DocketNumber： Docket Nos. 2783-86; 2784-86.
Filed Date： 3/21/1988
Status： Non-Precedential
Modified Date： 11/21/2020
MEMORANDUM FINDINGS OF FACT AND OPINION
WILLIAMS,
| Section 6651(a) Section 6653(a) | ||||
| Petitioner | Docket No. | Deficiency | Addition to Tax | Addition to Tax |
| Henry J. Knott | 2783-86 | $ 42,662.56 | $ 10,665.64 | $ 2,133.13 |
| Marion I. Knott | 2784-86 | 41,942.14 | 10,485.54 | 2,097.11 |
The issues we must decide are (1) whether a transfer of partnership interests in Wampler Village Limited Partnership by petitioners to two of their children as of January 1, 1976, resulted in gift tax liability under section 2501(a) and, if so, the amount of the liability; (2) if we find that petitioners are liable for gift tax, whether petitioners' failure to file timely gift tax returns for the calendar quarter ended1988 Tax Ct. Memo LEXIS 148">*150 March 31, 1976, was due to reasonable cause and not due to willful neglect within the meaning of section 6651(a); and (3) whether petitioners' failure to file timely gift tax returns for the calendar quarter ended March 31, 1976, was due to negligence or intentional disregard of rules and regulations pursuant to section 6653(a).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. Petitioners, Henry J. Knott ("H. J. Knott") and Marion I. Knott are husband and wife who resided at Baltimore, Maryland at the time their petitions were filed. Petitioners have 12 children, including Martin G. Knott ("M. G. Knott") and Sarah Lindsay Harris ("Harris").
H. J. Knott was 80 years old at the time of the trial and has spent his entire working life engaged in the construction and real estate development business. His projects have included the construction of houses for sale and apartments for rent. He engaged in this business as a sole proprietor as well as through partnerships and corporations. By 1970, H. J. Knott owned individually or through entities approximately 12 rental apartment projects. Many of the apartment projects that H. J. Knott constructed participated1988 Tax Ct. Memo LEXIS 148">*151 in financing programs administered by the Federal Housing Administration ("FHA") of the Department of Housing and Urban Development, including programs under section 221(d)(4) of the National Housing Act,
During the latter part of 1971, H. J. Knott submitted an application to the FHA pursuant to section 221(d)(4) of the National Housing Act for insurance of a mortgage to be obtained to finance the construction of an apartment project to be known as Wampler Village Apartments. H. J. Knott received a commitment from the FHA to insure the mortgage financing on or about January 6, 1972.
On or about July 20, 1972, H. J. Knott and Robert J. Romadka entered into an Agreement of Limited Partnership to form Wampler Village Limited Partnership ("Wampler Village" or "Partnership") under the laws of the State of Maryland. Wampler Village's stated purpose was to acquire and build the Wampler Village Apartments on a parcel of land which H. J. Knott owned. H. J. Knott entered into the Partnership1988 Tax Ct. Memo LEXIS 148">*152 with Romadka for two reasons. First, Romadka was an attorney and had been instrumental in convincing the prior owner of the property on which the apartments were to be built to sell it to H. J. Knott. Second, H. J. Knott wanted to acquire another parcel of real property in which Romadka had an interest. The transactions were structured to accomplish this result by allowing an exchange of partnership interests and providing for a conveyance of the real property in a manner that limited transfer taxes. Concurrently with the formation of Wampler Village, H. J. Knott conveyed the real property on which the apartments were to be constructed in exchange for a 99-percent interest as general partner. The property was placed on the Partnership's books at an agreed value of $ 49,500.00. Romadka contributed $ 500.00 cash and became the 1-percent limited partner.
On or about August 2, 1972, H. J. Knott and Romadka signed a
Section 25 of the
(1) The then balance in the capital account of Henry J. Knott as Special Limited Partner in the partnership, taking into account any reduction in the said capital account occasioned by any prior distributions to Henry J. Knott as Special Limited Partner pursuant to the provisions of Section 9(f)(1) 1988 Tax Ct. Memo LEXIS 148">*154 hereof;
(2) An amount of $ 185,000 (or such lesser amount which shall be equal to the Builders and Sponsors Profit and Risk allowance which is or which would be allowed by the FHA if the improvements referred to in this Section were the subject of FHA insured financing on the maximum allowable mortgage under the above referred to commitment, less $ 150,000);
(3) all advances or loans, in addition to the capital referred to in (1) above made to the partnership by Henry J. Knott as Special Limited Partner;
(4) The release of all letters of credit or guarantees made on behalf of the partnership by Henry J. Knott as Special Limited Partner.
