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PAUL O. HUBER and MARY J. HUBER, ET AL., Huber v. CommissionerDocket Nos. 15839-82, 24632-82, 26291-82, 30215-82.
United States Tax Court T.C. Memo 1984-593; 1984 Tax Ct. Memo LEXIS 79; 49 T.C.M. (CCH) 57; T.C.M. (RIA) 84593;November 9, 1984. John P. Sampson ,Joel A. Lopata ,FAYMEMORANDUM FINDINGS OF FACT AND OPINION
FAY,
Judge: Respondent determined deficiencies in petitioners' Federal income tax as follows:Petitioners Year Deficiency Paul O. Huber and 1977 $1,749.00 Mary J. Huber Phillip O. Boyer and 1977 1,533.00 Marian E. Boyer David L. Gillette and 1978 1,131.70 Doris P. Gillette Earl V. Gritton and 1977 2,250.00 Helen M. Gritton D. Wilson Hales and 1977 3,801.00 Anne Hales James R. Lindsley and 1977 2,070.00 Una F. Lindsley Gregory A. Miller, Jr. 1977 760.00 George W. Nixon and 1976 2,347.79 Janice M. Nixon 1977 4,100.00 Alan L. Nye and 1978 1,900.00 Beverly B. Nye Toffie G. Sawaya and 1978 1,908.00 Alice A. Sawaya Russell J. Smuin and 1976 1,485.00 Evelyn Smuin 1977 630.00 Henry A. Totzke and 1976 6,362.00 Martha V. Totzke 1977 5,188.00 Harvey P. Wheelwright 1977 885.00 and Marilyn G. Wheelwright Leo S. Bankhead and 1978 1,828.00 Diane C. Bankhead Jerald H. Bennion and 1978 3,668.00 Constance Bennion Virgil R. Condon and 1976 7,574.38 Marilyn Condon J. William DeYoung and 1977 1,044.00 Beth DeYoung Harold R. Eason and 1976 1,028.00 Rita C. Eason Val B. Johnson and 1977 2,430.90 Janet P. Johnson Rex M. Kohler and 1977 5,853.00 Ivy Jean Kohler J. Kirk Moyes and 1977 5,156.00 Sharyl B. Moyes Robert Crouch Newman 1976 1,180.00 and Eleanor R. Newman Alan L. Nye and 1976 4,545.00 Beverly B. Nye Ralph Nye 1976 8,554.00 O & M Plumbing & 1977 1,928.00 Heating Co. Henry A. Totzke and 1978 16,078.00 Martha V. Totzke G. Jerry Hayes 1978 9,950.00 and Joyce R. Hayes H. Norman Hayes 1978 10,563.00 H. Norman Hayes 1979 2,217.00 and Maurine Hayes *81 These cases have been consolidated for trial, briefing, and opinion. After concessions, the issues for decision are whether petitioners, as limited partners, are entitled to deductions for (1) their share of amounts paid by their respective partnerships for management fees, (2) their share of amounts paid by their respective partnerships for consulting fees, (3) their share of amounts paid by their respective partnerships for standing crops, (4) their share of amounts paid by their respective partnerships for rockpicking and land preparation expenses, and (5) depreciation in excess of the amount allowed by respondent.
BACKGROUND FINDINGS OF FACT
Some of the facts are stipulated and found accordingly.
All petitioners resided in Utah when they filed their petitions herein.
From 1974 through 1976 Paul Richins formed several corporations for the general purpose of engaging in investment and financial activities *82 partnerships (herein the partnerships). *83 the facts and opinion relating to each issue separately.
Issue 1.Management Fees FINDINGS OF FACT AND OPINION
Each partnership agreement contained a provision that Richtron, as general partner, would receive a management fee equal to 10 percent of the purchase price of the farm on the date the partnership agreement was executed. *84 several pieces of property. After several farms were selected, Richtron's appraisal department would value each farm based on the engineering department's determination of the condition of the property and the improvements which would be necessary. Richtron then negotiated the sales price and drafted the contracts for both the purchase of the farms and resale of the farms to the partnerships. Richtron also prepared all of the limited partnership agreements.
Mr. Richins personally contacted all of the limited partners prior to their investment in the partnerships. In some instances, he met with potential partners up to three separate times. Richtron did not keep records indicating the exact amount of time spent in organizing the partnerships, purchasing the farms, drafting documents, and contacting investors.
Richtron has managed all of the farms since they were acquired by the partnerships. Richtron's payroll during the years in issue was approximately $8,000 to $10,000 per month.
Each partnership deducted as management fees the amounts paid to Richtron pursuant to the partnership agreements. *85 share of the above-reported partnership deductions.In his notices of deficiency, respondent disallowed all of these deductions.
The issue is whether any of the so-called "management fees" are deductible by the partnerships. Respondent contends no deductions are allowable since the fees represent nondeductible capital expenses. Petitioners contend the fees are deductible as ordinary and necessary business expenses of the partnerships. For the following reasons, we find for respondent.
To be deductible by the partnerships, the fees must satisfy the requirements of
section 162(a) .Section 162(a) generally allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. In determining*86 whether any of the fees are deductible undersection 162(a) , "we look to the nature of the services performed [for which the fees were paid] * * * rather than to their designation or treatment by the partnership."Estate of Boyd v. Commissioner, 76 T.C. 646">76 T.C. 646Cagle v. Commissioner, 63 T.C. 86">63 T.C. 86539 F.2d 409">539 F.2d 409 (5th Cir. 1976). Expenditures incurred in connection with the organization and syndication of limited partnerships are capital in nature and, therefore, not currently deductible.Kimmelman v. Commissioner, 72 T.C. 294">72 T.C. 294, 304-305 (1979)Wildman v. Commissioner, 78 T.C. 943">78 T.C. 943Estate of Boyd v. Commissioner, supra at 667Bassett v. Commissioner, 26 T.C. 619">26 T.C. 619Rule 142(a) ;Wildman v. Commissioner, supra. In the instant case, it is clear that Richtron spent a significant amount of time organizing and syndicating the partnerships. Although petitioners argue that no portion of the so-called "management fees" paid to Richtron were for organizational expenses, we disagree. Richtron spent a great deal of time*88 in selecting which farms to purchases, negotiating with the owners, contacting limited partners, and in setting up the partnerships. Althoughno records were kept indicating how much time was spent by Richtron, we find that a portion of the 10 percent of the purchase price paid to Richtron in the first year of each partnership was in fact a payment for organization and syndication expenses and therefore not currently deductible.
Furthermore, the evidence also shows that although Richtron provided management services to the partnerships in the years following the initial year of each partnership, it received no payments in such years for its management services. Since the partnerships did not pay any additional management fees to Richtron, it is clear that a singificant portion of the initial fee was intended to be compensation for Richtron's future services. Such portions of the fees are not currently deductible by the partnerships.
Petitioners rely on the testimony of one of Richtron's employees who was involved in managing the farms. His testimony consisted of nothing more than bare assertions that the claimed fees were reasonable in relation to the services provided. *89 He failed to provide evidence, however, as to the number of people required to manage the farms or the amount of time that was necessary to provide such services. Thus, petitioners have failed to satisfy their burden of proving that the large amounts their partnerships deducted for management fees, such as $84,730 and $67,500 deducted by Moreland and Richfield, respectively, were deductible business expenses. Rule 142.We are convinced that a large portion of the amounts deducted as management fees was in fact for organizational expenses and future services both of which are not currently deductible expenses, and that the partnerships designated these payments as first-year management fees so that petitioners could get increased ordinary deductions in those years.
Although a small portion of the fees may have been for management services provided by Richtron in the year the partnerships took the deductions, we are in no position to allow a deduction for such a portion since petitioners have given us no basis for either valuing the services performed or allocating between deductible and nondeductible expenses. See
Wildman v. Commissioner, supra at 960Estate of Boyd v. Commissioner, supra at 668Issue 2.Consulting Fees FINDINGS OF FACT AND OPINION
When Richtron purchased each farm from third parties, a portion of the purchase price was allocated as and for a farming consultation fee to the sellers. Subsequently, in the sales contracts between Richtron and the partnerships, Richtron assigned its right to receive those consulting services to the partnerships. Eight of the partnerships in question did not provide any additional consideration to Richtron for this right nor did they agree to pay the fee. The remaining four partnerships did agree to pay the fee.
When negotiating the purchase price of each farm, Richtron introduced the idea of allocating a portion of the purchase price for a consulting fee. In return for this fee, the prior owners of each farm were expected to provide information concerning the farm's crop history, fertilizer program, and other similar information. Prior to negotiating a purchase, however, Richtron itself appraised each farm and determined its crop history, fertilizer program, and overall condition*91 in order to make an offer to the owner.
