DocketNumber: Docket No. 15857-85.
Citation Numbers: 54 T.C.M. 443, 1987 Tax Ct. Memo LEXIS 448, 1987 T.C. Memo. 451
Filed Date: 9/9/1987
Status: Non-Precedential
Modified Date: 11/20/2020
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER,
Petitioners Vincent E. Webb and Carol A. Webb, husband and wife, resided in Salt Lake City, Utah, at the time of filing the petition in this*450 case. Petitioners filed joint Federal income tax returns for the taxable years 1981 and 1982 4 using the cash method of accounting.
During 19981 and 1982 petitioner was a limited partner in approximately ten limited partnerships, one of which was the CFC-77 Partnership A (CFC 77-A), doing business as Town Park Apartments. CFC 77-A was formed on July 1, 1977, 5 on which date it acquired a 338-unit apartment complex (Town Park) located in Houston, Texas. The approximate cost of the apartment complex was $ 6,000,000. 6
*451 CFC 77-A, on July 26, 1982, entered into a purchase and sale agreement (Purchase Agreement) with National Property Investors 5 (National), a California limited partnership, to sell the Town Park property for a stated price of $ 9,900,000. Under the terms of the Purchase Agreement, National was required to: (1) Pay a $ 200,000 deposit into escrow upon the signing of the agreement; (2) pay $ 3,150,000 in cash upon closing; and (3) execute and deliver to CFC 77-A, on the closing date, a purchase money note in the amount of $ 6,550,000, secured by a wrap-around deed of trust.
On September 21, 1982, the closing date of the sale, National executed and delivered to CFC 77-A a purchase money note in the amount of $ 6,550,000 (the "wrap-around note"). On this date National also executed, in favor of CFC 77-A, a deed of trust as security for the purchase money note (wrap-around deed of trust). At the time of sale 7 there were two mortgages outstanding on the Town Park property (First and Second Deed of Trust) with balance of $ 3,388,093.93 and $ 642,972.33, respectively. The interest rate charged on the first and Second Deed of Trust loans was 8-3/4 percent per annum with a total monthly*452 principal and interest payment of $ 30,369 and $ 5,755, respectively. The notes for the First and Second Deed of Trusts were payable in the year 2002 and 1984, respectively.
Under the terms of sale, the wrap-around note was subordinated to the total underlying indebtedness of $ 4,031,066 (senior mortgage). The amount of the wrap-around note represented the unpaid balances of the senior mortgages plus the additional funds CFC 77-A advanced to National (the difference between $ 9,900,000 selling price and $ 3,350,000 deposit received by CFC 77-a); this is referred to as the senior mortgage being "wrapped" in the wrap-around note. The terms of the wrap-around note provided for the accrual of interest at the following rates:
From 9/22/82 to 9/19/84 | 9% per annum |
From 9/22/84 to 9/19/86 | 10% per annum |
From 9/20/86 to 9/19/87 | 10-3/8% per annum |
From 9/20/87 to 9/19/88 | 10-1/2% per annum |
From 9/20/88 to 9/19/89 | 10-5/8% per annum |
From 9/20/89 to 9/19/90 | 10-3/4% per annum |
From 9/20/90 to 9/19/91 | 10-7/8% per annum |
From 9/20/91 to 9/19/92 | 11% per annum |
*453
The note has a maturity date of September 19, 1992, and is payable as follows: (1) monthly installments of interest only commencing on October 20, 1982, and on the 20th of each month thereafter including September 20, 1983, computed at the rate of 8-1/4 percent per annum. The difference between interest at this rate and the rate specified above is due on September 20, 1984; (2) monthly installments of interest only at the interest rates specified above commencing on October 20, 1983, and on the 20th of each month thereafter until maturity when the entire unpaid principal balance, together with accrued interest, shall be due and payable.
The note provides, in pertinent part, as follows:
This note is a wraparound note, and the principal indebtedness evidenced hereby is inclusive on the indebtedness evidenced by (a) a note from Texas Gulf Industries, Inc. to the Mutual Life Insurance Company of New York dated December 19, 1973, and (b) a note from Reica Properties to Town Park Associates dated December 31, 1976.