* * *
On June 8, 1973, H. J. Knott made formal application to the FHA to substitute Wampler Village Limited Partnership as the sponsor of the Wampler Village Apartments project. The project was completed in November 1972 but the formal closing with the FHA did not take place until December 18, 1975, at which time the long term mortgage financing was placed on the property. Prior to obtaining the permanent mortgage, H. J. Knott had advanced to Wampler Village the funds necessary to construct the Wampler Village Apartments.
Wampler Village's1988 Tax Ct. Memo LEXIS 148">*155 unaudited balance sheet as of December 31, 1973 reflected the following assets and liabilities:
| Assets | |
| Cash | $ 61,390.00 |
| Accounts Receivable | 117.00 |
| Prepaid Expense | 61,673.00 |
| Land, Buildings and Maintenance | |
| Equipment Net of Depreciation | 2,735,129.00 |
| Total Assets | $ 2,858,309.00 |
| Liabilities | |
| Accrued Interest Payable | $ 168,318.00 |
| Tenants' Deposits | 39,424.00 |
| Construction Loan 2,860,352.00 | |
| Net Capital Deficiency | (209,785.00) |
| Total Liabilities | $ 2,858,309.00 |
As of December 31, 1974, Wampler Village's unaudited balance sheet showed the following:
| Assets | |
| Cash | $ 13,430.00 |
| Accounts Receivable | 117.00 |
| Investment | 45,287.00 |
| Prepaid Expense | 58,075.00 |
| Land, Buildings and Equipment | |
| Net of Depreciation | 2,479,691.00 |
| Total Assets | $ 2,596,600.00 |
| Liabilities | |
| Accrued Interest Payable | $ 89,977.00 |
| Tenants' Deposits | 38,154.00 |
| Construction Loan 2,850,352.00 | |
| Net Capital Deficiency | (381,883.00) |
| Total Liabilities | $ 2,596,600.00 |
On December 17, 1975, a
| General Partners | |
| Henry J. Knott | 12 percent |
| Martin G. Knott | 15 percent |
| Limited Partners | |
| Robert Romadka | 23 percent |
| Sara Lindsay Harris | 50 percent |
Romadka agreed to exchange his interest as a general partner for one as a limited partner and to reduce his interest in the partnership from 56.5 percent to 23 percent because the partnership was operating at a deficit. H. J. Knott informed him that it was likely he would otherwise have to make additional contributions to capital and H. J. Knott effectively exercised control over Romadka's interest. In exchange for their partnership interests, Harris and M. G. Knott contributed $ 1,550.00 and1988 Tax Ct. Memo LEXIS 148">*157 $ 550.00 in cash, respectively.
In addition to their cash contributions, Harris and M. G. Knott were subject to calls for additional capital contributions. Section 8(c) of the
The General Partner may call for additional contributions to capital of the partnership by all of the partners, other than Henry J. Knott as Special Limited Partner, or to Robert J. Romadka, Limited Partner, until such time as the total prior calls to all other partners shall have exceeded $ 200,000 in excess of the total capital, including that additional capital to be contributed pursuant to Section 8(a) hereof [advances by Henry for construction], in proportion to their then interest in partnership profits and losses as provided in Section 9(b)(2) hereof, said additional capital contributions to be credited to the partner's capital account. No Limited Partner on whom such call may be made shall be obligated to satisfy any such call, but if he, or his assignee or successor in interest does not, Section 8(d) hereof shall apply.
Although the contractual language is ambiguous, it appears that either H. J. Knott or M. G. Knott, 1988 Tax Ct. Memo LEXIS 148">*158 as general partner, could request additional capital contributions from themselves or Harris. Only H. J. Knott, as special limited partner, and Romadka were exempt from cash calls until prior calls exceeded $ 200,000 in excess of Wampler Village's total capital. As a limited partner, Harris was not obligated to respond to a call for additional capital. If she did not, the remaining partners had several options, including the right to advance such contributions on her behalf to be repaid with interest from her share of distributions from Wampler Village; the right to purchase her interest in Wampler Village or the right to make additional capital contributions and adjust their interests in partnership distributions accordingly.
