied in this case. Nothing in those cases precluded
petitioner from arguing that interests in the Atrium were
conveyed in conjunction with sales of its adjoining properties
and that an equitable allocation of the cost of the Atrium
Assets, pursuant to section 1.61-6(a), Income Tax Regs., should
be made to those interests to properly calculate gain or loss on
the conveyance of those interests. See, e.g., Fasken v.
Commissioner, 71 T.C. 650, 655-656 (1979) (when parts of a larger
property are sold, an equitable apportionment of basis among the
several parts is required for a proper calculation of gain,
section 1.61-6(a), Income Tax Regs., but that principle is not
- 52 -
limited to the severance of realty into two or more parcels, but
applies with respect to parts of the bundle of rights comprising
property, including easements). That argument, however, was not
made by petitioner, and we need not address it any further.
C. The Atrium Assets: Loss Deduction Under Section 165(a)
In a footnote in petitioner's brief, petitioner, relying on
Echols v. Commissioner, 950 F.2d 209 (5th Cir. 1991), argues that
it is entitled to a loss deduction under section 165(a) for 1987
equal to the cost of the Atrium Assets because, although the
Atrium was not abandoned in 1987, it was worthless. Petitioner
asserts:
The Atrium was completed during 1987; and an
independent appraisal has concluded that the Atrium had
a negative value (i.e., was worthless) as of
December 31, 1987. The proper year of deduction under
I.R.C. § 165(a) is 1987, as that is the year in which
the Atrium was completed (i.e., became a closed
transaction).
In response, respondent argues that petitioner's interpretation
of Echols v. Commissioner, supra, is inconsistent with authority
of this Court, and, in any event, the Atrium's worthlessness has
not been established.
Section 165(a) allows a deduction for any loss sustained
during the taxable year and not compensated for by insurance or
otherwise. To be allowable, a loss must be evidenced by closed
and completed transactions, fixed by identifiable events, and
actually sustained during the taxable year. Sec. 1.165-1(b),
(d)(1), Income Tax Regs. In Echols v. Commissioner, supra at
- 53 -
213, the Court of Appeals for the Fifth Circuit stated:
the test for worthlessness is a combination of
subjective and objective indicia: a subjective
determination by the taxpayer of the fact and the year
of worthlessness to him, and the existence of objective
factors reflecting completed transaction(s) and
identifiable event(s) in the year in question--not
limited, however, to transactions and events that rise
to the level of divestiture of title or legal
abandonment.
Nothing in that opinion, however, supports petitioner's apparent
assertion that completion of construction of the Atrium alone
provides sufficient objective evidence of the Atrium's
worthlessness. More importantly, petitioner has failed to
establish a loss equal to the cost of the Atrium Assets pursuant
to section 1.165-1(b) and (d)(1), Income Tax Regs., and we so
find. Therefore, petitioner is not entitled to a deduction under
section 165(a).
D. The 1988 Atrium Transaction: Disavowal of Form
1. Issue
The issue is whether petitioner may disavow the form of the
1988 Atrium Transaction. If we decide that issue for petitioner,
we must determine the substance of the 1988 Atrium Transaction.
2. Arguments of the Parties
Relying primarily on Helvering v. F. & R. Lazarus & Co., 308
U.S. 252 (1939), and Frank Lyon Co. v. Commissioner, 435 U.S. 561(1978), petitioner argues that the substance of the 1988 Atrium
Transaction, not its form, should govern for Federal income tax
purposes. Petitioner concedes that the 1988 Atrium Transaction
- 54 -
was in form a sale by LBC of a 48-percent interest in the Atrium
Property to ARICO for $17,100,000 and a lease of the Atrium Land
by UBD from LBC and LAL (following various transfers of interests
in the Atrium Property to LAL). Petitioner argues, however,
that, “as a matter of economic substance, the 1988 Atrium
Transaction was a loan from ARICO to the Bank.” In addition,
petitioner argues that, in cases where a taxpayer challenges the
form of a sale-leaseback transaction, no higher burden of proof
applies, and, therefore, petitioner need only persuade the Court
of the substance of the 1988 Atrium Transaction by the usual
preponderance of the evidence.
In respondent's brief, respondent presents the issue as
follows:
the petitioner has taken the position that the costs of
constructing the Atrium should have been allocated
among the adjoining properties rather than to the
Atrium itself. Accordingly, the notice of deficiency,
as a protective measure, reduced the adjusted basis of
the 48-percent interest in the Atrium sold by LBC to
zero, thereby increasing LBC's gain on the sale by
$13 million. The petitioner now claims that no gain or
loss should have been recognized on the Atrium
sale/leaseback because the transaction was merely a
financing arrangement. * * * it is the respondent's
position that the transaction was a sale/leaseback in
substance as well as form. It is also the respondent's
position, however, that the petitioner is precluded
from disavowing the form of the transaction.
In making the latter argument, respondent relies primarily on
Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), vacating
and remanding 44 T.C. 549 (1965); Estate of Weinert v.
Commissioner, 294 F.2d 750 (5th Cir. 1961), revg. and remanding
- 55 -
31 T.C. 918 (1959); Estate of Durkin v. Commissioner, 99 T.C. 561(1992), supplementing T.C. Memo. 1992-325; Illinois Power Co. v.
Commissioner, 87 T.C. 1417 (1986).
3. Analysis
a. Introduction
The terms of the various agreements that constitute the 1988
Atrium Transaction are unambiguous, and we so find. Indeed,
petitioner does not argue to the contrary. Rather, petitioner
contends that “[t]he issue in this case is the characterization,
for Federal income tax purposes, of a transaction that is cast in
form as a sale-leaseback, but in which the rights created are
those of a borrower and a lender.” This Court must determine as
a threshold matter, however, whether petitioner may disavow the
form of the 1988 Atrium Transaction.
b. The Danielson Rule Does Not Apply
In Commissioner v. Danielson, supra, the Court of Appeals
for the Third Circuit held that certain taxpayers were precluded
from challenging for tax purposes the terms of certain agreements
that made purchase price allocations to covenants not to compete.
The court enunciated the so-called Danielson rule:
a party can challenge the tax consequences of his
agreement as construed by the Commissioner only by
adducing proof which in an action between the parties
to the agreement would be admissible to alter that
construction or to show its unenforceability because of
mistake, undue influence, fraud, duress, etc. * * *
[Id. at 775.]
Even assuming, arguendo, that the Danielson rule applies in cases
- 56 -
where a taxpayer attempts to disavow the form of a sale-leaseback
transaction, this Court would not apply the rule in this
particular case. This Court has declined to adopt the Danielson
rule, see, e.g., Coleman v. Commissioner, 87 T.C. 178, 202 n.17
(1986); Elrod v. Commissioner, 87 T.C. 1046, 1065 (1986),11 affd.
without published opinion 833 F.2d 303 (3d Cir. 1987), and does
not apply the rule unless appeal in the particular case lies to a
Court of Appeals that has explicitly adopted the rule, see
Meredith Corp. & Subs. v. Commissioner, 102 T.C. 406, 439-440
(1994). The parties agree that appeal in this case will lie to
the Court of Appeals for the Eighth Circuit. The position of
that court with respect to the Danielson rule is unclear, see id.
at 440 (discussing Molasky v. Commissioner, 897 F.2d 334 (8th
Cir. 1990), affg. in part, revg. in part and remanding T.C. Memo.
1988-173), and, therefore, we shall not apply the Danielson rule
in this case.
c. Respondent’s Weinert Rule
Respondent argues that, apart from the Danielson rule, a
rule that originated in Estate of Weinert v. Commissioner, 294
F.2d 750 (5th Cir. 1961), revg. and remanding 31 T.C. 918 (1959),
precludes petitioner “from disavowing the form of the Atrium
sale/leaseback because the taxpayer's actions do not reflect an
honest and consistent respect for the transaction's putative
11
We decline respondent's invitation to reconsider our
position and to adopt the rule.
- 57 -
substance.” In Estate of Weinert, the Court of Appeals for the
Fifth Circuit (the Fifth Circuit) stated:
Resort to substance is not a right reserved for
the Commissioner's exclusive benefit, to use or not to
use--depending on the amount of the tax to be realized.
The taxpayer too has a right to assert the priority of
substance--at least in a case where his tax reporting
and actions show an honest and consistent respect for
the substance of a transaction. * * * [Id. at 755.]
Respondent principally cites Illinois Power Co. v. Commissioner,
87 T.C. 1417 (1986), as demonstrating the circumstances in which
this Court shall apply what respondent calls the “Weinert rule”
(respondent's Weinert rule). Petitioner argues that respondent's
Weinert rule is a “misrepresentation of the holding in Weinert.”
