DocketNumber： Docket No. 1392-76
Citation Numbers： 72 T.C. 294, 1979 U.S. Tax Ct. LEXIS 125
Judges： Simpson
Filed Date： 5/9/1979
Status： Precedential
Modified Date： 1/13/2023
*125
P was a limited partner in five limited partnerships. In 1971 or 1972, each of such partnerships invested in real estate improved by unprofitable vineyards. The partnerships held the land for resale and rented the vineyards. In addition, each limited partnership made a quaranteed payment within the meaning of
1.
2.
3.
4. Fair market value of the grape vines*126 determined.
*295 The Commissioner determined deficiencies in the petitioner's Federal income taxes as follows:
| Year | Deficiency |
| 1970 | $ 10,026 |
| 1971 | 28,199 |
| 1972 | 322 |
The parties have settled or conceded certain adjustments. The issues left for decision are: (1) Whether a guaranteed payment within the meaning of
*296 FINDINGS OF FACT
Some of the facts have been stipulated, and those facts are so found.
The petitioner, Sidney Kimmelman, a.k.a. Sydney Omarr, maintained his legal residence in Santa Monica, Calif., at the time he filed his petition in this case. He filed his Federal income tax returns for 1970, 1971, and 1972 with the Office of the Internal Revenue Service at Ogden, Utah.
Occidental Land Research (OLR) is a general partnership formed by William R. Decker and John Decker (the Deckers) in 1969. Since then, OLR has been active in real estate syndications in the areas of Ontario, Calif., and Cucamonga, Calif., and has organized approximately*130 75 limited partnerships for such purpose. In 1977, OLR was a general partner in at least 44 partnerships, 37 of which held land improved by grapevines. Prior to 1969, the Deckers were also active in real estate endeavors.
Occidental Construction Co., Inc. (OCC), was organized by the Deckers in 1963. From 1963 to 1968, OCC was engaged primarily in real estate development -- building and promoting residential housing. After 1968, OCC ceased its real estate development activities and, except for its involvement in real estate syndication, was essentially a dormant corporation. However, just prior to trial, OCC again became actively engaged in real estate development.
During portions of 1971 and 1972, the petitioner was a limited partner in five limited partnerships (the partnerships): Devore Rochester, Ltd. (Devore); Redwood Baseline, Ltd. (Redwood); Rochester Seventh Street, Ltd. (Rochester Seventh); Rochester Eighth Street, Ltd. (Rochester Eighth); and Sultana Baseline, Ltd. (Sultana). OLR is the general partner in Devore, Redwood, Rochester Seventh, and Rochester Eighth. Richard Blindell, who was a salesman for OLR at one time, is the general partner in Sultana. OCC performed*131 the same services for all five partnerships, and Sultana was operated in the same manner as the limited partnerships in which OLR was the general partner; therefore, in describing the operations of the partnerships, a reference to OLR in its capacity as a general partner will include Mr. Blindell.
During the late 1960's and early 1970's, there was a marked increase in the consumer demand for wine, and such increased *297 demand, together with generally favorable economic conditions, combined to create a boom in the wine industry. To meet the new demand for wine, thousands of acres of land, especially in northern California, were being purchased and converted to vineyards.
At the same time that vineyards were being developed in northern California, vineyards in southern California, especially in the Ontario-San Bernardino area, were suffering serious setbacks. A combination of smog, adverse weather conditions, industrial encroachment, and land speculation had seriously reduced the number of acres devoted to vineyards and diminished the productivity of the remaining acreage.
The Deckers were aware of the declining fortunes of the vineyards in the Ontario-San Bernardino area. *132 Relying on their years of experience in real estate, they believed that much of the land devoted to vineyards in this area was in the path of industrial or residential development in the not-so-distant future. In their view, these unproductive vineyards represented a sound investment opportunity; such land could be purchased at reasonable prices, held for several years, and then sold at appreciated prices for industrial or residential purposes.
In time, the Deckers became involved in syndicating investments in real estate in the Ontario-San Bernardino area through limited partnerships. By 1971, the Deckers, through OLR and OCC, had organized approximately 33 limited partnerships which had invested in real estate. In addition, they had established a standard procedure, or modus operandi, for handling such investments.