H. J. Knott also remained a special limited partner obligated under the
Warren Smith, C.P.A., was petitioners' accountant from the early 1950s until his retirement in 1986. Smith prepared petitioners' tax returns and financial statements, represented them in Internal Revenue Service examinations and maintained the regulatory accounting required in connection with FHA programs. In October 1976, Smith was asked to determine the amount due H. J. Knott as special limited partner under the Assets Cash $ 97,136.00 Accounts Receivable 45,000.00 Tenant Deposits 45,708.00 Prepaid Expenses 32,116.00 Land and Buildings Net of Depreciation (Fixed Assets) 2,224,254.00 Other Assets 24,741.00 Total Assets $ 2,468,955.00 Liabilities Accrued Interest Payable $ 21,441.00 Accrued Expenses Payable 5,700.00 Mortgage Payable -- Current 8,416.00 Tenant Deposits 40,293.00 Other Deposits 467.00 Mortgage Payable 3,141,584.00 Total Liabilities $ 3,217,901.00
Prior to the December 18, 1975, closing on the FHA-insured mortgage financing, H. J. Knott's advances as special limited partner were reflected in Wampler Village's books and records either as loans payable or accounts payable. When the FHA insured mortgage was closed, Smith closed out the loan and accounts payable accounts and transferred the amounts due to H. J. Knott's capital account because of Smith's view of the requirements of FHA regulations. The proceeds of the FHA insured mortgage were not sufficient1988 Tax Ct. Memo LEXIS 148">*162 to repay all of H. J. Knott's advances as special limited partner.
Under the FHA insured mortgage financing, Wampler Village was obligated to pay interest at a rate of nine percent per year on a $ 3,141,584.00 note. The total interest payable in 1976 was $ 293,374.00 less a $ 110,250.00 refund of prepaid interest. In 1977, the total interest payable was $ 284,333.00.
Although Wampler Village made substantial interest payments on the FHA insured mortgage in 1976 and 1977, it had additional funds available from operations with which to partially redeem H. J. Knott's special interest as special limited partner. The Partnership's Statement of Change in Financial Position for the year ended December 31, 1976 shows the following funds received and applied:
| FUNDS RECEIVED: | ||
| Net Loss | $ (169,815) | |
| Add Changes Not Requiring Funds: | ||
| Depreciation | 267,096 | |
| Funds Provided From Operations | $ 97,281 | |
| Decrease in Financing Expense- | ||
| Noncurrent | 658 | |
| Capital Contributions - Cash | 2,100 | |
| Capital Increased by Asset | ||
| Re-valuation | 126,791 | |
| Decrease in Working Capital | 133,443 | |
| TOTAL FUNDS PROVIDED | $ 360,273 | |
| FUNDS APPLIED: | ||
| Additions to Fixed Assets - | ||
| Purchases | $ 25,113 | |
| Additions to Fixed Assets - | ||
| Re-valuation | 126,791 | |
| Acquisition of Maintenance Equipment | 3,683 | |
| Increase in Mortgage Escrow Deposits | 19,302 | |
| Increase in Reserve for Replacement | 14,857 | |
| Deposit for [illegible] Indemnification | ||
| Fee | 55,125 | |
| Deduction of Long-Term Debt | 8,891 | |
| Redemption of Special Limited | ||
| Partnership Interest | 106,511 | |
| TOTAL FUNDS APPLIED | $ 360,273 |
1988 Tax Ct. Memo LEXIS 148">*163
Petitioners thus had $ 97,281.00 in funds provided from operations as well as sufficient additional funds to pay H. J. Knott $ 106,511.00 in partial redemption of his special limited partnership interest.