We believe that respondent's Weinert rule is an offshoot of
the Fifth Circuit's statement in Estate of Weinert. The Fifth
Circuit did not state that a taxpayer can argue the priority of
substance only if his tax reporting and other actions show an
honest and consistent respect for the substance of a transaction,
but rather, that a taxpayer can argue substance over form at
least when those conditions are met. In other words, the Fifth
Circuit statement does not make honest and consistent respect for
the substance of a transaction in tax reporting and other actions
the sine qua non of a taxpayer's right to disavow the form of a
transaction.
We note, however, that this Court in Illinois Power Co. v.
Commissioner, supra, applied respondent's Weinert rule and did
not allow a taxpayer to disavow the form of a gift transaction
- 58 -
because “for tax reporting and other purposes, * * * [the
taxpayer] consistently treated the transfer as a gift.” Id. at
1431. This Court, pursuant to the doctrine enunciated in Golsen
v. Commissioner, 54 T.C. 742, 756-757 (1970), affd. 445 F.2d 985(10th Cir. 1971), followed what it perceived to be the principles
established in Comdisco, Inc. v. United States, 756 F.2d 569, 578
(7th Cir. 1985). Nothing in Comdisco, however, makes honest and
consistent respect for the substance of a transaction in tax
reporting and other actions a condition precedent to a taxpayer’s
right to disavow the form of a transaction. Indeed, the Court of
Appeals for the Seventh Circuit quoted Estate of Weinert v.
Commissioner, supra at 755, and applied the reasoning and rule
expressed in that case, without expanding or altering the Fifth
Circuit's statement. Comdisco, Inc. v. United States, supra at
578. If honest and consistent respect for the substance of a
transaction were a precondition to a taxpayer’s disavowing the
form of a transaction, the Danielson rule or our own “strong
proof” standard, see, e.g., Meredith Corp. & Subs. v.
Commissioner, supra at 438 (“strong proof” required to show that
an allocation of consideration is other than that specified in a
contract), would be beside the point in any case where such
condition was not met. We have not, however, gone that far, but
have listed the taxpayer’s honest and consistent respect for the
substance of a transaction in tax reporting and other actions as
but one of at least four factors to be considered in determining
- 59 -
whether a taxpayer may disavow the form he has chosen. Estate of
Durkin v. Commissioner, 99 T.C. at 574-575 (explaining
application of Danielson rule and strong proof standard to facts
of that case). In any case in which the taxpayer fails to show
an honest and consistent respect for the substance of a
transaction, it may be difficult (if not impossible) for the
taxpayer to convince a court that he should be allowed to disavow
his chosen form, but we cannot say that, as a rule of law, he is
precluded from trying.12 Respondent’s Weinert rule is too broad;
the taxpayer’s lack of an honest and consistent respect for the
substance of a transaction may be an important (indeed, even
decisive) factor in determining that the taxpayer cannot disavow
his chosen form; it is not, however, a sufficient factor. See
infra sec. II.D.3.e.
d. Estate of Durkin v. Commissioner
12
In Federal Natl. Mortgage Association v. Commissioner,
90 T.C. 405, 426-428 (1988), affd. 896 F.2d 580 (D.C. Cir. 1990),
we set forth two grounds for not allowing the taxpayer to disavow
the form of transaction reported on its original income tax
return and financial reports. The first “more procedural” ground
was that the taxpayer’s tax reporting and other actions did not
show an honest and consistent respect for what, at trial, it
claimed to be the substance of the transaction. With respect to
the first ground, we said that we were “disinclined” to
recharacterize the transaction by hindsight. The second ground
“[m]ore importantly” was that the form of the transaction
corresponded to its substance. The Court of Appeals for the
District of Columbia Circuit affirmed our decision on the basis
of our substantive analysis. Federal Natl. Mortgage Association
v. Commissioner, 896 F.2d at 586. Had the first ground been
sufficient, we would have had no reason to discuss the second
(more important) ground.
- 60 -
Respondent cites Estate of Durkin v. Commissioner, supra at
571-575, and argues that this Court looked to three factors to
determine whether a taxpayer could disavow the form of its
transaction:
(1) whether the taxpayer seeks to disavow its own
return treatment of the transaction, (2) whether
following the rationale of Weinert, the taxpayer’s tax
reporting and actions show and [sic] honest and
consistent respect for the transaction, (3) whether the
taxpayer is unilaterally attempting to have the
transaction treated differently after it has been
challenged. * * *
We disagree with respondent that the rationale of Estate of
Durkin can be so easily distilled. In any event, we need not
rely on Estate of Durkin because of the peculiar facts of this
case.
e. Petitioner May Not Disavow the Form of the
1988 Atrium Transaction
This Court has previously stated that a “taxpayer may have
less freedom than the Commissioner to ignore the transactional
form that he has adopted.” Bolger v. Commissioner, 59 T.C. 760,
767 n.4 (1973). That freedom is further curtailed if a taxpayer
attempts to abandon its tax return treatment of a transaction.
See, e.g., Halstead v. Commissioner, 296 F.2d 61, 62 (2d Cir.
1961), affg. per curiam T.C. Memo. 1960-106; Maletis v. United
States, 200 F.2d 97, 98 (9th Cir. 1952);13 see also supra secs.
13
In Maletis, the Court of Appeals for the Ninth Circuit
stated as follows:
(continued...)
- 61 -
II.D.3.c. and d. (discussing Estate of Weinert v. Commissioner,
294 F.2d 750 (5th Cir. 1961), and Estate of Durkin v.
Commissioner, supra, respectively). Furthermore, when a taxpayer
seeks to disavow its own tax return treatment of a transaction by
asserting the priority of substance only after the Commissioner
raises questions with respect thereto, this Court need not
entertain the taxpayer's assertion of the priority of substance.
See, e.g., Legg v. Commissioner, 57 T.C. 164, 169 (1971), affd.
per curiam 496 F.2d 1179 (9th Cir. 1974).
In Legg, the taxpayers sold an apple orchard for $140,000,
received a downpayment of $20,000 and an installment obligation,
and elected to report the transaction on the installment method.
Id. at 167-168. Contemporaneously with that transaction, the
taxpayers executed an irrevocable trust, funded with the
installment obligation. Id. at 168. The Commissioner asserted
that the transfer of the installment obligation to the trust was
a disposition giving rise to gain. Id. The taxpayers argued to
(...continued)
The Bureau of Internal Revenue, with the
tremendous load it carries, must necessarily rely in
the vast majority of cases on what the taxpayer asserts
to be fact. The burden is on the taxpayer to see to it
that the form of business he has created for tax
purposes, and has asserted in his returns to be valid,
is in fact not a sham or unreal. If in fact it is
unreal, then it is not he but the Commissioner who
should have the sole power to sustain or disregard the
effect of the fiction since otherwise the opportunities
for manipulation of taxes are practically unchecked.
* * * [Maletis v. United States, 200 F.2d 97, 98 (9th
Cir. 1952).]
- 62 -
the Court “that since the sale and the creation of the trust
transpired simultaneously, the transaction in substance was a
sale consisting of a $20,000 downpayment and a lifetime
remuneration of $6,000 per year”, which transaction would not
result in gain on the disposition of an installment obligation.
Id. at 169. In response, this Court stated as follows:
The petitioners' first contention has little or no
justification in light of the fact that the form of the
transaction was contemplated and carried out by the
petitioners; it was their decision to report the sale
on the installment basis. A taxpayer cannot elect a
specific course of action and then when finding himself
in an adverse situation extricate himself by applying
the age-old theory of substance over form. [Id.]
Similarly, in this case, petitioner structured the 1988
Atrium Transaction as a sale by LBC of a 48-percent interest in
the Atrium Property to ARICO for $17,100,000 and a lease of the
Atrium Land by UBD from LBC and LAL. On its Federal income tax
return for the taxable year 1988, the UBC affiliated group
reported a gain of $3,803,496 on that sale, and, on its Federal
income tax returns for the taxable years 1989 through 1991, the
UBC affiliated group took deductions for rental expenses on
account of the Atrium Lease. In addition, after 1988, the
depreciation deductions claimed with respect to the Skyway and
that portion of the Atrium Structure placed in service prior to
1989 were computed on 51.5152 percent of the assets' cost bases.
As late as April 22, 1993, petitioner did not disavow its tax
return treatment of the 1988 Atrium Transaction. Indeed,
petitioner apparently does not dispute respondent's assertion
- 63 -
that petitioner claimed that the substance of the 1988 Atrium
Transaction was something other than its form only after
respondent, as a protective measure in response to the basis
allocation argument set forth in supra section II.B., reduced to
zero the adjusted basis of the 48-percent interest in the Atrium
sold by LBC.14
Under these circumstances, we shall not allow petitioner to
disavow the form and tax treatment of the 1988 Atrium
Transaction. Essentially, the timing of petitioner's
recharacterization of the 1988 Atrium Transaction gives this
Court very little confidence in embarking upon a burdensome
search for the substance of that transaction. Although there
exists the possibility that our approach may forsake the true
substance of the 1988 Atrium Transaction, that is a risk that
this Court can bear in light of petitioner's actions. To allow
petitioner to assert the priority of substance in this case would
only embroil this Court in petitioner's post-transactional tax
planning. We decline that invitation.