Each partnership deducted the amounts paid to the prior owners of the farms as "consulting fees" on its return in the year the farms were purchased.
Rule 142(a) ;Botany Mills v. United States, 278 U.S. 282">278 U.S. 282sec. 162(a)(1) . Respondent argues that petitioners have failed*92 to provide any evidence that these fees were reasonable compensation for consulting services actually rendered by the prior owners. Seesec. 1.162-7(a), Income Tax Regs. Petitioners contend that it was necessary to pay these fees in order to obtain valuable information about the farms. They have failed, however, to show either that the prior owners of the farms did in fact consult with the partnerships after they sold the farms to Richtron or that the partnerships received from such owners any information in addition to that received by Richtron before making the purchase. Furthermore, petitioners' witness testified that the amount of time the prior owners consulted the partnerships was at most one day per farm. Thus, we find that the amounts deducted by the partnerships for "consulting fees" were not reasonable compensation for consulting services which, at most, consisted of a few hours of discussion with the prior owners of the farms. We conclude that the fees were simply part of the purchase price of each farm and therefore should be added to the partnerships' bases in the farms. See
Sanders v. Commissioner, 75 T.C. 157">75 T.C. 157Stevens v. Commissioner, 46 T.C. 492">46 T.C. 492388 F.2d 298">388 F.2d 298 (6th Cir. 1968). Accordingly, we sustain respondent's determination that no portion of these consulting fees is deductible undersection 162(a)(1) .Issue 3. Standing Crops FINDINGS OF FACT AND OPINION
Pursuant to their contracts to purchase farms from Richtron, five of the partnerships in issue agreed to pay certain sums to Richtron for "standing crops" located on the farms. *94 of deficiency, respondent disallowed all of the above-claimed deductions except for $6,744 of Moreland's deduction.
The issue is whether the partnerships were entitled to deduct the amounts they paid for standing crops in the years they acquired the farms. Since petitioners and their respective partnership are considered "farmers" under
section 1.61-4(d), Income Tax Regs. ,section 1.61-4(a), Income Tax Regs. :The profit from the sale of livestock or other items which were purchased is to be ascertained by deducting the cost from the sales price in the year in which the sale occurs, * * *.
This Court*95 has previously held this regulation valid, seeD. E. Alexander v. Commissioner, 22 T.C. 234">22 T.C. 234Sykes v. Commissioner, 57 T.C. 618">57 T.C. 618Petitioners' sole contention is that the crops were sold to the lessees of the farms in the same year the partnerships purchased the farms and therefore they were entitled to deduct the cost of the standing crops that year. There is no evidence in the record, however, to support this contention. The leases entered into between the partnerships and third parties do not show that ownership of the crops was transferred to the lessees nor that additional payments were made as payments for those crops. Thus, the five partnerships are not entitled to deductions for the amounts paid for standing*96 crops in the years they purchased the farms, but they may be entitled to deduct the amounts allocated to standing crops in the years they actually sell the crops. See
Sykes v. Commissioner, supra , Issue 4. Rockpicking and Land Preparation Expenses FINDINGS OF FACT AND OPINION
Two of the partnerships in issue, Moreland and Grandview, entered into agreements with Richtron to have Richtron perform land preparation and rockpicking services on their farms. Although some rockpicking and land preparation is necessary each year, the rockpicking and land preparation required by Moreland and Grandview were major project because these farms were in poor condition when purchased by the partnerships. The partnerships wanted the land to be improved to increase its value for eventual resale.
Moreland paid $37,300 to Richtron for these services in 1978 and Grandview paid $11,500 and $13,626 to Richtron for these services in 1978 and 1979, respectively. Each partnership deducted deducted its respective amount on its return for the year in question, and petitioners claimed a distributive share of the deductions. In his notices of deficiency, respondent*97 disallowed $36,735 of Moreland's deduction and $11,500 and $7,625.32 of Grandview's deductions for 1978 and 1979, respectively.
The issue is whether the amounts paid by the two partnerships to Richtron for rockpicking and land preparation are deductible expenses under
section 162 . Respondent argues that these expenses are nondeductible capital expenditures undersection 263 .section 162 . For the following reasons, we agree with respondent.Section 263(a) provides that no current deduction shall be allowed for any amount paid out for permanent improvements or betterments made to increase the value of any property. It is necessary to take into consideration the purpose for which an expenditure is made in determining whether such expenditure is capital in nature or constitutes *98 a current expense.Oberman Manufacturing Co. v. Commissioner, 47 T.C. 471">47 T.C. 471section 162 ; such expenditures are distinguishable from those for replacements, alterations, improvements or additions which prolong the useful life of the property, increase its value or make it adaptable to a different use.Secs. 1.162-4 and1.263(a)-1(a)(1), Income Tax Regs. ;Oberman Manufacturing Co. v. Commissioner, supra. Rule 142(a) .The evidence herein establishes that the farms purchased by Moreland and Grandview were in poor condition and that the purpose for the extensive rockpicking and land preparation was to increase the value of these farms for eventual resale. The extent of rockpicking and land preparation was*99 greater than would ordinarily be necessary to keep the farms in an efficient operating condition. Although a small portion of the rockpicking and land preparation may have constituted necessary annual maintenance expenses, we are in no position to allow a deduction for such a portion since petitioners have failed to give us a basis for making such a determination.
Accordingly, we conclude that no portion of the rockpicking and land preparation expenses is deductible by the partnerships and therefore such expenses must be capitalized under
section 263 .Issue 5. Depreciation FINDINGS OF FACT AND OPINION
Moreland, which purchased its farm from Richtron for $562,300, is the only partnership to which this issue is applicable. Moreland's farm consisted of 1,427 acres of land, two houses, two potato cellars, irrigation equipment, wells, sheds, and barns. *100 Based on the portion of the purchase price which it allocated to the depreciable property, Moreland took a depreciation deduction of $18,124 in 1978 of which petitioners claimed a distributive share. In his notice of deficiency, respondent disallowed $1,990 of Moreland's depreciation deduction for 1978.
The issue is whether Moreland is entitled to a depreciation deduction in excess of the amount allowed by respondent. Where, as here, a combination of depreciable and nondepreciable property is purchased for a lump sum, the basis for depreciation cannot exceed an amount which bears the same proportion to the lump sum as the value of the depreciable property at the time of acquisition bears to the value of the entire property at that time.
Sec. 1.167(a)-5, Income Tax Regs. ;Randolph Building Corp. v. Commissioner, 67 T.C. 804">67 T.C. 804Rule 142(a) .Petitioners argue that Moreland's allocation of the total purchase price to the depreciable assets complied with
section 1.167(a)-5, Income Tax Regs. Respondent argues, however, that Moreland simply valued the depreciable assets based on their fair market value at the time of acquisition and not based on their proportionate share of the purchase price of the farm. We agree with respondent.Petitioners rely entirely on the testimony of one of Richtron's farm managers who stated that the value allocated to each piece of depreciable property was reasonable. His testimony was based, however, on the fair market values of the items of depreciable property at the time of acquisition rather than on their proportionate share of the total purchase price of the farm.
As the formula in
section 1.167(a)-5, Income Tax Regs. , applies to this case, Moreland's basis for depreciation cannot exceed the total purchase price ($562,300) times a fraction, the numerator of which is the value of the depreciable property at the time of acquisition*102 and the denominator of which is the value of the entire property at that time. The farmland itself had a fair market value approximately equal to Moreland's total purchase price and the depreciable assets had an aggregate fair market value of $226,762. Thus, since the lump sum paid for the farm was less than the aggregate fair market values of the depreciable and nondepreciable property, the basis allocable to the depreciable property pursuant to this formula must be less than the fair market values. Decisions will be entered under Rule 155.Footnotes
1. Cases of the following petitioners are consolidated herewith: Philip O. Boyer and Marian E. Boyer, David L. Gillette and Doris P. Gillette, Earl V. Gritton and Helen M. Gritton, D. Wilson Hales and Anne Hales, James R. Lindsley and Una F. Lindsley, Gregory A. Miller, Jr., George W. Nixon and Janice M. Nixon, Alan L. Nye and Beverly B. Nye, Toffie G. Sawaya and Alice A. Sawaya, Russell J. Smuin and Evelyn Smuin, Henry A. Totzke and Martha V. Totzke, Harvey P. Wheelwright and Marilyn G. Wheelwright, docket No. 24632-82; Leo S. Bankhead and Diane C. Bankhead, Jerald H. Bennion and Constance Bennion, Virgil R. Condon and Marilyn Condon, J. William DeYoung and Beth DeYoung, Harold R. Eason and Rita C. Eason, Val B. Johnson and Janet P. Johnson, Rex M. Kohler and Ivy Jean Kohler, J. Kirk Moyes and Sharyl B. Moyes, Robert Crouch Newman and Eleanor R. Newman, Alan L. Nye and Beverly B. Nye, Ralph Nye, O & M Plumbing & Heating Co., Henry A. Totzke and Martha V. Totzke, docket No. 26291-82; and G. Jerry Hayes and Joyce R. Hayes H. Norman Hayes, H. Norman Hayes and Maurine Hayes, docket No. 30215-82.↩
2. The parties agree that for purposes of this case Paul Richins and all of the companies he formed are the same entity. ↩
3. Petitioners are limited partners in the following 12 limited partnerships:
Catlow Valley 2, 3, 4, 5 and 7
Burley Farms
Kanosh Farms
Moreland Properties
Grandview Properties
Shoshone Farms
West Taber
Richfield Farms↩
4. Catlow Valley 5 and 7 were sold to the partnerships at a profit the year after Richtron purchased them.↩
5. We note that the Court does not know how Richtron treated any of the payments received from the partnerships herein for Federal income tax purposes. ↩
6. The 12 partnerships in issue were to operate for the following number of years:
↩ Burley 25 All Catlow Farms 20 Grandview 22 Kancsh 10 Moreland 24 Richfield 20 Shoshone 20 West Taber 15 7. The following amounts were deducted by the partnerships as management fees:
↩ Limited Partnerships Amount Burley $35,000 Catlow Valley 2 16,500 Catlow Valley 3, 4, 5 & 7 16,970 each Grandview 21,000 Kanosh 23,000 Moreland 84,730 Richfield 67,500 Shoshone 45,000 West Taber 20,000 8. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. ↩
9. We note that, as part of The Tax Reform Act of 1976, sec. 709 was enacted to deal with such fees. Sec. 709(a) expressly provides that syndication fees are not deductible and that, except as provided by sec. 709(b), organization fees are not deductible. Sec. 709(b) allows a partnership to elect to amortize and deduct over a period of not less than 60 months its capital expenditures incurred in organizing the partnership. However, sec. 709(b) is inapplicable in the present case, since it is effective only with respect to organization fees paid or incurred in taxable years beginning after December 31, 1976.Tax Reform Act of 1976, Pub. L. 94-455, sec. 213(f)(3), 90 Stat. 1549.↩
10. The following amounts were deducted by the partnerships as consulting fees:
↩ Limited Partnerships Amount Burley $15,000 Catlow Valley 2, 3, 4, 5 & 7 1,927 each Grandview 6,400 Kanosh 8,000 Moreland 15,500 Richfield 19,500 Shoshone 18,000 West Taber 11,900 11. The five limited partnerships which paid for "standing crops" are Catlow Valley 2, Catlow Valley 3, Catlow Valley 4, Moreland, and Richfield. ↩
12. The following amounts were deducted by the partnerships for standing crops:
↩ Limited Partnership Amount Catlow Valley 2 & 3 $2,252 each Catlow Valley 4 2,253 Moreland 39,500 Richfield 24,500 13.
Sec. 1.61-4(d), Income Tax Regs.↩ , provides that all individuals, partnerships, or corporations that cultivate, operate, or manage farms for gain or profit, either as owners or tenants, are designated as farmers.14. Sec. 182 is not applicable because it is an elective section and the partnerships failed to make such an election. See
sec. 1.182-6(a), Income Tax Regs.↩ 15. Moreland allocated the following amounts for these depreciable assets from the total purchase price of $562,300:
↩ (1) Brick House $38,000 (2) Frame House 19,500 (3) Potato Cellars 30,000 (4) Sheds and Barns 12,000 (5) Irrigation Equipment 61,422 (6) Wells 65,840 TOTAL $226,762 16. Pursuant to the formula in
sec. 1.167(a)-5, Income Tax Regs. , Moreland's basis allocable to the depreciable property cannot exceed the following:$562,300 X 226,762/789,062 = $161,594.70↩
17. Since we have sustained all of respondent's determinations, the parties agree that we need not determine the effect of the at risk rules under sec. 465 in this case.↩
Document Info
Docket Number： Docket Nos. 15839-82, 24632-82, 26291-82, 30215-82.
Filed Date： 11/9/1984
Precedential Status： Non-Precedential
Modified Date： 11/21/2020