In a typical syndication handled by OLR, the Deckers, acting through OCC, located the land to be purchased and then negotiated on behalf of OCC for its purchase. It was their belief that conducting negotiations through OCC, a real estate development corporation, offered certain psychological advantages over conducting their business through OLR, a real estate investment*133 business. Once the desired real estate had been identified, a team of experts employed by either OCC or OLR proceeded to make the necessary arrangements for OCC to purchase the land. For example, a civil engineer was hired to survey the land and to search the title to the land. A title insurance company insured title to the land. An accounting firm was retained to establish and maintain the books and records for *298 the new enterprise. In addition, a "banking connection" was used to set up the deeds of trust executed by OCC in connection with the purchase. One express condition of the deeds of trust was the following:
It is a specific stipulation of this Deed of Trust that the grape vines on the real property described herein are hereby considered personal property and are EXCLUDED FROM THE SECURITY GIVEN HEREON; further that the Trustor herein has a right to remove, destroy or relocate any and all said vines.
Finally, an escrow agent was used to handle the actual purchase. Each member of the team was paid a fee for his services.
At or around the same time, OLR issued a prospectus for the limited partnership. In the typical prospectus, the purchase of the real estate*134 by the limited partnership was described as "an outstanding opportunity for investment." Also, it was "the general intention of the partnership to hold the property for approximately three to five years unless previously resold at a profit." The factors which the prospectus emphasized to promote investment all pointed to the resale of the land in the future for industrial or residential purposes. In addition, the Deckers prepared a limited partnership agreement.
At the time OLR and OCC performed most of these services, the particular limited partnership to which the land would be ultimately transferred was not yet organized. OCC in effect acted as a nominee for parties to be named later.
OCC purchased the land on varying terms. Generally, a small downpayment was required. In addition, OCC executed a deed of trust with respect to the remainder of the purchase price. Subsequently, OCC resold the real estate to a limited partnership for exactly the amount it had paid for it. The limited partnership assumed the deed of trust and executed a promissory note. In addition, OLR was paid a "general partner fee" which varied with the cost of the real estate. The attorney retained by *135 OCC and OLR was paid a separate fee, and OCC and OLR did not receive a broker's fee or other real estate commission upon the sale of the various parcels to the limited partnerships.
Generally, if the land was improved by grapevines, OLR attempted to negotiate a lease with a local vineyard operator. In a typical lease, the partnership received a percentage of gross receipts from grape sales, and the lessee incurred and paid all of the expenses of maintaining the vines. However, OLR was not *299 always successful in leasing all of its syndicated properties which were improved by grapevines. The partnerships were obligated to pay the real property taxes.
The partnerships involved in this case are typical of the land syndications organized by OLR. Each was organized toward the end of the petitioner's taxable year. Summarized below is information regarding the date the partnerships were formed and the date OCC transferred the real estate to them:
| Date land | ||
| Partnership | Date formed | transferred |
| Devore | 12/20/71 | 12/28/71 |
| Redwood | 12/29/71 | 12/31/71 |
| Rochester Seventh | 12/26/72 | 12/29/72 |
| Rochester Eighth | 12/26/72 | 12/29/72 |
| Sultana | 11/13/72 | 11/17/72 |
For each of the*136 partnerships, William Decker allocated the purchase price between the land and the vines based on general observations; he had no established criteria for making such allocations. A "general partner fee" was charged the partnerships by the general partner equal to approximately 10 percent of the sum of the purchase price of the land and such fee (10-percent fee). Summarized below is the acreage, purchase price, allocation of the purchase price to land and vines, and the 10-percent fee for each of the partnerships:
| Total | |||||
| purchase | Allocation | ||||
| Partnership | Acreage | price | To land | To vines | 10% fee |
| Devore | 9.6 | $ 76,800 | $ 22,512 | $ 54,288 | $ 8,888.89 |
| Redwood | 52.0 | 205,000 | 74,500 | 130,500 | 22,778.00 |
| Rochester Seventh | 9.6 | 96,000 | 71,000 | 25,000 | 10,666.00 |
| Rochester Eighth | 9.6 | 96,000 | 71,000 | 25,000 | 10,666.00 |
| Sultana | 20.0 | 85,000 | 60,000 | 25,000 | 9,444.00 |
The downpayment paid by the partnerships varied between 2 and 10 percent of the purchase prices. Each partnership also agreed to pay to the general partner a yearly management fee of 1 percent of "the original purchase price."
