DocketNumber: Docket No. 2258-80.
Citation Numbers: 42 T.C.M. 1651, 1981 Tax Ct. Memo LEXIS 87, 1981 T.C. Memo. 655
Filed Date: 11/10/1981
Status: Non-Precedential
Modified Date: 11/21/2020
MEMORANDUM FINDINGS OF FACT AND OPINION
FEATHERSTON,
1. Whether a payment by petitioners for the release from liability on a promissory note which arose from the prior purchase of certain property constitutes a reduction of the capital gain recognized on the sale of that property, as contended by respondent, or an ordinary business expense deduction under
2. Whether all or part of certain legal fees constitute an expense of selling the property or an ordinary business expense.
FINDINGS OF FACT
Some of the facts are stipulated and are found accordingly.
Petitioners Lester Kisska (hereinafter petitioner) and Virginia B. Kisska, husband and wife during the pertinent period, were legal residents of Ferndale, Washington, when they filed their petition. They timely filed their joint Federal income tax return for 1977 with the Internal Revenue Service Center, Ogden, Utah.
In 1973, petitioners purchased an apartment building in Seattle, Washington, from Michael R. Mastro (Mastro) and Joan1981 Tax Ct. Memo LEXIS 87">*89 K. Mastro 2 and Isaac S. and Nancy Gamel and as part of the consideration gave a promissory note secured by a deed of trust. The principal amount of the promissory note was $ 430,000. The building was used by petitioner for rental purposes.
At the time of the purchase, petitioner was involved in various other businesses. Diversified Investors, Limited, which managed the apartment building, collected all of the rents and made all of the required payments under the promissory note and deed of trust.
Approximately 1-1/2 to 2 years after the purchase of the building, petitioner was notified by Mastro that he was late in the mortgage payments. Petitioner terminated the management contract with Diversified Investors, Limited, and hired a second management company. This company quit after 4 months, declaring the building to be unmanageable. Petitioner attempted once again to employ an individual to collect rents, but this attempt failed.
After being notified of his delinquency in mortgage payments, petitioner1981 Tax Ct. Memo LEXIS 87">*90 began to pay Mastro from his own funds rather than money collected from the rental of the apartment building. He also spent many weekends attempting to repair the building, a task he found nearly impossible due to extensive vandalism. The building continued to deteriorate and, consequently, many tenants refused to pay that on the damaged building.
In early 1977, petitioner decided to stop making mortgage payments and to allow Mastro to repossess the building. Mastro commenced an action in the Superior Court of King County, Washington, to collect on the promissory note and to foreclose on the deed of trust. When payments became delinquent, Mastro began to telephone petitioners, often late at night, so frequently that petitioners sought and obtained on March 23, 1977, a temporary restraining order forbidding Mastro to contact petitioners. Petitioners also counterclaimed in the foreclosure suit, alleging injury to petitioner's health, as well as harassment and misrepresentation as to the building.
Pending the foreclosure proceeding, other buyers expressed interest in the building, and negotiations for the sale of the apartment building took place among petitioners, the Mastros, 1981 Tax Ct. Memo LEXIS 87">*91 the Gamels, James J. Boyd and Earnell M. Boyd, N. Robert Nakao and Eiko P. A. Nakao, and Liem E. Tuai and Winnie J. Tuai. Petitioners refused to sign an agreement drafted among these parties because it lacked a provision releasing them from any future liability; without such a clause, if the new purchasers failed to make the requisite payments, petitioners would be liable for the payments during the years remaining on the promissory note and deed of trust.
On May 19, 1977, an agreement was entered into among petitioners, the Mastros, the Gamels, and the Boyds. Under this agreement, petitioners conveyed the apartment building to the Boyds in consideration for the Boyds' assumption of the remaining liability on the promissory note and deed of trust. Petitioners agreed to pay Gamel and Mastro the sum of $ 17,200 for installment payments in arrears plus $ 4,547.64 in tax reserve payments. In addition to these delinquent payments, petitioners also agreed to pay Gamel and Mastro $ 25,000 to be released from any personal liability on the original deed of trust and promissory note. In addition to the release clause in the agreement, a separate release document was executed whereby Gamel1981 Tax Ct. Memo LEXIS 87">*92 and Mastro again agreed to look for payment on the promissory note and deed of trust from only the Boyds or the building. Gamel and Mastro also agreed to dismiss their foreclosure action in the Superior Court while petitioners agreed to dismiss their counterclaims.
Petitioners paid $ 1,380 to an attorney to represent them in the foreclosure suit and the negotiation of the settlement agreement pursuant to which the building was conveyed to the Boyds.
Petitioners deducted the $ 25,000 payment as a liability release expense incurred in the operation of the apartment building. They also deducted the $ 1,380 payment to the attorney as legal fees incurred in the apartment rental business. In the notice of deficiency, respondent disallowed these deductions and, instead, applied the payments to reduce petitioners' capital gain by $ 13,190.
OPINION
Petitioners contend that they are entitled to deductions for the $ 25,000 payment to Mastro and the $ 1,380 payment of legal fees under
We agree with respondent that petitioners' liability to make this disputed payment had its origin in a transaction involving the acquisition and disposition of the apartment building, a capital asset. Amounts expended in the acquisition or disposition of a capital asset are nondeductible1981 Tax Ct. Memo LEXIS 87">*94 and must be added to the asset's basis or offset against its selling price.
1981 Tax Ct. Memo LEXIS 87">*95 We think it clear that the $ 25,000 was paid to settle petitioner's liability on the note given on his investment to the mortgage property. If, however, the payment can be considered unrelated to his investment in the apartment building, there is no foundation on which to predicate a deductible expense. If the payment was not related to that investment, petitioners merely settled their personal nonbusiness, noncapital liability on the promissory note by a $ 25,000 payment, and a deduction is not allowable for a personal expense. See
Petitioners further maintain that the payment was a deductible business expenses under
Petitioners contend that the payment is a noncapital expenditure1981 Tax Ct. Memo LEXIS 87">*97 made to obtain a release from contingent liability in the nature of a guaranty. Such payments, they argue, have been held to be deductible from ordinary income, citing
We agree with respondent that petitioners were not guarantors. Although it is true that, absent the release, petitioners night have been called upon to make payments if the purchasers had failed to meet their obligations, petitioners paid the $ 25,000 to terminate their obligations arising from their1981 Tax Ct. Memo LEXIS 87">*98 own liability on a promissory note which they had signed in a capital transaction. Thus, they were not guarantors in any sense of the word.
Petitioners further contend that had the $ 25,000 been paid some time after the sale, it would not have been in connection with the foreclosure litigation and would have constituted a payment in discharge of a guaranty. Petitioners' contention is erroneous.
Whenever paid, the payment required to discharge the note would be made to terminate a claim of potential liability arising from petitioners' promissory note secured by a deed of trust on the apartment building. 8
It has been stipulated that $ 1,380 was paid to an attorney with regard to the foreclosure suit and for his review of the agreement. Because the suit and the agreement involved the disposition of a capital asset, they were capital transactions, and the accompanying legal fees must be capitalized.
Petitioners argue, however, 1981 Tax Ct. Memo LEXIS 87">*99 that a more precise assessment must be made. Although the suit started as a foreclosure action, they state, its scope expanded to include a request for the appointment of a receiver and counterclaims alleging harassment, injury to health, and misrepresentation as to the building's condition These, petitioners maintain, fall under the rubric of ordinary and necessary expenses. 9
Petitioners correctly state that is appropriate cases, allocations may be made between deductible expenses and capital ones involved in the same litigation or payment.
1981 Tax Ct. Memo LEXIS 87">*101
1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise noted.↩
2. The name "Mastro" appears in petitioners' briefs and the stipulation of facts as "Maestro," while respondent's brief and the various agreements refer to "Mastro."↩
3.
(a) In General.--There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * * ↩
4.
(a) General Rule.--There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.↩
5. The fact that the asset involved here is a sec. 1231 asset rather than a capital asset per se does not serve to exclude the building from treatment under the origin-of-the-claim test. "Conceptually, [sec. 1231] assets used in the trade or business clearly seem to constitute capital assets in that by definition, they are used for the further production of goods and services." J. Mertens, Law of Federal Income Taxation, Code Commentary to ch. 1, subch. P, sec. 1231, at 45 (1979). The root transaction here involves the acquisition and disposition of an income producing asset; whether the asset is termed capital or sec. 1231 is irrelevant for purposes of assessing the capital or noncapital nature of the transaction.↩
6. Consideration of the "primary purpose" for a payment was the prevailing test before it was rejected in
7. This origin distinguishes the present case from
8. Under the
9. Even if an allocation were to be made, it is unclear why expenses related to an injury to personal health would be a business expenses.↩
10. In
11. As an aid in allocation, petitioners include a copy of the lawyer's account sheets. The explanation of charges in these sheets, however, does not provide a convincing basis for allocation since the charges combine the purportedly distinct claims; for example, preparation of the temporary restraining order is combined with "Conferences" and preparation of an answer, affirmative defenses and counterclaim. Even if we were to find the temporary restraining order costs to be business costs, a finding by no means certain, we would have no guidance in dividing the charge.↩
Commissioner of Internal Revenue v. D. J. Condit , 333 F.2d 585 ( 1964 )
Anchor Coupling Company, Inc. v. United States , 427 F.2d 429 ( 1970 )
Putnam v. Commissioner , 77 S. Ct. 175 ( 1956 )
Harrison E. Spangler and Myrtle B. Spangler v. Commissioner ... , 323 F.2d 913 ( 1963 )
Dr. Warren B. Demink and Mrs. Helen Demink v. United States , 448 F.2d 867 ( 1971 )
Welch v. Helvering , 54 S. Ct. 8 ( 1933 )
Arrowsmith v. Commissioner , 73 S. Ct. 71 ( 1952 )
United States v. Gilmore , 83 S. Ct. 623 ( 1963 )
Woodward v. Commissioner , 90 S. Ct. 1302 ( 1970 )
United States v. Hilton Hotels Corp. , 90 S. Ct. 1307 ( 1970 )