Under the terms of the wrap-around deed of trust National is "Grantor," Jack Baumgardner is "Trustee," and CFC 77-A is "Beneficiary." The pertinent provisions of*454 this deed of trust provides as follows:
(a) On page 2 it states that:
all rights granted herein are subject and subordinate in all respects to (a) First Lien Deed of Trust dated December 19, 1973 (the "First Deed of Trust") * * * to secure the payment of a $ 3,800,000 note (the "First Lien Note") dated December 19, 1973, payable to the Mutual Life Insurance Company of New York; and (b) Subordinate Deed of Trust dated December 31, 1976 (the "Second Deed of Trust") * * * to secure the payment of a $ 700,000 note (the "Second Lien Note") dated December 31, 1976, payable to Town Park Associates;; and (c) Subordinate Deed of Trust dated August 22, 1974 (the "Supplemental Deed of Trust") * * * to secure the First Lien Note (the First Deed of Trust, Second Deed of Trust and Supplemental Deed of Trust are sometimes collectively referred to herein as the "Underlying Deed(s) of Trust").
(b) Paragraph 7(a) states, in part, that:
It is fully understood that Grantor will comply with and will perform in accordance with each, every and all of the terms, covenants and conditions of the Underlying Note(s) and the Underlying Trust Deed(s), other than the payment of installments of principal*455 and interest which Beneficiary agrees to pay hereunder. This covenant shall inure solely to the benefit of the Beneficiary and shall not constitute an assumption of any Underlying Deed of Trust.
(d) Paragraph 28 states, in part, that:
This Deed of Trust is a wraparound deed of trust, and is subject and subordinate to the Underlying Deeds of Trust. The principal indebtedness of $ 6,550,000 evidenced by the Note includes $ 3,388,093.93 which is the principal balance due on the First Deed of Trust as of the date hereof and $ 642,972.33 which is the principal balance due on the Second Deed of Trust as of the date hereof. Beneficiary agrees to pay all payments of the principal and interest of the Underlying Deeds of Trust occurring from and after the date of this Deed of Trust, in accordance with the terms of the Underlying Deeds of Trust, * * *.
(e) Paragraph 29(a) states, in part, that:
Beneficiary by accepting this Deed of Trust agrees:
To make or cause to be made all payments of principal and interest payable pursuant to the Deed of Trust (as hereinafter defined), on or before the dates on which such payments are due, including any "Balloon Amount" as defined herein. In*456 the event there is no collecting agent as set forth in paragraph 29(f) hereof, Beneficiary agrees to indemnify and hold Grantor harmless from and against any and all liability, duty or responsibility for the payment of the First Lien Note or any part thereof, and any interest, fees and damages which have become or may hereafter become due thereon and for any loss, damage, expense or cost arising from or related to any default under the Underlying Deed of Trust (First) caused by or related to an act or omission of Beneficiary.
(f) Paragraph 29(f) states, in part, that:
The Beneficiary shall, upon request of Grantor, appoint a person qualified * * * to act at all times as Beneficiary's collecting agent to receive and collect all payments to be made by Grantor to Beneficiary under the Note and this [wrap-around] Deed of Trust and to disburse those payments first to or for the benefit of the beneficiaries under the Underlying Deeds of Trust and then the balance to the Beneficiary.
(h) Paragraph 29(h) states, in part, that:
Should the aggregate payments required under the Underlying Deeds of Trust exceed for any reason the amount of the monthly installments payable under the [wrap-around]*457 Note, and should Grantor make directly to the beneficiaries of the Underlying Deed(s) of Trust the payments required under the Underlying Deeds of Trust, any such excess shall be accumulated and such excess as accumulated shall be known as the "Accumulated Deficiency" and shall be payable by Beneficiary, together with interest at the Prime Rate * * *.
Additionally, the Purchase Agreement specifically addresses the treatment to be given to the underlying indebtedness, stating in pertinent part, as follows:
Paragraph 5
The deed [that conveys the apartments to the purchaser] shall expressly provide that the grantee
CFC 77-A on its 1982 tax return, reported the sale of the Town Park property on the installment basis. CFC 77-A computed the gain from this sale using a gross profit percentage 8 that was computed with the total selling price, ($ 9,900,000) used as the contract price. 9 Respondent, 10 using a gross profit percentage for which the selling price 11 was reduced by the underlying indebtedness, recomputed the percentage*458 of gain to be reported on each installment. 12 It is this increased percentage of gain respondent seeks to include in petitioner's income that has resulted in the current dispute. 13 The sole point of contention is how the underlying indebtedness of Town Park should be treated with respect to the computation of the contract price and the gross profit percentage.
*459 OPINION
Respondent admits that this is a wrap-around financed installment sale 14 which falls within the provisions of
Petitioner, relying*460 on section 453 and numerous opinions of this court regarding the installment sale of encumbered real property to compute its gain, argues that
We recently examined
Respondent, pursuant to this regulation, asserts that in a wrap-around mortgage transaction the purchaser claims not to take the property "subject to" the underlying indebtedness but that such a transaction will be treated, in the tax law, the same as if the property was taken "subject to" the underlying indebtedness. Respondent's treatment of the wrap-around financed*462 installment sale will not be upheld.
In
Since 1955, when this Court found in
Absent respondent's reliance on the language of
In the
*464 In
In holding for the taxpayer we stated that the terms "assumed" and "taken subject to," as used in section 29.44-2, Regs. 111 (not
Following the
[T]he Court [in Stonecrest] recognized that the regulations applying to "subject to" and "assumed" sales were carefully tailored to the specific circumstances presented in the "subject to" and "assumed" situations.
*468 In the wrap-around financed transaction the full purchase price is paid and taxed to the seller. In this type of transaction no part of the purchase price escapes taxation to the seller, therefore, there is no need to apply a greater gross profit percentage to the installment payments the seller receives. Thus, as we stated in
We reject respondent's argument that
Although the seller in a wrap-around financed transaction does not recognize as much gain in the year of sale as if he had "assumed" the underlying mortgage, 21 taxpayers have the right to structure business dealings in a way that may decrease their tax burden.
*470
1. Respondent, in his notice of deficiency, made numerous adjustments to petitioner's loss deductions taken with respect to ten partnerships in which petitioner held interests. ↩
2. The parties have settled all issues, except the adjustments to the capital gains resulting from the sale of Town Park apartments, CFC-77 Partnership A, (CFC 77-A). ↩
3. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue. All rule references are to the Tax Court Rules of Practice and Procedure. ↩
4. Carol A. Webb is a party to this case solely by filing a joint income tax return with her husband, Vincent E. Webb. Reference will be made hereafter, singularly, to Vincent E. Webb as petitioner. ↩
5. CFC 77-A's general partners were (1) Clark Financial Corporation and (2) S. Spence Clark. For the 1982 taxable year the partnership had 40 limited partners. ↩
6. The 1977 and 1978 tax returns for CFC 77-A were examined by the audit division of the Internal Revenue Service and certain adjustments were proposed. The case was subsequently petitioned to this Court and a stipulation of facts was entered into by the parties. The stipulation of facts resolved many of the issues that were in dispute. The issues that remained were decided by this Court in
7. The closing statement shows the date of the actual sale to be Sept. 21, 1982. However, the outstanding balances were taken as of Sept. 22, 1982. We do not think this is of any meaningful significance in the resolution of the issue before us. ↩
8. The gross profit percentage is computed by dividing the total gross profit realized on the sale by the total contract price. It is the computation of the total contract price that is in dispute.
The gross profit percentage, as computed by CFC 77-A, was 77.24 percent. ↩
9.
The term "contract price" means the total contract price equal to selling price reduced by that portion of any qualifying indebtedness * * * assumed or taken subject to by the buyer, which does not exceed the seller's basis in the property * * *. ↩
10. Respondent proposed some adjustments to the computation of the gain realized on the sale including adjustments to correct the basis of the property to take into account adjustments agreed to in
11.
12. The parties have agreed that $ 53,356 of the gain resulting from the sale is sec. 1250 recapture income. ↩
13. Respondent's method requires each partner to report as gain 98.33 percent of payments received.
Petitioner's share of the gain was computed as follows:
Partnership adjustment | $ 767,371 |
multiplied by petitioner's profit sharing % | .5877% |
Adjustment allocated to petitioner | 4,510 |
60 % capital gain deduction | 2,706 |
Increased proposed to petitioner's income | $1,804 |
14. We note that paragraph (f) of the wrap-around Deed of Trust permits the seller, at the request of the purchaser, to appoint a collecting agent for the seller, to receive and collect all payments due to the seller and to distribute these payments first to or for the benefit of the mortgagees on the underlying indebtedness. Respondent has not challenged this provision as rendering the genuineness of the wrap-around note herein involved invalid, therefore, we do not consider this. We note, however, that the facts and circumstances of this case illustrate that the parties intended to have this clause inserted merely as a protective device if the grantor fails to meet obligations under the agreement. Should this clause become operative the nature and effect of the wrap-around note may change. See
15.
16. For convenience we will refer to this case as "
17. This distinction in treatment has been applied by this Court in the following cases:
19. In each case where this Court has applied
20. S. Rept. No. 96-1000 at 7 (1980),
21. In the "assumption of" or "subject to" financed sale the seller must include any excess underlying indebtedness over the seller's adjusted basis in the property as payment received in the year of sale. This increases the amount of gain reported in that year. ↩