4. Conclusion
Petitioner may not disavow the form of the 1988 Atrium
Transaction.
14
Our resolution of the issue presented in supra sec. II.B.
leaves respondent without the need to make any protective
adjustment with respect to the adjusted basis of the 48-percent
interest in the Atrium sold by LBC. We assume, therefore, that
respondent would seek only to maintain the UBC affiliated group's
treatment of the 1988 Atrium Transaction as reported on its tax
returns.
- 64 -
III. Corporate Minimum Tax Issue
A. Introduction
On its consolidated returns since at least 1976, and
continuing through 1986, the UBC affiliated group computed its
tax under section 56(a), if any, based on a “consolidated”
computation of that tax (UBC's method), see infra sec. III.C.1.
In the notice of deficiency for docket No. 3723-95, respondent
accepted and used UBC's method in computing the tax under section
56(a) (the corporate minimum tax) for the UBC affiliated group's
1977, 1980, 1984, and 1985 taxable years. In the petition filed
in docket No. 3723-95, petitioner claims that it is entitled to
calculate the corporate minimum tax for the UBC affiliated
group's 1977, 1980, 1984, and 1985 taxable years on a separate
return basis (petitioner's method), see infra sec. III.C.2.,15
and claims refunds for those years on that basis.
B. The Corporate Minimum Tax Provisions
The corporate minimum tax provisions, as in effect for the
years in issue, are sections 56, 57, and 58, and the regulations
thereunder. Section 56 provides, in part, as follows:
SEC. 56 ADJUSTMENTS IN COMPUTING ALTERNATIVE MINIMUM
TAXABLE INCOME.
(a) General Rule.--In addition to the other taxes
imposed by * * * [chapter one of subtitle A of the
Code], there is hereby imposed for each taxable year,
with respect to the income of every corporation, a tax
15
It should be noted that, during those years in issue, no
member of the UBC affiliated group actually filed separate tax
returns.
- 65 -
equal to 15 percent of the amount by which the sum of
the items of tax preference[16] exceeds the greater of--
(1) $10,000, or
(2) the regular tax deduction for the
taxable year (as determined under subsection
(c)).
* * * * * * *
(c) Regular Tax Deduction Defined.--For purposes
of this section, the term “regular tax deduction” means
an amount equal to the taxes imposed by * * * [chapter
one of subtitle A of the Code] for the taxable year
(computed without regard to this part and without
regard to the taxes imposed by sections 531 and 541),
reduced by the sum of the credits allowable under
subparts A, B, and D of part IV. * * *[17]
C. The Two Methods
1. UBC's Method
Under UBC's Method, which respondent contends is correct,
each member of the UBC affiliated group first determines its
separate “items of tax preference” pursuant to section 57. Then,
each member's separate items of tax preference are aggregated to
establish the UBC affiliated group's total for items of tax
preference (UBC's total preferences). That total is reduced by
the UBC affiliated group's regular tax liability (the amount that
should appear on Schedule J of its return) (UBC's consolidated
regular tax) or, if there is no such liability, the minimum tax
exemption.18 The 15 percent minimum tax rate of section 56(a) is
16
Items of tax preference are set forth in sec. 57.
17
The quoted provisions were in effect for the UBC affiliated
group's 1985 taxable year. For purposes of this case, prior
versions of sec. 56, in effect for 1977, 1980, and 1984, were not
materially different from the 1985 version.
18
This sentence reflects a stipulation of the parties. We
(continued...)
- 66 -
then applied to the excess, if any, of UBC's total preferences
over UBC's consolidated regular tax or the exemption amount. The
resulting figure is the UBC affiliated group's corporate minimum
tax.
2. Petitioner's Method
Under petitioner's method, each member of the UBC affiliated
group first determines its separate items of tax preference
pursuant to section 57. Then, each member's separate regular tax
deduction under section 56(c) (separate regular tax deduction) is
determined by using the method of allocation provided in sections
1552(a)(2) and 1.1502-33(d)(2)(ii), Income Tax Regs. (the 1502-
33(d) allocation).19 The 15-percent minimum tax rate of section
18
(...continued)
believe that the minimum tax exemption amount would be used if
the consolidated regular tax were greater than zero and less than
$10,000.
19
Sec. 1552(a) provides that, pursuant to regulations
prescribed by the Secretary, the earnings and profits of each
member of an affiliated group, see sec. 1504, required to be
included in a consolidated return for such group filed for a
taxable year shall be determined by allocating the tax liability
of the group for such year among the members of the group in
accordance with one of several methods set forth in sec.
1552(a)((1) through (4)), which method must be elected in the
first consolidated return filed by the group. Beginning with its
1967 taxable year, the UBC affiliated group elected to allocate
its consolidated regular tax liability among its members in
accordance with sec. 1552(a)(2) and sec. 1.1502-33(d)(2)(ii),
Income Tax Regs. Sec. 1552(a)(2) provides:
The tax liability of the group shall be allocated to
the several members of the group on the basis of the
percentage of the total tax which the tax of such
member if computed on a separate return would bear to
the total amount of the taxes for all members of the
group so computed.
(continued...)
- 67 -
56(a) is then applied to the excess of each member's separate
items of tax preference over the amount, if any, determined under
the 1502-33(d) allocation. Each member's resulting minimum tax,
if any, is then aggregated to derive the UBC affiliated group's
corporate minimum tax.
Under petitioner's method, the aggregate of the members'
separate regular tax deductions, which will be utilized by the UBC
affiliated group to reduce items of tax preference subject to the
15-percent minimum tax, will not equal the consolidated regular
tax liability of the group. That lack of equivalence is a result
of the following: (1) Loss companies are not allocated any
portion of the consolidated regular tax liability, which results
(...continued)
Sec. 1.1502-33(d)(2)(ii), Income Tax Regs., provides:
(ii)(a) The tax liability of the group, as
determined under paragraph (b)(1) of §1.1552-1, shall
be allocated to the members in accordance with
paragraph (a)(1), (2) or (3) of §1.1552-1, whichever is
applicable;
(b) An additional amount shall be allocated to
each member equal to a fixed percentage (which does not
exceed 100 percent) of the excess, if any, of (1) the
separate return tax liability of such member for the
taxable year (computed as provided in paragraph
(a)(2)(ii) of §1.1552-1), over (2) the tax liability
allocated to such member in accordance with (a) of this
subdivision (ii); and
(c) The total of any additional amounts allocated
pursuant to (b) of this subdivision (ii) (including
amounts allocated as a result of a carryback) shall be
credited to the earnings and profits of those members
which had items of income, deductions, or credits to
which such total is attributable pursuant to a
consistent method which fairly reflects such items of
income, deductions, or credits, and which is
substantiated by specific records maintained by the
group for such purpose.
- 68 -
in no separate regular tax deduction for such members with
separately computed items of tax preference; (2) the separately
computed items of tax preference are not aggregated on a
consolidated basis; and (3) the aggregate amount allocated under
the 1502-33(d) allocation to members with positive taxable income
may exceed the consolidated regular tax liability of the group.20
D. Analysis
1. Issue
The issue is whether petitioner is entitled to refunds of
payments made to satisfy the UBC affiliated group's corporate
minimum tax liabilities for the years in issue.
20
That description of the consequence of petitioner’s method
is based on a stipulation of the parties. We find it somewhat
confusing. We believe that the primary reason that the aggregate
of the amounts allocated under the 1502-33(d) allocation may
exceed the consolidated regular tax liability of the group is
sec. 1.1502-33(d)(2)(ii)(b), Income Tax Regs., which allows for
an allocation of additional amounts no greater than the excess of
the separate return tax liability over the amount allocated in
accordance with the ratio of separate return tax liability to the
aggregate thereof for the group. For example, assume the
following: (1) The consolidated group comprises A, B, and C;
(2) A has taxable income of $100, B has taxable income of $100,
and C has a loss of $40; and (3) the regular tax rate is
35 percent. The consolidated regular tax liability would equal
$56 (35 percent of $160 (consolidated regular taxable income)).
Under petitioner's method, both A and B would be allocated
50 percent of that amount because the ratio under sec. 1.1502-
33(d)(2)(ii)(a), Income Tax Regs., for both is $35:$70, see sec.
1.1552-1(a)(2), Income Tax Regs., (we assume that the separate
return tax liability of the loss corporation is zero; if
negative, then A & B's ratios would only increase, resulting in
greater initial allocations to A & B anyway); thus both A and B
are allocated $28. But sec. 1.1502-33(d)(2)(ii)(b), Income Tax
Regs., allows an allocation of an additional amount that is no
greater than $7 ($35 - $28), which could result in a total
allocation to A & B of $70. Seventy dollars is greater than the
consolidated regular tax liability of $56.
- 69 -
2. Arguments of the Parties
Relying principally on Gottesman & Co. v. Commissioner,
77 T.C. 1149 (1981), petitioner argues that, in the absence of any
contrary guidance in the Code or regulations thereunder, section
56(a) imposes a minimum tax on every corporation and that the UBC
affiliated group must, therefore, compute its corporate minimum
tax by aggregating the tax imposed under section 56(a) on each
member of the group. Petitioner argues that, in calculating each
member's separate corporate minimum tax, it is entitled to adopt
any reasonable method of determining each member's separate
regular tax deduction under section 56(c), in particular the 1502-
33(d) allocation. Petitioner goes so far as to argue that
petitioner is required to use the 1502-33(d) allocation for
determining the separate regular tax deductions of the UBC
affiliated group's members under section 56(c). Petitioner argues
that, for the years in issue, the amount of the UBC affiliated
group's corporate minimum tax under petitioner's method is less
than the tax under UBC's method and, therefore, petitioner is
entitled to a refund for those years.
Respondent acknowledges that the regulations relating to
consolidated returns (the consolidated return regulations)21 do not
directly address the computation of the corporate minimum tax for
groups filing consolidated returns. Respondent argues, however,
that under the general rule of section 1.1502-80, Income Tax Regs.,
21
See secs. 1.1501-1 through 1.1552-1, Income Tax Regs.
- 70 -
the minimum tax liability of the UBC affiliated group is determined
by the Code or other law otherwise applicable. Thus, respondent
contends that section 56(a)(2) and (c), the legislative history
thereof, and certain case law remain applicable, requiring the
regular tax deduction of the UBC affiliated group under section
56(c) to equal the amount of tax actually imposed on the group under
chapter one of subtitle A of the Code for the taxable year (without
regard to the corporate minimum tax and certain other provisions).
Respondent argues that, under petitioner's method, the aggregate of
the members' separate regular tax deductions will not equal UBC's
consolidated regular tax. Moreover, respondent argues, petitioner's
method reduces the UBC affiliated group's corporate minimum tax only
if the total of the members' separate regular tax deductions exceeds
UBC's consolidated regular tax. Respondent states: “Consequently,
if the Court limits the total ``regular tax deduction' to the UBC
group's consolidated regular tax liability, petitioner's overpayment
claims become moot and resolution of the Separate Return Issue
unnecessary.” In other words, we need not determine the proper
method of calculating the corporate minimum tax in the context of
corporations filing consolidated returns if we decide that the
deduction under section 56(c) for an affiliated group of
corporations filing a consolidated return is limited to the tax
actually imposed on such group under chapter one of subtitle A of
the Code for the taxable year (without regard to the corporate
minimum tax and certain other provisions and reduced by the sum of
certain credits) (the actually imposed chapter one tax).
- 71 -
3. Discussion
Initially, the dispute between the parties seems to involve two
countervailing principles of the law relating to consolidated
returns: (1) “``Each corporation is a separate taxpayer whether it
stands alone or is in an affiliated group and files a consolidated
return'”, Wegman's Properties, Inc. v. Commissioner, 78 T.C. 786,
789 (1982) (quoting Electronic Sensing Prods., Inc. v. Commissioner,
69 T.C. 276, 281 (1977)), and (2) “the purpose of the consolidated
return provisions * * * is ``to require taxes to be levied according
to the true net income and invested capital resulting from and
employed in a single business enterprise, even though it was
conducted by means of more than one corporation'”, First Natl. Bank
in Little Rock v. Commissioner, 83 T.C. 202, 209 (1984) (quoting
Handy & Harman v. Burnet, 284 U.S. 136, 140 (1931)). The nature of
petitioner's refund claim with respect to the UBC affiliated group's
corporate minimum tax liabilities, however, allows us to restrict
our analysis to the centerpiece of the parties' dispute, i.e., the
amount of the deduction under section 56(c) for an affiliated group
of corporations. In other words, if we decide that the deduction
under section 56(c) for an affiliated group of corporations is
limited to its actually imposed chapter one tax, the parties will
have no material disagreement in their computations pursuant to Rule
155 regarding the UBC affiliated group's corporate minimum tax
liabilities for the years in issue. Therefore, we shall first
address that issue.
Section 1501 provides, in part, as follows:
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An affiliated group of corporations shall * * * have
the privilege of making a consolidated return with respect
to the income tax imposed by chapter 1 for the taxable
year in lieu of separate returns. The making of a
consolidated return shall be upon the condition that all
corporations which at any time during the taxable year
have been members of the affiliated group consent to all
the consolidated return regulations prescribed under
section 1502 prior to the last day prescribed by law for
the filing of such return. * * *
Pursuant to section 1502, Congress has granted to the Secretary of
the Treasury broad authority to prescribe such regulations as he may
deem necessary with respect to the making of consolidated returns.
There are no regulations, however, that directly address the
calculation of the corporate minimum tax for an affiliated group of
corporations that makes a consolidated return.22 In the absence of
consolidated return regulations governing a particular point, this
Court shall look to the Code or other law. See, e.g., Wegman's
Properties, Inc., & Subs. v. Commissioner, supra at 790; sec.
22
On Mar. 19, 1970, the Internal Revenue Service (the IRS)
issued Technical Information Release No. 1032, which stated, in
part, as follows:
The Internal Revenue Service today announced that
amendments will be made to the regulations to reflect
the effect on consolidated returns and partnerships of
the addition by the Tax Reform Act of 1969 of the
minimum tax for tax preferences.
The amendment relating to consolidated returns
will make clear that the election by affiliated groups
of corporations to file a consolidated Federal income
tax return is effective with respect to the computation
of the minimum tax as well as the regular income tax.
Those amendments, however, were never made. On July 31, 1984,
the IRS issued, but never finalized, a proposed amendment to sec.
1.1502-2, Income Tax Regs., which would have added the corporate
minimum tax to the list of taxes to be computed as part of an
affiliated group's consolidated tax liability.
- 73 -
1.1502-80, Income Tax Regs.
Section 56(a) imposes, with respect to the income of every
corporation, a tax equal to 15 percent of the excess of the sum of
the items of tax preference over the greater of $10,000 or the
regular tax deduction.23 Section 56(c) defines the term “regular tax
deduction” to mean “an amount equal to the taxes imposed” by chapter
one of subtitle A of the Code for the taxable year (computed without
regard to the corporate minimum tax and certain other provisions),
reduced by the sum of certain credits. In Norwest Corp. & Subs. v.
Commissioner, T.C. Memo. 1995-600, which involved the same Norwest
Corp. that is the successor in interest to the UBC affiliated group
in this case, this Court held that the amount of the section 56(c)
deduction for an affiliated group of corporations is limited to the
actually imposed chapter one tax of the affiliated group. That
holding was based primarily on the rationale of Sparrow v.
23
One court has stated that the purpose of the corporate
minimum tax “is to make sure that the aggregating of tax-
preference items does not result in the taxpayer's paying a
shockingly low percentage of his income as tax.” First Chicago
Corp. v. Commissioner, 842 F.2d 180, 181 (7th Cir. 1988), affg.
88 T.C. 663 (1987). This Court in First Natl. Bank in Little
Rock v. Commissioner, 83 T.C. 202, 214 (1984), examined the
legislative history of the corporate minimum tax and distilled
two general principles:
First, the tax was intended to limit the tax benefits
and advantages from certain tax exemptions and special
deductions referred to as tax preference items. * * *
Second, Congress did not undertake a revision of the
Code provisions granting the tax preferences or other
substantive provisions such as the consolidated return
regulations. Instead, liability for this additional
tax is generally to be measured by the provisions
imposing it.
- 74 -
Commissioner, 86 T.C. 929 (1986).
In Sparrow, the taxpayers argued that the regular tax for
purposes of calculating their alternative minimum tax under section
55 was the tax that would have been imposed under section 1 and not
the lesser amount of tax that was actually imposed with the benefit
of the income averaging provisions of sections 1301-1305. This
Court stated:
section 55(b)(2) (now section 55(f)(2)) defines regular
tax as “the taxes imposed by this chapter for the taxable
year.” (Emphasis added.) “This chapter” is Chapter 1 of
Subtitle A of the Code. It encompasses sections 1 through
1397. Thus, the regular tax includes the taxes imposed by
sections 1 through 1397; in particular, the tax imposed by
section 1. However, section 1301 allows a taxpayer to
reduce the tax on averageable income thereunder. The
amount so determined under section 1301 thus becomes the
tax imposed by section 1. Sec. 1301 * * *. This figure
therefore is the regular tax and must be used in computing
the alternative minimum tax.
* * * Petitioners would have us read section 55(b)(2) (now
section 55(f)(2)) as defining regular tax as the tax
computed under section 1 regardless of the tax actually
imposed thereunder. This we cannot do. The statutory
language is “taxes imposed.” [Sparrow v. Commissioner,
supra at 934-935.]
Similarly, section 1.1502-2, Income Tax Regs., provides that
the tax liability of an affiliated group of corporations is
determined by adding together the taxes imposed under various
sections of chapter one of subtitle A of the Code on the group's
consolidated taxable income for the taxable year; the total of the
taxes so determined is equal to the taxes imposed on an affiliated
group under chapter one of subtitle A of the Code. No other taxes
are imposed on an affiliated group or any of its separate members
under chapter one of subtitle A of the Code. Therefore, the
- 75 -
deduction under section 56(c) for an affiliated group is limited
initially to an amount equal to the amount determined pursuant to
section 1.1502-2, Income Tax Regs., which regulation provides a
computation of the amount of taxes imposed on an affiliated group
under chapter one of subtitle A of the Code.
The 1502-33(d) allocation advanced by petitioner, however,
would require us to read section 56(c) as defining the term “regular
tax deduction” to mean an amount of tax that is not actually imposed
by chapter one of subtitle A of the Code. That we cannot do. The
statutory language is “taxes imposed”. The 1502-33(d) allocation is
a method of allocating the tax liability determined pursuant to
section 1.1502-2, Income Tax Regs., for purposes of determining the
earnings and profits of each member of an affiliated group. See
sec. 1552; secs. 1.1552-1(a) and (b)(1), 1.1502-33(d)(2), Income Tax
Regs. The amounts allocated to each member of an affiliated group
under the 1502-33(d) allocation are certainly derived from and may
in the aggregate equal the amount of taxes imposed on the
affiliated group pursuant to chapter one of subtitle A of the Code
for the taxable year, but are not, themselves, taxes so imposed.
The fact that section 1.1552-1(b)(2)(ii), Income Tax Regs., treats
the amounts allocated under the 1502-33(d) allocation as a liability
of each member of the affiliated group does not convert such amounts
into taxes imposed by chapter one of subtitle A of the Code for
purposes of section 56(c).24
24
Petitioner's argument that the 1502-33(d) allocation is used
(continued...)
- 76 -
Petitioner's reliance on Gottesman & Co. v. Commissioner,
77 T.C. 1149 (1981), is misplaced. In Gottesman, this Court held
that, since the consolidated return regulations did not mandate a
consolidated calculation of the accumulated earnings tax under
section 531, the taxpayer was permitted to use a separate company
calculation. In this case, however, petitioner seeks to adopt a
method that is contrary to an express provision of the Code, section
56(c). Gottesman is inapposite.
In light of our analysis, we believe that petitioner's other
arguments do not merit discussion. In conclusion, the deduction
under section 56(c) for an affiliated group of corporations is
limited to the group's actually imposed chapter one tax, and,
therefore, petitioner's claims for refunds must fail.
E. Conclusion
Petitioner is not entitled to refunds of payments made to
satisfy the UBC affiliated group's corporate minimum tax liabilities
for the years in issue.
IV. Furniture and Fixtures Recovery Period Issue
A. Introduction
We must determine the applicable recovery period for certain
furniture and fixtures (the furniture and fixtures) placed in
service by various members of the UBC affiliated group during the
group’s 1987, 1988, and 1989 taxable years. The applicable recovery
24
(...continued)
for other purposes, such as the addition to tax under sec.
6655(a), does not change our conclusion that the amounts derived
from such allocation are not taxes imposed by chapter one of
subtitle A of the Code.
- 77 -
period is an element in the calculation of the deduction for
depreciation allowed by section 167. The parties disagree as to
whether the recovery period applicable to the furniture and fixtures
is 5 years or 7 years. Petitioner argues that it is 5 years, while
respondent argues that it is 7 years. UBC originally determined
that the recovery period applicable to the furniture and fixtures
was 7 years and applied that period to the furniture and fixtures in
making its consolidated returns for 1987, 1988, and 1989. In the
relevant petitions, petitioner avers that UBC’s original
determination of the applicable recovery period was mistaken, and
that the correct applicable recovery period is 5 years. Petitioner
asks that the Court determine an overpayment in tax on account of
that mistake. The aggregate cost bases for the furniture and
fixtures placed in service in 1987, 1988, and 1989 are $5,710,643,
$1,490,930, and $546,707, respectively.
The parties disagree as to whether a similar question is before
the Court with respect to the UBC affiliated group’s 1990 and
(short) 1991 taxable years. During those years, various members of
the UBC affiliated group placed in service additional furniture and
fixtures (the 1990-91 furniture and fixtures). UBC determined that
the recovery period applicable to the 1990-1991 furniture and
fixtures was 5 years and applied that period to those furniture and
fixtures in making its consolidated returns for 1990 and 1991.
Respondent made no adjustment with respect to that determination.
In the relevant petition, petitioner included the 1990-91 furniture
and fixtures with the furniture and fixtures in its averment that
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UBC had mistakenly used a 7-year recovery period. In the answer,
respondent merely denied petitioner’s averment. In their respective
trial memoranda, neither party identified the discrepancy in
treatment between the furniture and fixtures and the 1990-91
furniture and fixtures. In their stipulations, however, the parties
recognize the discrepancy, and petitioner concedes that it is not
entitled to any additional depreciation with respect to the 1990-91
furniture and fixtures. On brief, petitioner argues that the only
applicable recovery period issue before the Court concerns the
furniture and fixtures. Respondent argues that the Court must also
determine the applicable recovery period with respect to the 1990-91
furniture and fixtures because that issue either (1) was put in
issue by the petition or (2) was tried with consent of the parties.
We do not believe that petitioner intended to put into issue
the applicable recovery period with respect to the 1990-91 furniture
and fixtures, nor do we believe that that issue was tried with
petitioner’s consent. Rule 31(d) requires us to construe all
pleadings to do substantial justice. Substantial justice would not
be done were we to hold petitioner to an unintended construction of
its pleading, especially in light of respondent’s uninformative
response. Clearly, the issue was not tried with petitioner’s
consent in light of the stipulation and the lack of any notice by
respondent that he intended to raise the issue. The parties have
relied only on the stipulated facts in briefing this issue, so we
cannot conclude that petitioner failed to object to evidence that
should have put petitioner on notice that the applicable recovery
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period with respect to the 1990-91 furniture and fixtures had been
put into play by respondent. Section 6214 provides us with
jurisdiction to determine an increased deficiency if a claim
therefor is asserted by the Secretary at or before the hearing.
Respondent has not relied on section 6214, so we assume that
respondent does not argue that he asserted a timely, appropriate
claim. We conclude that the recovery period applicable to the 1990-
91 furniture and fixtures is not before the Court for decision.
B. Applicable Recovery Period; Class Life
Section 168(c) provides that the applicable recovery period of
5-year property is 5 years and the applicable recovery period of
7-year property is 7 years. Section 168(e)(1) generally defines
5-year property as property having a class life of more than 4
years, but less than 10 years, and 7-year property as property
having a class life of 10 years or more, but less than 16 years.
“Class life”, as defined by section 168(i)(1), is determined by
reference to former section 167(m), as in effect prior to its repeal
by the Omnibus Budget Reconciliation Act of 1990, Pub. L. 101-508,
sec. 11812(a), 104 Stat. 1388, 1388-534. Section 167(m) provided for
a depreciation allowance based upon the class life prescribed by the
Secretary of the Treasury or his delegate. The class lives of
depreciable assets can be found in a series of revenue procedures
issued by the Commissioner. See sec. 1.167(a)-11(b)(4)(ii), Income
Tax Regs. The revenue procedure in effect for the years in issue in
this case is Rev. Proc. 87-56, 1987-2 C.B. 674 (Rev. Proc. 87-56).
Rev. Proc. 87-56 divides assets into two broad categories: (1)
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Asset guideline classes 00.11 through 00.4, consisting of specific
depreciable assets used in all business activities (the asset
category), and (2) asset guideline classes 01.1 through 80.0,
consisting of depreciable assets used in specific business
activities (the activity category). The specific asset guideline
classes in issue are asset guideline classes 00.11 and 57.0 (classes
00.11 and 57.0, respectively). Classes 00.11 and 57.0, and their
headings, are as follows:
SPECIFIC DEPRECIABLE ASSETS USED IN ALL BUSINESS
ACTIVITIES, EXCEPT AS NOTED:
00.11 Office Furniture, Fixtures, and Equipment:
Includes furniture and fixtures that are not a
structural component of a building. Includes
such assets as desks, files, safes, and
communications equipment. Does not include
communications equipment that is included in
other classes * * *
* * * * * * *
DEPRECIABLE ASSETS USED IN THE FOLLOWING ACTIVITIES:
* * * * * * *
57.0 Distributive Trades and Services:
Includes assets used in wholesale and retail
trade, and personal and professional services.