For 1977, Wampler Village's Statement of Change in Financial Position also indicates that Wampler Village had funds available from operations:
| FUNDS PROVIDED | ||
| Net Loss | $ (235,237) | |
| Add Charges Not Requiring Funds: | ||
| Depreciation | 286,391 | |
| Funds Provided From Operations | $ 51,154 | |
| Decrease in Prepaid Finance Expense | 764 | |
| TOTAL FUNDS PROVIDED | $ 51,918 | |
| FUNDS APPLIED: | ||
| Increase in Mortgage Expense | ||
| Deposits | $ 12,388 | |
| Increase in Reserve for Replacement | 13,402 | |
| Increase in Fixed Assets | 5,289 | |
| Reduction of Long-Term Debt | 10,384 | |
| Increase in Working Capital | 10,455 | |
| TOTAL FUNDS APPLIED | $ 51,918 |
The Partnership thus had $ 51,154.00 available in 1977 some of which could have been used to redeem H. J. Knott's special limited partnership interest.
As of December 31, 1975, the owner's equity in Wampler Village was expressed on its books1988 Tax Ct. Memo LEXIS 148">*164 as a deficit of $ 748,946.00, representing the amount by which the liabilities of the Partnership exceeded the book value of its assets. On its Federal Partnership Return of Income for the taxable year 1976, Wampler Village elected to increase its basis in its property under section 754 by $ 106,511.00, the amount paid in 1976 to H. J. Knott in partial redemption of his interest as special limited partner.
On their Federal income tax return for the taxable year 1976, petitioners reported $ 126,791.00 as gain from the sale or exchange of part of H. J. Knott's interest in Wampler Village to Harris and M. G. Knott. This amount represented $ 20,280.00 realized as the net result of the decrease in H. J. Knott's proportionate share of liabilities, which was treated as a deemed distribution, and $ 106,511.00 in cash distributions made to H. J. Knott in 1976 as special limited partner.
Neither H. J. Knott nor Marion I. Knott, who had previously filed gift tax returns, filed gift tax returns on the transfer of partnership interests to Harris or M. G. Knott. Petitioners believed that Wampler Village's liabilities exceeded the value of its assets, and consequently, that the interests transferred1988 Tax Ct. Memo LEXIS 148">*165 had no present value. H. J. Knott generally consulted with his accountant and attorney concerning tax matters when making financial plans.
The parties have agreed that for purposes of determining a deficiency in Federal gift tax, if any, the partnership interests are deemed to have been transferred during the first quarter of 1976. On April 25, 1984, petitioners each filed a gift tax return for the first quarter of 1976. The returns showed no gift tax liability but set forth their consent to have gifts made by them during the calendar year 1976, if any, treated as made one half by each of them.
William I. Currie, a real estate appraiser and consultant, valued the Wampler Village Apartments property as of December 31, 1975, at H. J. Knott's request. In his report dated January 28, 1987, he concluded, using the income approach to valuation, that the established market value of the property as of December 31, 1975, was between $ 3,000,000.00 and $ 3,300,000.00. Leonard S. Rodwin, an appraiser with the Engineering and Valuation Branch of the Internal Revenue Service, valued the Wampler Village Apartments property as of January 1, 1976. In his report dated March 13, 1985, he concluded, 1988 Tax Ct. Memo LEXIS 148">*166 also using the income approach, that the fair market value of the property as of January 1, 1976, was $ 3,580,000.00. The parties have now stipulated that the fair market value of the real property and improvements owned by Wampler Village and shown as "Fixed Assets" on Wampler Village's Financial Statement was $ 3,365,000.00 on December 31, 1975, and at the time of the transfers to Harris and M. G. Knott.
Substituting the stipulated fair market value for the depreciated book value of the land and buildings set forth on the December 31, 1975, Financial Statement,
| Assets | |
| Cash | $ 97,136.00 |
| Accounts Receivable | 45,000.00 |
| Tenant Deposits | 45,708.00 |
| Prepaid Expenses | 32,116.00 |
| Land and Building | |
| (Fixed Assets) | 3,365,000.00 |
| Other Assets | 24,741.00 |
| Total Assets | $ 3,609,701.00 |
| Liabilities | |
| Accrued Interest Payable | $ 21,441.00 |
| Accrued Expenses Payable | 5,700.00 |
| Mortgage Payable -- Current | 8,416.00 |
| Tenant Deposits | 40,293.00 |
| Other Deposits | 467.00 |
| Mortgage Payable | 3,141,584.00 |
| Total Liabilities | $ 3,217,901.00 |
| Net Asset Value | $ 391,800.00 |
| (Net Amount Available | |
| for Distribution) |
1988 Tax Ct. Memo LEXIS 148">*167
Because Wampler Village owed H. J. Knott $ 403,397.00 as of January 1, 1976, if it had been liquidated at that time neither Harris, M. G. Knott nor Romadka would have received any of the proceeds.