The partnerships met with varying degrees of success in their efforts to*137 lease the vineyards. The grape production on Devore and Redwood was insufficient to produce a profit, and therefore, those vineyards could not be leased. The maintenance of those *300 vineyards varied with the availability of funds, though many of the vines were living at the time of trial.
The grape production on Rochester Seventh and Rochester Eighth was sufficient by 1974 to lease the properties. While these vineyards have been maintained adequately since 1974, they produced no income for the limited partnerships prior to 1974, and thereafter, any such income to the partnerships was de minimis.
The Sultana vineyards did not generate any income, but they also did not generate any expenses for the partnership; the partnership agreed with a local vineyard operator that he could have the grapes if he would maintain the vines.
The partnerships were not concerned, however, with the inability of the vineyards to generate current income, because they did not purchase the properties for that purpose. With respect to the vines, the partnerships were merely concerned with keeping them alive. Most of the vines involved herein were planted around the turn of the century.
At about *138 the same time as the Deckers became involved in real estate syndications, they also became interested in whether grapevines could be transplanted. They were fully aware of the fact that the thousands of acres of new vineyards in northern California were uniformly established by planting slips. A "slip" is a joint cut from a mature vine, which is permitted to sprout in a nursery and is then transplanted; it generally requires 5 years for a slip to become a mature vine. In addition, they knew that transplanting mature vines was unheard of in the wine industry. It was uncertain whether grapevines could be successfully transplanted because of their tap roots, which extended vertically into the ground for several feet. It was equally unclear whether a transplant program was economically feasible, whether the equipment to successfully carry out a major transplant program existed, and what would be the mechanics or logistics of such a program. Yet, they believed that if a transplant program could be conducted successfully, new vineyards could be established much more quickly than by the planting of slips.
After awhile, the Deckers contacted viticulturists and ranchers to get their views*139 on the matter. Then, they conducted time and labor studies, the results of which they converted into pro forma costs. From an economic standpoint, they considered each varietal available for transplantation to be of equal economic *301 value because they believed that the price and productivity of the various varietals were inversely related. They also decided to transplant the vines only when they were dormant, which occurred from around September to March each year. The vines were to be transplanted bare-rooted, i.e., completely removed from the soil. All of the vines would be transplanted from vineyards in the Ontario, Calif., area to northern California.
In February 1972, the Deckers transplanted 65 vines in a single row on land they had rented for that specific purpose in northern California. However, these vines did not fare very well. Many of them were damaged, though it was not clear whether a frost subsequent to the transplant, or the transplant itself, caused the damage. The cost of the transplant far exceeded the Deckers' estimates. In February 1973, the Deckers extended the row by transplanting an additional 40 vines.
In February 1974, the Deckers used the*140 knowledge acquired from the earlier two transplants to transplant 4 acres of vines in the Fresno, Calif., area. During their first year, the vines produced approximately the same quantity of grapes as they produced in the Ontario area, which was 2 to 4 tons per acre. However, in the second year, they produced 6 to 8 tons of grapes per acre. These grapes were never harvested commercially. Again, the actual cost of the operation exceeded the estimates.
In late 1974 and early 1975, the boom in the wine industry ended. Though demand for wine continued strong, the supply of grapes far exceeded the available crushing capacity, so the price of grapes declined. As a consequence, there was no longer a need for additional vineyards. In view of the economic conditions, OLR postponed further experimentation with and consideration of its transplant program.
On their Federal returns for the years at issue, the partnerships deducted the 10-percent fee and claimed depreciation and an investment credit on the value of the vines as determined by the Deckers. Two of the partnerships also claimed additional first-year depreciation on such vines. In his Federal income tax returns for the years*141 at issue, the petitioner reported his distributive share of the partnerships' income and losses. After an audit of the partnership returns, the Commissioner determined that the value of the vines should be reduced, resulting in a reduction in the allowable depreciation and investment credit, and that the 10-percent fee was not deductible. In the notice of *302 deficiency issued to the petitioner, the Commissioner made corresponding adjustments in the petitioner's distributive shares of partnership income and losses.
For purposes of the notice of deficiency, the Commissioner determined that the grapevines had the following values:
| Partnership | Value |
| Devore | 0 |
| Redwood | $ 16,637 |
| Rochester Seventh | 0 |
| Rochester Eighth | 0 |
| Sultana | 9,534 |
At the trial, the Commissioner presented the testimony of an expert witness who concluded that some of the vines had a different value than that determined by the Commissioner in his deficiency notice. Accordingly, the Commissioner adopted the values found by his expert and now maintains that the grapevines had the following values:
| Partnership | Value |
| Devore | $ 2,130 |
| Redwood | 11,085 |
| Rochester Seventh | 2,130 |
| Rochester Eighth | 2,130 |
| Sultana | 4,610 |
*142 OPINION
The first issue for decision is whether guaranteed payments under
The petitioner argues that the payments at issue are guaranteed payments under
In
If we were to allow a section 162(a) deduction in the case of a partner's rendering services to his partnership which are capital in nature, it would be the only*144 instance that such a deduction would be allowed for a capital expenditure. We see no reason why employment of the entity theory of partnerships in this facet of partnership taxation should require the automatic deductibility of guaranteed payments and hence make such a holding an anomaly in tax law as far as capital expenditures are concerned. * * *
[Emphasis in original.]
Our decision in
Since
*304 After carefully considering the petitioner's arguments, we conclude that they are merely repetitious of those raised, fully considered, and rejected by us and the Fifth Circuit in
Next, we must decide whether the 10-percent fees are currently deductible or are capital expenditures. The petitioner argues the fees are ordinary and necessary business expenses and therefore deductible, whereas the Commissioner argues the fees were incurred in connection with organizing and syndicating the partnerships and therefore are capital expenditures.
Section 162 generally allows deductions for ordinary and necessary business expenses. Under section 263, capital expenditures are not deductible. Though the line separating ordinary business expenses from capital expenditures is not always clearly marked, it is generally true that the term "business expense" includes only those expenditures which are a part of the current cost of operating the business. "When, however, an expenditure is made for the acquisition of an asset the useful life of which will extend beyond the year in which cost is incurred, such expenditure is considered as a capital item, and is not generally deductible as a business expense." (
Expenditures incurred*147 in connection with the organization and syndication of limited partnerships are capital in nature and, therefore, not currently deductible.
*148 In deciding whether the 10-percent fees are ordinary and necessary business expenses or capital expenditures, we must look to the nature of the services performed by OLR. The petitioner bears the burden of proving the fees are currently deductible (
The evidence presented by the petitioner is wholly unconvincing. He summarizes the services performed by OLR as:
the assumption by the General Partners of the responsibility to each limited partner in connection with his investment and for the establishment of operating procedures related thereto, including collection of rents from leases of vines, collection from partners of contributions, deposit in bank accounts and payments of obligations, supervision of the bookkeeping functions once initially established by the accountants and thereafter fulfilled by the issuance of annual reports and tax returns.
However, the fees at issue ranged from $ 8,888.89 to $ 22,778, and it is very unlikely that they were paid for such minor administrative services, especially since *149 a management fee of 1 percent of the purchase price was deemed sufficient for such services in subsequent years. 3 The petitioner attempts to explain the size of the 10-percent fee by arguing that, during the first year, OLR performed substantial other services in addition to those performed in connection with organizing and syndicating the *306 partnerships, and that such other services exceeded those in subsequent years. Yet, the evidence does not reasonably support such position, especially since all of the partnerships were organized toward the end of the petitioner's taxable year, and the 10-percent fee was 10 times the management fee paid in subsequent years. Finally, the evidence presented by the petitioner is singularly vague regarding exactly what services were performed by OLR.
On the other hand, the evidence strongly suggests that, in fact, the 10-percent fees were paid to OLR for organizing*150 and syndicating the partnerships. OCC and OLR performed substantial services in connection with the organization and syndication of the partnerships. OCC located and inspected the land. It also searched the title, conducted the negotiations, and ultimately purchased the land. At the same time, OLR was advertising, circulating prospectuses, paying large fees and commissions, and incurring other expenses promoting the investment and locating potential investors. In addition, OLR prepared the partnership agreements, and OCC handled the escrow accounts and the deeds of trust. Most of these services were performed before the partnerships were organized, and OCC and OLR received no fees or commissions for their services other than the 10-percent fees. Under these circumstances, we must conclude that the 10-percent fees were costs of organization and syndication, and as such, they must be capitalized. 4
*151 The next issue for decision is whether the grapevines are "tangible personal property" within the meaning of
The term "
(1) (A) of a character subject to the allowance for depreciation under section 167, (B) acquired by purchase after December 31, 1957, for use in a trade or business or for holding for production of income, and (C) with a useful life (determined at the time of such acquisition) of 6 years or more.
(b)
Property can qualify*153 for the investment credit if it constitutes tangible personal property or, subject to certain limitations, other tangible property. In
Under State law, affixation to the land is generally a basis for distinguishing personal property from other property. Similarly, under State law, an agreement by the parties may, under certain circumstances, convert real property to personal property. See, e.g.,
(1) Is the property capable of being moved, and has it in fact been moved?
(2) Is the property designed or constructed to remain permanently in place?
(3) Are there circumstances which tend to show the expected or intended length of affixation, i.e., are there circumstances which show that the property may or will have to be moved?
(4) How substantial a job is removal of the property, and how time-consuming is it? Is it "readily removable"?
(5) How much damage will the property sustain upon its removal?
(6) What is the manner of affixation of the property to the land?
Applying these criteria to the facts in our case leads to the conclusion that the grapevines are an "inherently permanent structure" within the meaning of
Our conclusion is supported by
Because we believe that commonsense dictates that citrus trees or trees in general are more commonly associated with land and because of their inherently permanent nature it is our judgment that citrus trees cannot reasonably be regarded as items of personal property for the purposes of
It appears that the grapevines are essentially similar to citrus trees in their attachment to the land. Though there are some slight differences between grapevines and citrus trees, such differences are not of sufficient magnitude to warrant a different conclusion in this respect. 5 The petitioner attempts to distinguish the citrus tree cases by arguing that there was an agreement to remove the grapevines from the land. However, at the times the vineyards were acquired, there was nothing more than a hope that grapevines could be transplanted successfully. Even now, the only transplant programs that have occurred were on a small scale and were more in the nature of experiments; *157 it has not been shown that a widespread program of transplanting grapevines can be carried on successfully. Thus, we are not convinced that when the vineyards were acquired, there was a bona fide plan to sever the grapevines from the land and sell them separately.
Finally, we must determine the fair market value of the grapevines so the partnerships can determine the depreciation deductions and investment credits to which they are entitled. By now, it is generally accepted that the price at which a willing buyer will purchase property from a willing seller, when neither *310 party is acting under compulsion and both parties are fully informed of all the*158 relevant facts and circumstances, establishes fair market value.
The Commissioner's expert is a highly qualified real estate appraiser. He first became an appraiser in 1960, and since then, he has had extensive experience in valuing real estate in and around the Ontario-San Bernardino, Calif., area. He has valued farmland on many occasions, and he has valued land improved by grapevines in the Ontario-San Bernardino area. He is a member of the American Society of Farm Managers and Rural Appraisers and the California Society of Farm Managers and Rural Appraisers. He is designated an Accredited Rural Appraiser.
Before valuing the grapevines, he personally inspected the vineyards owned by the partnerships. He analyzed the production of vineyards*159 in the area and determined that environmental influences had drastically reduced the production of vineyards in the Ontario-San Bernardino area. He ascertained the number of harvested acres of vineyards in San Bernardino County, the tons of grapes per acre, and the average price per ton for a 3-year period from 1970 to 1972. Using such information, he obtained the income which the vines could be expected to produce, and he computed the fair market value of the vines based on such projected income. Then, he examined at least 11 other sales involving comparable agricultural or farmland in the vicinity of the land in issue. In such sales, he ascertained the prices paid for the land and any amounts allocated to the purchase of producing vineyards. In addition, he carefully scrutinized the terms of each of the comparable sales. Because the downpayment required of each of the partnerships ranged between 2 and 10 percent, and because of other terms favorable to the partnerships, he determined the prices paid by them exceeded the fair market value of the land. In reaching his valuations, he considered what *311 effect, if any, the possibility of transplanting the vines would have*160 on value and concluded as follows: 6
Consideration was given to the economic feasibility of possible vine removal for replanting on more agriculturally oriented land. However, inquiry and experience suggests that any such scheme to replant a mature vineyard does not appear to have merit or economic feasibility and is fraught with hazard.
*161 The petitioner's expert is a land developer. At the time of the trial, he had developed over 10,000 acres of vineyards in California. In computing the fair market value of the vines, he analyzed the California wine industry and found that, economically speaking, the industry appeared to have a promising future in the early 1970's. He assumed that the transplantation of vines was a viable method of establishing a vineyard. In determining the best use for the vines, he concluded as follows:
Since * * * [OLR] has established the transplantable potential of mature vines in their transplant program and since there is strong demand for the development of vineyards in high yield areas, the value of the vines as a transplantable asset must be considered, and is, therefore, the primary use treated in this report.
Using three different valuation approaches, he then proceeded to compute the value of the vines. Under the capitalization of income approach, he used the yields per acre, and prices paid for grapes, in the Modesto and San Joaquin areas of California, to compute the gross revenue. From such revenue, he subtracted the cost of maintaining the vines and capitalized the remainder*162 using a capitalization rate of 10. Finally, he subtracted the cost of transplanting the vines to reach a fair market value of $ 7,434.44 per acre for the vines. Under the cost approach, he computed the cost of developing 1 acre of a new vineyard using conventional methods, and from such figure, he eliminated costs which would be avoided by transplanting vines, resulting in a vine value of $ 3,454 per acre. Under the court-award approach, he determined the value of the vines by reference to value placed on certain vines by a court of the State of *312 California. Under such approach, he valued the vines at $ 7,187.70 per acre. Combining these three approaches, he concluded that the vines were worth $ 6,000 per acre on the relevant valuation date.
In our judgment, the valuation of the petitioner's expert and of the Deckers is based on an unsound assumption. Both the income and cost approaches and the Deckers' original allocations are premised on the assumption that the possibility of transplanting the vines dramatically affected their value. It is true that future events which can be anticipated with reasonable certainty at the valuation date may be considered in arriving*163 at fair market value (see, e.g.,
The court-award approach employed by the petitioner's expert is equally unconvincing. We know nothing about the facts and *313 circumstances in that case. For example, we do not know the varietal of vines involved, where they were located, whether punitive damages were involved, and when the vines were damaged. We were not provided a citation to the case, and we could not otherwise locate it. Without a good deal more information about the vines involved in that case, we can place no weight on the value based thereon.
On the other hand, the analysis of the Commissioner's expert is very persuasive. In general, his valuation report*165 was a thorough and comprehensive analysis of the factors influencing the fair market value of the land and vines. The petitioner's only objection to the analysis of the Commissioner's expert is that such expert failed to take into consideration the possibility of transplanting the vines, but for the reasons that we have already set forth, we are entirely satisfied with his conclusion on this matter.
In one respect, however, we disagree with the conclusions of the Commissioner's expert. Such expert concluded that the prices paid by the partnerships for the properties exceeded their fair market values, and he allocated between the land, vines, and other improvements only the amounts which he considered to represent the total fair market value of the property. Yet, for purposes of determining allowable depreciation and investment credit, we must consider the prices actually paid for the properties. Accordingly, we hold that the fair market value of the vines must be determined by allocating the price actually paid for each property between the land, vines, and other improvements in the same proportion as did the Commissioner's expert. Cf.
1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the years in issue, unless otherwise indicated.↩
2. See also
3. From the partnership agreement, it is not clear whether the management fee was also due for the first year.↩
4. The petitioner also argued that such fees are deductible under sec. 212. However, sec. 212 does not enlarge the range of allowable deductions vis-a-vis sec. 263, but "merely enlarged the category of incomes with reference to which expenses were deductible."
5. In
6. At the trial, the petitioner objected to the admission in evidence of a portion of the report of the Commissioner's expert. In the petitioner's view, a letter in such report written by a viticulturist expressing the opinion that vines could not be successfully transplanted was inadmissible hearsay. However, under