Includes section 1245 assets used in marketing
petroleum and petroleum products * * *
Rev. Proc. 87-56 at 676, 686. The class lives specified for classes
00.11 and 57.0 are 10 and 9 years, respectively.
If the furniture and fixtures are described in class 00.11,
they have a class life of 10 years and, by virtue of section
168(e)(1), are 7-year property, with an applicable recovery period
of 7 years. See sec. 168(c)(1). If the furniture and fixtures are
described in class 57.0, they have a class life of 9 years and, by
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virtue of section 168(e)(1), are 5-year property, with a applicable
recovery period of 5 years. See id.C. Arguments of the Parties
The parties agree that the applicable recovery period for the
furniture and fixtures turns on whether the furniture and fixtures
are described in class 00.11 or class 57.0. Class 00.11 is in the
asset category and class 57.0 is in the activity category. It is
clear that, at least in theory, the same item of depreciable
property can be described in both the asset category and the
activity category. See, e.g., Rev. Proc. 87-56 (class 35.0,
excluding assets in class 00.11 through 00.4). Petitioner,
explicitly, and respondent, implicitly, agree that the furniture and
fixtures are described in both class 00.11 and 57.0. They disagree,
however, on the classification that takes priority.
Petitioner argues that (1) logic and precedent require that the
particular (class 57.0) should prevail over the general (class
00.11), (2) legislative and administrative history support that
result, and (3) a recent ruling of the Commissioner’s, Rev. Rul. 95-
52, 1995-2 C.B. 27, amounts to a concession by the Commissioner with
respect to the issue before us. Respondent relies on (1) the “plain
language” of Rev. Proc. 87-56, (2) administrative history, and (3)
our decision in Norwest Corp. & Subs. v. Commissioner, T.C. Memo.
1995-390.
D. Discussion
In Norwest Corp. & Subs. v. Commissioner, T.C. Memo. 1995-390,
we addressed the same issue presented in this case. We held that
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class 00.11 takes priority over class 57.0. Petitioner argues that
that conclusion is wrong. Petitioner argues that, in Norwest Corp.,
we failed adequately to analyze two cases: Walgreen Co. & Subs. v.
Commissioner, 68 F.3d 1006 (7th Cir. 1995), revg. and remanding 103
T.C. 582 (1994), on remand T.C. Memo. 1996-374, and JFM, Inc. &
Subs. v. Commissioner, T.C. Memo. 1994-239.
The primary issue in Walgreen Co. was whether certain leasehold
improvements, currently described in class 57.0, were excluded from
class 50.0 (class 50.0) of Rev. Proc. 72-10, 1972-1 C.B. 721, 730
(Rev. Proc. 72-10), by virtue of being described in class 65.0
(class 65.0) of Rev. Proc. 72-10. Class 65.0 is entitled “Building
Services” and includes, among other things, “the structural shells
of buildings and all integral parts thereof”. The Court of Appeals
for the Seventh Circuit (the Seventh Circuit) traced the provenance
of class 65.0 to an asset category, “Buildings”, in Rev. Proc. 62-
21, 1962-2 C.B. 418, 419 (Rev. Proc. 62-21). The Seventh Circuit
summarized the relevant aspects of Rev. Proc. 62-21 as follows:
In 1962 the Internal Revenue Service prescribed useful
lives both for types of asset and types of business. Rev.
Proc. 62-21, 1962-2 Cum. Bull. 418. One type of asset was
“Buildings,” defined as including “the structural shell of
the building and all integral parts thereof.” One type of
business was “Wholesale and Retail Trade.” An asset might
be a building used in wholesale and retail trade, and thus
fall into two useful-lives groups. To take care of such
overlaps, Rev. Proc. 62-21 provided that an asset that
fell within both an asset group and an activity group
would be classified in the asset group.
Walgreen Co. & Subs. v. Commissioner, supra at 1007. The Seventh
Circuit noted that, unlike Rev. Proc. 62-21, Rev. Proc. 72-10 did
not contain a priority rule. Walgreen Co. & Subs. v. Commissioner,
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supra at 1008. The Government had based one of its arguments for
affirmance on the assumption that the old (Rev. Proc. 62-21)
priority rule remained in effect (i.e., that any asset described
both in class 50.0 and class 65.0 would be deemed to be only in
class 65.0, for which a longer useful life coincidentally had been
specified). Walgreen had not challenged that assumption, and,
immediately after reviewing the evolution of the asset
classification system, the Seventh Circuit stated that it would
accept the assumption for purposes of deciding the appeal. (The
Seventh Circuit remanded to the Tax Court to find whether any or all
of the leasehold improvements in question were excluded from class
50.0 by virtue of being described in class 65.0; we found that some
were and some were not.)
Petitioner makes the simplistic argument that, since the
Seventh Circuit stated that class 50.0 (now class 57.0) included all
assets used in wholesale or retail trade except those in class 65.0,
and the furniture and fixtures would not be in class 65.0, they must
be in class 57.0. We do not draw that conclusion. The priority
rule of Rev. Proc. 62-21 provided not only that the asset category
of buildings prevailed over the activity category of wholesale and
retail trade but also that the asset category that included office
furniture and fixtures likewise prevailed. The consideration that
the Seventh Circuit gave to the evolution of the asset
classification system before accepting the assumption of the
Government as to the survival of the Rev. Proc. 62-21 priority rule
with respect to class 65.0 leads us to conclude that the Seventh
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Circuit might have reached a similar conclusion even without the
taxpayer’s concession to the Government’s assumption. We attach
little significance to the language to which petitioner directs our
attention. Walgreen Co. & Subs. v. Commissioner, supra, does not
support petitioner’s argument.
JFM, Inc. & Subs. v. Commissioner, supra, is also inapposite.
In that case, among other things, we had to determine the
classification under Rev. Proc. 87-56 of gasoline pump canopies and
related assets. We determined that class 57.0 (and 57.1)
specifically included gasoline pump canopies. We rejected the
Commissioner’s attempt to classify the assets under the broad
definition of “Land Improvements” in class 00.3, on the basis that
such class was a “catchall” provision, which specifically excluded
assets “explicitly included” in other classes. Petitioner draws our
attention to the following statement in JFM, Inc.: “It is clear
that classes 57.0 and 57.1 were intended to cover all possible types
of real or personal property used in marketing petroleum products”.
We made that statement in the context of rejecting the
Commissioner’s class 00.3 classification, which excludes assets
described in other classes, and we do not read that statement as
establishing any priority between class 57.0 and 00.11.
Petitioner also relies on Rev. Rul. 95-52, 1995-2 C.B. 27,
arguing that it shows that the recovery period of furniture can be 5
years because, under the circumstances in the ruling, furniture is
included in class 57.0. It is true that, in the ruling, the
Commissioner held that some furniture is in class 57.0. The
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furniture in question, however, was furniture described as “consumer
durable property” (described in Rev. Proc. 95-38, 1995-2 C.B. 397,
398) subject to rent-to-own contracts entered into with individuals.
The furniture was generally used in an individual’s home. That
furniture, thus, does not fall within class 00.11, which pertains to
“Office Furniture, Fixtures, and Equipment”.
Petitioner’s argument that legislative and administrative
history support its position is basically an argument that policy
goals such as simplification and controversy avoidance would be
served by holding that the activity category includes all
depreciable property used in the named activities. Whether or not
that may be true, but it is not the pattern of the classification
system, which, in specific instances, excludes asset category items
from the activity category. See, e.g., Rev. Proc. 87-56, classes
35.0, 37.11, 80.0. Rev. Proc. 87-56 also excludes from the asset
category items described in the activity category, see, e.g.,
classes 00.12, 00.3, 00.4. We do not discern the absolute position
that petitioner advocates in the history it has cited to us.
Petitioner’s argument that the particular should prevail over
the general is an argument based on common sense and general rules
of construction. See, e.g., Wood v. Commissioner, 95 T.C. 364, 371
(1990) (“when Congress has dealt with a particular classification
with specific language, the classification is removed from the
application of general language”), revd. 955 F.2d 908 (4th Cir.
1992). Petitioner, however, has not persuaded us that, in this
case, class 57.0 is the specific and class 00.11 is the general.
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There are exceptions from the asset category for items classified in
the activity category and vice versa. We are not convinced that the
activity categorization of class 57.0 is more specific than the
asset categorization of class 00.11 in the case of office furniture
and fixtures. Petitioner’s suggested rule of construction is of no
help to it here.
Respondent argues that the plain language of Rev. Proc. 87-56
provides that the asset category consists of “Specific Business
Assets Used in All Business Activities” and that the inclusive
adjective, “all”, plainly establishes a priority of asset
categorization over activity categorization, except where a specific
exception applies. We do not agree. The adjective “all” simply
serves to define a class in the category; it does not help solve the
priority question raised by a class in the activity category that,
on its face, also includes the furniture and fixtures. Respondent
also argues that his position is supported by the history of the
asset depreciation guidelines. We have already discussed some of
that history, but, at the risk of repeating ourselves, will set
forth respondent’s argument:
Rev. Proc. 87-56's predecessors all grouped depreciable
assets into the same two broad categories, specific assets
used in all business activities and assets used in
specific business activities. See, Rev. Proc. 83-35,
1983-1 C.B. 745; Rev. Proc. 77-10, 1977-1 C.B. 548; and
Rev. Proc. 72-10, 1972-1 C.B. 721. Those revenue
procedures were patterned after the first depreciation
guideline revenue procedure, Rev. Proc. 62-21, 1962-2 C.B.
418. Rev. Proc. 62-21 provided for four groups of
depreciable assets. The first group, corresponding to the
asset category of Rev. Proc. 87-56, consisted of assets
used by business in general. The second, third, and
fourth groups, corresponding to the activity category of
Rev. Proc. 87-56, consisted of assets used in non-
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manufacturing activities, manufacturing activities, and
transportation, communication, and public utilities,
respectively. Specifically excluded from the second,
third, and fourth groups were any assets coming within the
first group. Although Rev. Proc. 87-56 and its immediate
predecessors do not explicitly exclude from the activity
category assets coming within the asset category, all
continue the same pattern.9
9
The legislative history of ACRS indicates that Congress
understood Rev. Proc. 87-56's predecessors as providing
that assets which are encompassed in classes in both the
asset and activity categories are to be classified in the
asset class. In describing the ADR system which was
incorporated into ACRS, the Conference Committee Report on
the Tax Reform Act of 1986 states: Under the ADR system, a
present class life ("mid-point") was provided for all
assets used in the same activity, other than certain
assets with common characteristics (e.g., automobiles).
H.R. Conf. Rep. No. 99-841, 99th Cong., 2d Sess. 38
(1986), 1986-3 C.B. Vol. 4, 38 (emphasis added)
(automobiles comprised an asset category class (Class
00.22) under Rev. Proc. 83-35, 1983-1 C.B. 745).
We are not interpreting a statutory provision. Although
Congress clearly was concerned with the Commissioner’s
implementation of the class life system, and the system implements
section 167, we are interpreting an administrative creation, and,
thus, we must determine the administrator’s intent. We are
persuaded by respondent that Rev. Proc. 62-21 established a pattern
that was carried over into subsequent revenue procedures, including
Rev. Proc. 87-56. Notwithstanding the failure to continue a
specific priority rule in subsequent revenue procedures, there is
sufficient similarity in style and organization between Rev. Proc.
62-21 and its successors that we think that a similar priority rule
was intended, and we so find.
E. Conclusion
The furniture and fixtures are described in class 00.11.
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Therefore, they have a class life of 10 years and, by virtue of
section 168(e)(1), are 7-year property, with an applicable recovery
period of 7 years. See sec. 168(c)(1).
V. Net Operating Loss Issue
A. Introduction
Section 172(a) allows a “net operating loss deduction” for the
aggregate of net operating loss carrybacks and carryovers to the
taxable year. The term “net operating loss” (NOL) is defined in
section 172(c). Section 172(b) provides the carryback and carryover
periods for NOLs. Section 172(b)(1)(A) and (B) provides that,
generally, the carryback period for a NOL is 3 years and the
carryover period is 15 years. Section 172(b)(1)(L) provides a
special rule with respect to the bad debt losses of commercial
banks: The portion of the NOL of a commercial bank that is
attributable to bad debt losses is prescribed a carryback period of
10 years and carryover period of 5 years. Section 172(l) provides a
rule for determining the portion of a bank’s NOL attributable bad
debt losses:
The portion of the net operating loss for any taxable year
which is attributable to the deduction allowed under
section 166(a) shall be the excess of --
(i) the net operating loss for such taxable
year, over
(ii) the net operating loss for such taxable
year determined without regard to the amount
allowed as a deduction under section 166(a) for
such taxable year.
Section 166 allows a deduction for bad debts. Section 1.1502-11,
Income Tax Regs., prescribes how consolidated taxable income is to
be determined. Among other things, it prescribes that consolidated
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taxable income is to be determined by taking into account the
separate taxable income of each member of the group and “[a]ny
consolidated net operating loss deduction”. Section 1.1502-21(a),
Income Tax Regs., provides that the consolidated NOL deduction is
equal to the aggregate of the consolidated NOL carryovers and
carrybacks to the taxable year. In pertinent part, section 1.1502-
21(b)(1), Income Tax Regs., provides that the consolidated NOL
carryovers and carrybacks to the taxable year shall consist of any
consolidated NOLs of the group that may be carried back or over to
the taxable year under the provisions of section 172(b). Section
1.1502-21(f), Income Tax Regs., provides rules for determining the
consolidated NOL. In pertinent part, it provides that the
consolidated NOL shall be determined by taking into account the
separate taxable income, “as determined under §1.1502-12”, of each
member of the group. Finally, section 1.1502-12, Income Tax Regs.,
provides that the separate taxable income of a member, “including a
case in which deductions exceed gross income”, is determined, with
certain modifications, as if the member were not a member of the
group.
The dispute between the parties concerns the calculation of
that portion of the consolidated NOL of the UBC affiliated group
for 1987 that is attributable to bank bad debt losses (and, thus,
subject to the special carryback and carryforward rules of section
172(b)(1)(L)). For 1987, the UBC affiliated group consisted of both
bank and nonbank members. The parties have no dispute over how to
determine the bad debt portion of the NOL of any bank member. Their
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dispute concerns the determination of the bank bad debt portion of
the consolidated NOL. We agree with respondent’s determination.
B. Facts
All of the facts relevant to this issue have been stipulated.
In abbreviated form, those facts are as follows:
By Form 1139, Corporation Application for Tentative Refund (the
Form 1139), dated November 18, 1988, UBC claimed tentative refunds
for the taxable years 1977, 1978, 1979, 1981, 1984, and 1985 based
on the carryback of a NOL from the UBC affiliated group's 1987
taxable year (the 1987 consolidated NOL).
UBC carried a portion of the consolidated 1987 NOL back to the
UBC affiliated group's taxable years 1977, 1978, and 1981.
On the Form 1139, UBC calculated the portion of the
consolidated 1987 NOL subject to the 10-year carryback provided for
by section 172(b)(1)(L) (the bad debt portion) by (1) determining
the bad debt and nonbad debt portions of each loss bank member's
NOL, (2) allocating the consolidated 1987 NOL among the loss
members and, in the case of loss bank members, between the bad debt
and nonbad debt portions of their NOLs, and (3) aggregating the
portions of the consolidated 1987 NOL allocated to the bad debt
portions of the loss bank members' NOLs.
On the Form 1139, UBC determined the bad debt portion of each
loss bank member's NOL by taking the excess of its NOL over its NOL
less its bad debt deduction (i.e., an amount equal to the lesser of
the bank's NOL or bad debt deduction). Thus, for example, in the
case of United Bank of Aurora-South (Aurora-South), a bank member
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of the affiliated group, which had an NOL of $341,183 and a bad
debt deduction of $136,881, the bad debt portion of the NOL was
determined to be $136,881.
After determining the bad debt portion of each loss bank
member's NOL, UBC allocated the consolidated 1987 NOL among the
group's loss members and, in the case of the loss bank members,
between the bad debt and the nonbad debt portions of their NOLs.
The allocation was made in proportion to the aggregate of the loss
members' NOLs. For example, $41,861 of the consolidated 1987 NOL
was allocated to the bad debt portion of Aurora-South's NOL (The
bad debt portion of Aurora South’s NOL was $136,881; the
consolidated NOL, as adjusted by respondent, was $9,239,383, and
the aggregate of all loss members’ NOLs, as adjusted by respondent
was $38,752,008. So, $32,636 = $136,881 x (9,239,383 ÷
38,752,008).) The sum of $48,710 of the consolidated 1987 NOL, as
adjusted by respondent, was allocated to the nonbad debt portion of
Aurora-South’s NOL. (The nonbad debt portion of Aurora South’s NOL
was $204,302; $48,710 = $204,302 x (9,239,383 ÷ 38,752,008).)
After allocating the consolidated 1987 NOL among the loss
members, UBC determined the bad debt portion of the consolidated
1987 NOL by aggregating the portions of the consolidated 1987 NOL
allocated to the bad debt portions of the loss bank members' NOLs.
The bad debt portion so determined was $8,731,874, of which
$2,152,283 was attributable to separate return limitation year
(SRLY) bank members and $6,579,591 was attributable to non-SRLY
bank members. Based thereon UBC claimed consolidated 1987 NOL
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carrybacks to the UBC consolidated group's taxable years 1977,
1978, and 1981 under the provisions of section 172(b)(1)(L)
totaling $6,924,421 ($6,579,591 (non-SRLY bank members) + $344,830
(SRLY carryback to 1981)).
In respondent’s notice of deficiency issued to petitioner for
the UBC affiliated group's taxable years 1977 through 1980, 1984,
and 1985 (the "notice"), respondent adjusted the consolidated 1987
NOL to take into account various proposed adjustments. As UBC did
on the Form 1139, respondent calculated the bad debt portion of the
consolidated 1987 NOL by (1) determining the bad debt and nonbad
debt portions of each loss bank member's NOL, (2) allocating the
consolidated 1987 NOL among the loss members and, in the case of
loss bank members, between the bad debt and nonbad debt portions of
their NOLs, and (3) aggregating the portions of the consolidated
1987 NOL allocated to the bad debt portions of the loss bank
members' NOLs.
In the notice, respondent, like UBC on the Form 1139,
determined the bad debt portion of each loss bank member's NOL by
taking the excess of its NOL over its NOL less its bad debt
deduction (i.e., an amount equal to the lesser of the bank's NOL or
bad debt deduction). Thus, for example, in the case of Aurora-
South, which had an NOL of $341,183 and a bad debt deduction of
$136,881, the bad debt portion of the NOL was determined to be
$136,881.
After determining the bad debt portion of each loss bank
member's NOL, respondent, like UBC, allocated the consolidated 1987
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NOL among the group's loss members and, in the case of the loss
bank members, between the bad debt and the nonbad debt portions of
their NOLs. The allocation was made in proportion to the aggregate
of the loss members' NOLs. For example, $32,636 of the
consolidated 1987 NOL (as adjusted by respondent) was allocated to
the bad debt portion of Aurora-South's NOL. The bad debt portion
of Aurora-South’s NOL was $136,881; the consolidated NOL, as
adjusted by respondent, was $9,239,383, and the aggregate of all
loss members’ NOLs, as adjusted by respondent was $38,752,008.
Thus, $32,636 = $136,881 x (9,239,383 ÷ 38,752,008). The sum of
$48,710 of the consolidated 1987 NOL, as adjusted by respondent,
was allocated to the nonbad debt portion of Aurora-South’s NOL.
The nonbad debt portion of Aurora-South’s NOL was $204,302;
$48,710 = $204,302 x (9,239,383 ÷ 38,752,008).
After allocating the consolidated 1987 NOL among the loss
members, respondent, in the notice, like UBC on the Form 1139,
determined the bad debt portion of the consolidated 1987 NOL by
aggregating the portions of the consolidated 1987 NOL allocated to
the bad debt portions of the loss bank members' NOLs. The bad debt
portion so determined was $6,263,417, of which $1,677,978 was
attributable to SRLY bank members and $4,585,439 was attributable
to non-SRLY bank members. Based thereon the notice allowed NOL
carrybacks to the UBC affiliated group's taxable year 1977 of
$4,585,439 (non-SRLY bank members) and taxable year 1981 of
$268,839 (SRLY carryback).
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C. Petitioner’s Position
Petitioner contends that the method used both by UBC on the
Form 1139 and respondent in the notice to determine the bad debt
portion of the consolidated 1987 NOL is incorrect. Under the
method asserted by petitioner, the bad debt portion of the
consolidated NOL is equal to the excess of the consolidated 1987
NOL over the consolidated 1987 NOL computed without the bad debt
deductions of the bank members. Under that method, regardless of
whether the consolidated 1987 NOL on the Form 1139 ($12,549,042) or
in the notice ($9,239,383) is used, since the bad debt deductions
of the bank members for 1987 total $61,296,286, elimination of such
bad debt deductions from the consolidated 1987 NOL (i.e., the
"without" calculation) would eliminate the consolidated 1987 NOL
and result in substantial consolidated taxable income for the UBC
consolidated group. Under those circumstances, there would be no
consolidated 1987 NOL to be allocated among the loss members of the
group. Thus, under the method asserted by petitioner, the entire
amount of the consolidated 1987 NOL is attributable to bad debt
deductions of bank members, and the entire portion of the
consolidated 1987 NOL allocated to the loss bank members is subject
to the 10-year carryback provisions of section 172(b)(1)(L).
D. Discussion
Consider a business with $100 of gross income, deductions
other than bad debts of $80, and deductible bad debts of $30. The
business has a NOL of $10. Under the general rule of section
172(b)(1)(A), the NOL may be carried back 3 years and carried over
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15 years, and the constituent parts of the NOL are of no importance
in determining the business’s eligibility for such treatment. If
the corporation were a commercial bank, however, then, because of
section 172(b)(1)(L), the constituent parts of the NOL would be
important, because the special period rules of section 172(l) apply
only to that portion of the NOL attributable to the deduction
allowed by section 166 (the bad debt portion). In theory, the bad
debt portion of the NOL might be determined in a number of ways. A
simple way would be to determine that, since the bad debt deduction
of $30 accounted for approximately 27 percent of the total
deductions of $110, 27 percent of the NOL, i.e., $2.70, is the bad
debt portion. Section 172(l)(1) adopts a different rule, one that
is favorable to the intended recipients, commercial banks. Under
section 172(l)(1), on the facts of our simple example, if the
corporation were a commercial bank, the bad debt portion is $10.
The assumption is that deductions for (losses from) bad debts
constitute the NOL to the extent of such deductions.
Neither party disagrees that section 172(l)(1) works as
described. Their disagreement concerns the composition of the
consolidated NOL. Respondent would allocate the consolidated NOL
among the loss members of the UBC affiliated group in proportion to
each loss member’s share of the aggregate of all loss member’s NOLs
and would further allocate each bank loss member’s share of the
consolidated NOL between the bad debt portion of the bank member’s
NOL and the remainder of the bank loss member’s NOL in proportion
to those relative amounts. Thus, assume that affiliated group ABC,
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making a consolidated return of income, had a consolidated NOL of
$10, and each member had separate taxable incomes as follows:
Member A $100
Member B (80)
Member C (30)
Further assume that Member C is a commercial bank, and is the only
member that is a commercial bank, and that the bad debt portion of
its NOL is $20. Respondent would apportion 73 percent of the
consolidated NOL ($7.30) to Member B and 27 percent ($2.70) to
Member C. Respondent would further determine that the bad debt
portion of the consolidated NOL is $1.82 ($20 x ($10 ÷ $110)).
Under petitioner’s method: "[T]he bad debt portion of the
consolidated NOL is equal to the excess of the consolidated NOL
over the consolidated NOL computed without the bad debt deductions
of the bank members.” Thus, with respect to affiliated group ABC,
petitioner would determine that the bad debt portion of the
consolidated NOL is $20.
The difference between the parties is whether the special
ordering rule of section 172(l)(1) should be applied to a
consolidated NOL. The gist of petitioner’s argument is that the
consolidated return regulations provide that the consolidated NOL
must be determined on a consolidated basis. Petitioner would,
thus, analogize an affiliated group with both bank and nonbank loss
members (and with a consolidated NOL) to a separate corporation
with both bad debt and nonbad debt losses (and an NOL) and apply
section 172(l)(1) to the consolidated NOL.
We find no basis in the consolidated return regulations for
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petitioner’s analogy. Although the consolidated return regulations
do speak in terms of a “consolidated net operating loss”, see sec.
1.1502-21(b)(1), Income Tax Regs., it is quite clear that the
consolidated net operating loss is to be determined by taking into
account the “separate” taxable income, including the separate NOL,
of each member of the group. See secs. 1.1502-12, 1.1502-21(f),
Income Tax Regs. The separately determined losses of each member
of the affiliated group do not lose their distinct character (to
the extent that such distinct character is important) upon
consolidation. Cf. Amtel, Inc. v. United States, 31 Fed. Cl. 598,
600 (1994), (“a member of an affiliated group may have a separate
net operating loss with independent significance for income tax
purposes”) affd. without published opinion 59 F.3d 181 (1995).
Moreover, section 172(l)(1) is a special rule that prioritizes a
bank’s losses. Nothing in that section leads us to believe that
Congress intended to give a priority to a bank member’s bad debt
losses as against a nonbank member’s losses in the context of a
consolidated return.
E. Conclusion
As stated, we agree with respondent’s determination of the
appropriate method to determine the bad debt portion of the
consolidated NOL.
Decisions will be entered
under Rule 155.
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APPENDIX