Respondent issued his notices of deficiency to petitioners on November 27, 1985. Petitioners timely filed their petitions with this Court on January 30, 1986.
OPINION
Section 2501 imposes a tax on property transferred by gift. When property is transferred for "less than an adequate and full consideration in money or money's worth," the excess of the fair market value of the property over the consideration received is deemed a gift. Section 2512(b). A property's fair market value is the "price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of the relevant facts." Section 25.2512-1, Gift Tax Regs. The valuation of an interest in property for Federal tax purposes is a question of fact. Section 25.2512-3(a), Gift Tax Regs.;
The primary issue we must decide is whether H. J. Knott's transfer of interests in Wampler Village to his children gave rise to gift tax liability. Respondent argues that H. J. Knott transferred a 65-percent interest in Wampler Village for less than adequate and full consideration, resulting in a gift in the amount of a fair market value of the interests transferred less the cash paid for those interests. Petitioners argue that H. J. Knott could not have transferred a 65 percent interest to his children because he owned only 43.5 percent of Wampler Village before the transfer and continued to own 12 percent afterward. In any case, petitioners contend that the identity of the transferor is irrelevant because at the time of the transfers, the interests had no value in excess of the consideration paid and obligations assumed by Harris and M. G. Knott on admission to the Partnership.
Intrafamily transfers are subject to special scrutiny and are presumed to be gifts.
We believe that Romadka was merely a nominee of H. J. Knott and that H. J. Knott transferred the entire 65 percent interest in Wampler Village to M. G. Knott and to Harris. H. J. Knott was at all times in control of the Wampler Village Apartments project. He contributed the land to form the Partnership and advanced the funds necessary to build the apartments. H. J. Knott made Romadka a partner because Romadka had assisted H. J. Knott in acquiring the land for the project and some additional land. If Wampler Village was unable to repay the money H. J. Knott had advanced, Romadka, as the only other partner, had agreed to repay him. In 1975, H. J. Knott informed Romadka that Wampler Village was running short on funds. As a result, H. J. Knott testified, Romadka "took the reduction [in his partnership interest] without any argument." In H. J. Knott's eyes, and in ours, Romadka was a partner of1988 Tax Ct. Memo LEXIS 148">*170 considerably lesser influence in partnership affairs. H. J. Knott determined the interest Romadka would receive and maintain in Wampler Village. H. J. Knott also set the price of M. G. Knott's and Harris' partnership interests. Romadka had to say in the matter. Consequently, although only part of the 65 percent interest was transferred to Harris and M. G. Knott directly through a reduction in L's interest in Wampler Village, he in effect transferred the entire 65 percent interest.
In determining the net value of a business, section 25.2512-3(a), Gift Tax Regs., provides factors to consider:
(1) A fair appraisal as of the date of the gift of all of the assets of the business, tangible and intangible, including good will;
(2) The demonstrated earning capacity of the business; and
(3) The other factors set forth in paragraph (f) of § 25.2512-2 relating to the valuation of corporate stock. The "other factors" referred to in subparagraph (3) that are applicable in this case include the economic outlook of the particular industry, the company's management, and the degree of control represented by the interest to be valued. See section 25.2512-2(f), Gift Tax Regs.
Respondent1988 Tax Ct. Memo LEXIS 148">*171 presented two expert witnesses in support of his determination that gifts were made of partnership interest. The experts were asked to determine the value as of January 1, 1976, of the partnership interests transferred to Harris and M. G. Knott.
Edward A. Bard, a financial analyst with the Internal Revenue Service, valued Wampler Village as an ongoing business. Bard determined the net underlying asset value of Wampler Village by substituting its fair market value for the book value on the 1975 balance sheet and adjusting the capital account to bring the credit side into balance. He then concluded that the value of the 65-percent interest transferred was equal to 65 percent of the underlying asset value. Bard thus valued the transferred interests as follows: