DocketNumber： Docket No. 11617-77.
Filed Date： 2/26/1981
Status： Non-Precedential
Modified Date： 11/21/2020
MEMORANDUM FINDINGS OF FACT AND OPINION
SCOTT,
Petitioner is both a lawyer and a certified public accountant. He was admitted to practice law in the State of Utah in 1956 and became a certified public accountant in Utah in 1960. Prior to 1970 and after 1971 petitioner was a professor of accounting at Weber State College, Ogden, Utah. During 1970 and 1971 petitioner took a leave of absence from his position with Weber State College to work in the tax department of Elmer Fox & Company, a CPA firm. The leave of absence was taken by petitioner*658 in order that he might establish an internal tax training program for the employees of Elmer & Company. In 1967 petitioner published a book entitled "1968 Utah Capital Tax Guide as Related to the Internal Revenue Code." Also prior to the years in issue petitioner had served as tax adviser for a number of corporations and businesses and also as a management consultant for businesses and corporations. While petitioner taught at Weber State College he engaged in the practice of law. During 1971 petitioner was a Justice of the Peace and in this capacity received fees for which he was issued a Form W-2 by South Odgen City.
Apartment Enterprises (Apartment) was incorporated on September 24, 1970. During 1971, 1972 and the first half of 1973 petitioner was the president of Apartment. During its fiscal years July 1, 1971 to June 30, 1972, and July 1, 1972 to June 30, 1973, Apartment paid petitioner compensation for serving as its president. Petitioner represented Apartment in negotiating the purchase of the Bellevue Estates apartments, the 88th East apartments, the Casino Terrace apartments, the Lynnview apartments, and the Norlang Estates apartments. The agreements to purchase these*659 various apartments were negotiated by Apartment for the benefit of limited partnerships of which Apartment was the general partner and the rights under each agreement were assigned to the partnership which was to own the apartments. These limited partnerships were B & L Partnership Limited (B & L), Norlang Estates Partnership Limited (Norlang), and 88th East & Casino Terrace Partnership (88th East). Apartment participated in the management of the properties acquired by the limited partnerships. The Bellevue Estates apartments and the Lynnview apartments were acquired by B & L, the Norlang Estates apartments were acquired by Norlang, and the 88th East apartments and the Casino Terrace apartments were acquired by 88th East.
In March 1971 petitioner and four other individuals organized a partnership named Chateau. There was no written partnership agreement but each of the partners owned an equal interest in the partnership. The partnership was organized to construct, own and operate the Chateau apartments and shortly after its formation began construction of the apartments. Before the end of 1971, Mr. J. Blair Jones, the partner who was actually engaged in supervising the construction*660 of the apartment buildings, withdrew from the partnership. As of December 31, 1971, petitioner and each of the remaining four partners held a 25 percent interest in Chateau.
The principal place of business of petitioner and of Apartment during the years here in issue was Ogden, Utah. The apartments owned by B & L were in Seattle, Washington, and the partnership address was Seattle, Washington. The apartments owned by Norlang were in British Columbia, Canada, and the address of that partnership was Vancouver, British Columbia, Canada. The apartments owned by 88th East were also in Seattle, Washington, and this was the address of that partnership. The apartments owned by Chateau were in Centerville, Utah, which is approximately 16 miles from Ogden, Utah.
The books of Chateau were maintained in its office of Main Street in Centerville, Utah, near the place the apartments were constructed. During 1971 until Mr. Blair Jones withdrew from the partnership, petitioner would visit the Chateau office two or three days a week and after Mr. Jones withdrew from the partnership he visited the office daily. On occasions he would visit the office more than once in the same day.
Apartment*661 was also the general partner and participated in the management of apartment properties of several partnerships other than those heretofore listed.
Petitioner's books and records for the year 1971 and the books and records of B & L, Norlang and 88th East were maintained on a cash basis of accounting. Petitioner's income tax returns were filed on a cash basis and the Forms 1065 (U.S. Partnership Return of Income) were filed by the partnerships on a cash basis. In 1971 petitioner had a 1.19 percent interest in the income and loss of Norlang and a 6.616 percent interest in the income and loss of B & L.
The contract by which Norlang purchased the Norlang Estates apartments was signed on October 29, 1971. On the first page of the contract it is stated that the contract is made on the 31st day of August 1971. The deed transferring the Norlang Estates apartments to Norlang was recorded on October 29, 1971. The final sales contract for the purchase of the Norlang Estates apartments was drafted by a Canadian attorney. This attorney was given an interim agreement which had been signed by Apartment and Omega Concrete Pumping Co. Ltd. in April 1971. The Agreement entered into between*662 Norlang and Norlang Development Limited the seller of the Norlang Estate apartments, provided in part as follows:
2. The purchase price shall be $ 1,555,000.00 (subject to a discount of $ 50,000.00 as hereinafter referred to). In addition the purchaser shall pay $ 175,000.00 for construction interest, financing points, and all other financing fees incurred by the Seller during the construction of said apartments. Said amounts payable in the following manner:
(a)
(b)
The closing statement for the purchase of the Norlang Estates apartments was as follows:
VENDOR: NORLANG DEVELOPMENTS LTD.
PURCHASER: NORLANG*663 ESTATES LTD.
PROPERTY: LANGLEY APARTMENTS [Norlang Estates apartments]
ADJUSTMENT DATE: NOVEMBER 1, 1971.
| DEBIT | CREDIT | |
| TO PURCHASE PRICE | $ 1,730,000.00 | |
| BY DE DEPOSIT | $ | |
| TO Adjustment of Taxes | 389.82 | |
| TO Adjustment of Insurance | ||
| (Sept. 17) | 2,075.11 | |
| TO Tax debit held by National Trust | 11,100.00 | |
| BY National Trust mortgage balance | 1,379,632.50 | |
| BY Rental deposits | 2,014.00 | |
| BY November rents | 11,550.93 | |
| BY Construction interest payable | ||
| to National Trust | 175,000.00 | |
| BY Balance due to North Road Holdings | ||
| Ltd. Mortgage | 175,367.50 | |
| $ 1,743,564.93 | $ 1,743,564.93 |
E. & O. E.
NOTES:
1. All utilities such as electricity, gas, fuel oil, etc., to be adjusted in cash on the possession day directly between the Vendor and the Purchaser.
2. Fulton, Cumming, Bird, Richards are authorized to pay the above sums where applicable.
The $ 50,000 discount was to be received by Norlang if the second mortgage on the property was paid off before a specified date. This second mortgage was paid in January 1972 which was before the specified date.
On the Form 1065 filed by Norlang for the year 1971, which return was signed by petitioner in*664 his capacity as president of the general partner, Apartment, a deduction was taken for interest expense in the amount of $ 185,284 which included the $ 175,000 paid under the purchase contract for the Norlang Estates apartments. On this return in the depreciation schedule the acquisition date of the Norlang Estates apartments was shown as July 1, 1971. On this return, for depreciation purposes buildings were shown as having a basis of $ 1,271,000 and equipment, furniture and appliances were shown as having a basis of $ 279,000. The $ 50,000 discount provided for in the contract was not deducted in determining the basis of the Norlang Estates apartments. A note beneath the depreciation schedule stated as follows:
Partnership property is Depreciated in accordance with Canadian Tax Law.
Partnership assets are located entirely in Canada. The Partnership does not have any assets within the United States, nor does it conduct business within the United States. All Partnership business is conducted in Canada.
On this Form 1065 return of income of Norlang a net loss of $ 320,711 was reported and this loss was allocated to the general partner and the various limited partners, including*665 petitioner, on the basis of their respective interests in the partnership. The loss allocated to petitioner was $ 3,817. Of the $ 175,000 paid by Norlang to the seller of the Norlang Estates apartments, $ 30,000 went to Russell B. Swartz in discharge of his real estate commission. One-half of this commission, or $ 15,000, was paid by Mr. Swartz to petitioner pursuant to an agreement dated August 9, 1971.
In January 1973 the Revenue agent who was performing an aduit of the return of income of Norlang and petitioner's income tax return requested information from petitioner corroborating the interest deduction claimed on the Norlang 1971 return of income. On January 17, 1973, petitioner wrote the National Trust Company asking for the information requested by the Revenue agent and suggested that the response be purchased as follows:
In response to your request for interest paid to us, we have determined from our records that we received the total amount of $ interest to November 1, 1971.
On or about January 28, 1973, petitioner received a letter from the National Trust Company stating that "Interest paid from date of first advance, May 29th, 1971 to Ocotober 31st, 1971*666 -- $ 41,038.82." When petitioner presented this letter to the Revenue agent, the date May 29, 1971, had been changed to May 29, 1970, and the interest figure appearing in the letter had been changed from $ 41,038.82 to $ 141,038.82. The Revenue agent wrote the National Trust Company on February 15, 1973, for information regarding the interest expense claimed by Norlang on its 1971 return of income. The agent received in reply a letter dated February 21, 1973, which showed the interest paid as originally shown in the letter to petitioner before alterations were made in the document. The alterations made in the letter to petitioner from the National Trust Company were made by petitioner before the document was presented to the Revenue agent.
On the 1970 Form 1065 return of income of B & L, which return was signed by petitioner as an officer of Apartment, the Bellevue Estates apartments and the Lynnview apartments were shown on the depreciation schedule as having been acquired on October 1, 1970. The contract for purchase of the Bellevue Estates apartments by Apartment was signed by the parties to the contract on December 22, 1970, but recited that the agreement was made on October 1, 1970. *667 The Bellevue Estates apartments were transferred by Apartment to B & L. The cash was received from the buyer in the transaction involving the Bellevue Estates apartments on December 28, 1970, and the escrow agent opened the escrow on that date. The real estate contract for the purchase and sale of the Bellevue Estates apartments was drafted by the escrow agent from an earnest money agreement submitted to the escrow agent by the real estate agent in the transaction and from an interim or proposed contract supplied to the escrow agent by petitioner. Petitioner had written to the real estate agent on December 12, 1970, enclosing a preliminary offer to purchase the Bellevue Estates apartments. The earnest money receipt and the agreement relative to the purchase of the Bellevue Estates apartments which was submitted to petitioner by a letter dated December 18, 1970, recites that the purchase price of the apartments is $ 1,700,000 payable as follows:
$ 50,000 in cash, including above earnest money of $ 10,000.00, as full down payment which be deposited in the form of certified or Cashier's check with Herbert J. Droker, Escrowee, the purchasers on or before 5:00 P.M. on December 31, 1970. *668 The sellers shall credit the $ 50,000.00 as pre-paid interest on the unpaid balance of the purchase contract hereinafter shown herein. Further payments by purchaser are to be made as follows: $ 25,000.00 on January 15, 1971: $ 25,000.00 on July 15, 1971; and $ 50,000.00 on January 15, 1973. The sale shall be closed as of December 31, 1970.
The contract for the purchase of the Bellevue Estates apartments, signed December 22, 1970, provides in part:
The date of closing of said sale and purchase is October 1, 1970.
2. The total purchase price is ONE MILLION FIVE HUNDRED FIFTY THOUSAND DOLLARS ($ 1,550,000.00), payable as follows:
a. ONE MILLION ONE HUNDRED THIRTY NINE THOUSAND, EIGHTY FIVE and 73/100 DOLLARS ($ 1,139,085.73), herein called "Schedule A balance", which sum is identical to the principal balance adjusted for interest of the Deed of Trust dated August 20, 1968, recorded September 6, 1969, under King County Auditor's File No. 6402888, executed by Seller to Firstbank Mortgage Corporation as beneficiary, assigned by Firstbank Mortgage Corporation to and held by United Benefit Life Insurance Company, known as "United of Omaha". The Schedule A balance shall be paid*669 as follows: * * *
b. The Purchaser shall pay FIFTY THOUSAND DOLLARS ($ 50,000.00) interest on the 31st day of December, 1970; TWENTY-FIVE THOUSAND DOLLARS ($ 25,000.00) interest on the 15th day of January, 1971; TWENTY-FIVE THOUSAND DOLLARS ($ 25,000.00) on the 1st day of July, 1971; and FIFTY THOUSAND DOLLARS ($ 50,000.00) interest on the 15th day of January, 1973. It is fully agreed between the parties hereto that Seller's equity shall bear interest in the following amounts for the period specified, in addition to the interest payments provided in section (3) below:
| Period | Interest |
| October 1, 1970 through December 31, 1971 | $ 60,000 |
| January 1, 1971 through December 31, 1972 | 45,000 |
| January 1, 1973 through December 31, 1973 | 45,000 |
3. The balance of the purchase price in the amount of $ 410,914.27, being Seller's equity, shall be increased by $ 4,761.63 (the resultant of prorated deposits, real estate taxes, insurance premiums and reserve accounts) to $ 415,675.90, herein called "Schedule B Balance". The Schedule B Balance shall bear interest determined as follows: * * *
The prorating of th insurance policy and other charges relative to the Bellevue Estates*670 apartments sale were done ad of January 1, 1971. Although the instructions to the escrow agent by the parties were that the transaction was to close as of the last day of 1970, the prorating was done as of January 1, 1971, to avoid the necessity of calculating the expenses of 1970 to be charged to the seller for one day of that year. The rent for the entire year 1970 from the Bellevue Estates apartments was received and kept by the seller and the seller did not bill petitioner or Apartment for any expenses for 1970, nor was any 1970 income allocated to Apartment.
Petitioner negotiated on behalf of Apartment the purchase of the Lynnview apartments which Apartment transferred after purchase toB & L. The contract for the purchase of the Lynnview apartments states that it was made on the first day of October 1970. The transaction was closed in late December 1970 although the contract provided that the "closing date shall be October 1, 1970" and further provided for adjustments of taxes, insurance and various other items as of the closing date. The prior owner, Harry Pryde, operated the apartments until the end of December 1970. He collected the rent on those apartments through*671 December 1970, deducted the expenses for that period of time and did not turn any portion of the receipts or receive any reimbursement of the expenses from petitioner or Apartment of B & L. When the transaction with respect to the Lynnview apartments was closed in late December and B & L took over the operation of the apartments on January 1, mortgage payments with respect to the apartments were made directly to the prior owner, Harry Pryde. The contract for the sale of the Lynnview apartments to Apartment provided that the property was subject to the following liabilities, with the balances as of the date of sale as listed:
| Union Federal Savings | |
| & Loan Association | $ 586,693.05 |
| Reuben Gunst | 10,224.24 |
| Harry Pryde (Seller's | |
| Equity) | 93,296.67 |
The contract recites that the total purchase price of the Lynnview apartments is $ 686,000. It further recites that--
Fourteen Thousand Dollars ($ 14,000)
(b) The Purchaser shall pay Fifteen Thousand Dollars ($ 15,000) interest on or before the 31st day of December, 1970. It is fully agreed between the parties hereto that Seller's equity shall bear interest for the period specified below, and that thereafter interest*672 shall be as provided in section (3).
| PERIOD | INTEREST |
| 10-1-1970 through 9-30-71 | $ 14,000 |
3. The balance of the purchase price in the amount of ($93,296.67), designated as Seller's equity shall be increased or decreased by those prorated amounts contained in and set forth on the closing statement, which is incorporated by reference herein. The closing date shall be October 1, 1970.
On the original partnership return of income of 88th East, which was signed by petitioner Paul M. Hansen as the chief executive officer of Apartment, the depreciation schedule showed that the 88th East apartments and the Casino Terrace apartments were acquired on July 1, 1971. On a first amended partnership return of income for 88th East these apartments were shown as having been acquired on November 1, 1971, and this same acquisition date was shown on a second amended return. Petitioner represented Apartment in the acquisition of the 88th East apartments and the Casino Terrace apartments from G & M. Investments. These apartments were turned over by Apartment to 88th East after their acquisition. The real state contract was dated November 5, 1971, although negotiations with respect*673 to the purchase of the apartments took place in the fatter part of November and December 1971 and the final closing and release of the escrow funds with respect to the purchase and distribution of funds to the sellers occurred on January 6, 1972. In May 1972 the Revenue agent examining the 88th East partnership return of income looked at the prospectus for this partnership. He placed paper clips on certain pages of the prospectus and asked for copies of those pages. One of the pages on which a paper clip was placed was a letter dated November 29, 1971, addressed to "Mr. Paul Hansen, B & L Enterprises, Ltd., 817 Oak Drive, South Ogden, Utah" and signed by M. R. Mastro for G. & M. Investments. This letter stated:
The following is submitted as per our telephone conversation of November 25, 1971.
| Recap | |
| 88 Units | |
| 144 Units | |
| 232 Units at 10,500 | $ 2,436,000.00 |
The last sentence of the letter stated:
Terms can be arranged with considerable flexibility and I do feel that this represents an attractive long term investment.
After requesting*674 photostatic copies of items in the prospectus, including a copy of the letter dated November 29, 1971, the Revenue agent receive in the mail a document which was a copy of the November 29, 1971, letter with the date removed and the price per unit as shown in the letter of $ 10,500 with a total of $ 2,436,000 also removed. Also removed were the statements "Completed November 1, 1971" under the 88th East apartments and "To be completed January 1, 1971" under the Casino Terrace apartments. Later at a meeting between the Revenue agent and a representative of the seller of the 88th East apartments and the Casino Terrace apartments, the agent received a copy of the requested letter from the representative with the dates and amounts shown thereon.
The various buildings in the Chateau apartments complex were designated by letters. In addition to the apartment buildings there was a clubhouse building in the complex. Records of the Utah Power and Light Company show the following information with respect to electrical hookups to tenants' apartments during 1971:
| Connection | Apartment | Power to Unit | |
| Tenant | Date | Number | Date Set |
| Don Hansen | 9-27-71 | 3-D | 9-27-71 |
| Jay P. Clark | 10-04-71 | 1-D | 9-27-71 |
| Larry Castano | 9-27-71 | 2-D | 9-27-71 |
| Chateau Corporation | 9-27-71 | H & B - D | 9-27-71 |
| Frank A. Jones | 11-01-71 | 4-D | 9-27-71 |
| Kent H. Saxey | 10-05-71 | 2-D | 9-27-71 |
| Leo J. Millner | 10-11-71 | 6-D | 9-27-71 |
| Elden Zuchetto | 11-02-71 | 5-D | 9-27-71 |
| James Veruille | 9-27-71 | 10-D | 9-27-71 |
| [Illegible] Brown | 11-01-71 | 9-D | 9-27-71 |
| [Illegible] Dalby | 9-27-71 | 8-D | 9-27-71 |
| Andrew S. Jensen | 11-01-71 | 10-E | 10-11-71 |
| [Illegible] Porter | 11-04-71 | 9-E | 10-11-71 |
| Linda Callihan | 10-11-71 | 8-E | 10-11-71 |
| Joe L. Swapp | 12-24-71 | 7-E | 10-11-71 |
| Wayne Newton | 10-11-71 | 6-E | 10-11-71 |
| Richard Brady | 5-05-72 | 5-E | 10-11-71 |
| Hal Lines | 11-9-71 | 4-E | 10-11-71 |
| Chateau Corporation | 10-04-71 | H & B - E | 10-04-71 |
| Kent Pantone | 11-17-71 | 3-E | 10-11-71 |
| Jerry W. Wheeler | 11-02-71 | 2-E | 10-11-71 |
| George B. LeSueur | See old sheet | 1-E | 10-11-71 |
| Bruce Foster | 2-15-72 | 3-F | 10-11-71 |
| John M. Beasley | 9-01-72 | 7-F | 10-11-71 |
| Delores Hannen | 5-07-72 | 1-F | 10-11-71 |
| Chateau Corporation | 9-28-71 | H & B - F | 9-28-71 |
| Richard B. Roberts | 8-14-72 | 4-F | 10-11-71 |
| John K. Busenback | 4-01-72 | 5-F | 10-11-71 |
| Kenneth R. Kotter | 5-19-72 | 6-F | 10-11-71 |
| Russell D. Street | 2-02-72 | 7-F | 10-11-71 |
| [Illegible] Sparks | 12-26-71 | 10-F | 10-11-71 |
| [Illegible] Unck | 12-27-71 | 9-F | 10-11-71 |
| Arthur Thumball | 1-19-72 | 8-F | 10-11-71 |
| James W. MaGaughey | 1-10-72 | 10-T | 10-11-71 |
| Steven D. Page | 1-28-72 | 9-T | 10-11-71 |
| [Illegible] Blosen | 4-15-72 | 8-T | 10-11-71 |
| Chateau Corporation | 9-28-71 | H & B - T | 9-28-71 |
| Charles Fields | 3-12-72 | 7-T | 10-11-71 |
| Fred M. Owen | 2-22-72 | 6-T | 10-11-71 |
| John Barton | 5-01-72 | 5-T | 10-11-71 |
| Larry G. Brady | 2-28-72 | 4-T | 10-11-71 |
| Gary S. Miller | 8-07-72 | 3-T | 10-11-71 |
| Kent H. Saxey | 1-24-72 | 2-T | 10-11-71 |
| James Veruille | 2-07-72 | 1-T | 10-11-71 |
*675 Prior to the date of setting of power to the units, Chateau had a temporary hookup for electric power to the buildings. The records of Chateau show a payment to Utah Power and Light of July 21, 1971, in the amount of $ 453. The record also shows that power to building A was set on January 12, 1972.
When apartments were rented in the various buildings of the Chateau apartments, the power units in the apartments were never transferred to the tenants' names until after the tenants moved into the apartments, and at times when a tenant moved into an apartment prior to the time the power was transferred to the tenant's name, the tenant would use power from the hookup in the name of Chateau. There were persons living in the Chateau apartments on September 9, 1971. Building A was completed in 1971 and apartments rented in it. Chateau tried to get tenants moved in before Christmas and some actually moved in right after Christmas. There was a furnished model apartment in building T. This building was finsihed in September 1971 and the model apartment was open for inspection at that time.
Each of the apartments in the various buildings of the Cheteau apartments contained appliances, *676 draperies and carpeting which were installed prior to a tenant moving into an apartment. The clubhouse was completed and furniture and fixtures installed therein sometime prior to the end of the 1971.
Chateau did not maintain a double entry set of books for the year 1971. The records kept in the single entry set of books were transferred to a computer and the records kept on a computer. Anna Rae Nelson was the bookkeeper for Chateau from the time it commenced operations until February of 1972. She kept the books under the general direction of petitioner. She verified bills and the drew the checks in payment thereof and entered the amounts in the books.
Beginning in April 1971 petitioner received checks from Chateau. The following shows the check number, date and amount of the checks received:
| Check Number | Date | Amount |
| 123 | 4/01/71 | 750 |
| 134 | 4/13/71 | 1,000 |
| 135 | 4/13/71 | 750 |
| 139 | 4/15/71 | 500 |
| 165 | 5/07/71 | 750 |
| 178 | 6/01/71 | 750 |
| 245 | 7/12/71 | 750 |
| 278 | 8/03/71 | 750 |
| 371 | 9/03/71 | 750 |
| 403 | 10/04/71 | 750 |
| 484 | 11/01/71 | 750 |
| 599 | 12/20/71 | 750 |
The total amount of these checks--$ 9,000--was treated on the books of Chateau as a partner's draw. The*677 following shows how the partners' accounts were handled on Chauteau's books through the end of 1976:
Chateau Partnership Analysis of Capital Account
| Paul | Byron | Paul | Evan | |
| Hansen | Naisbitt | Naisbitt | Evans | |
| 1971--Capital Contributed | 0 | 0 | 0 | 0 |
| Loss - Ordinary | (43781) | (43781) | (43781) | (43780) |
| Draw - | 9000 | 0 | 0 | 0 |
| Blance 1971 | (52781) | (43781) | (43781) | (43780) |
| 1972--Capital Contributed | ||||
| Schedule I | 28454 | 13255 | 13255 | 13255 |
| Loss - Ordinary | ( 337) | ( 337) | ( 337) | ( 337) |
| Draw - | ( 8000) | 0 | 0 | 0 |
| Loss - Sect. 1231 | (29663) | (45380) | (45380) | (45381) |
| Balance 1972 | (62327) | (76243) | (76243) | (76243) |
| 1973--Capital Contributed | ||||
| Schedule II | 3317 | 3317 | 3317 | 3317 |
| Loss - Ordinary | ( 60) | ( 60) | ( 60) | ( 60) |
| Draw - | ( 5250) | 0 | 0 | 0 |
| Loss - Sect. 1231 | ( 6662) | ( 6661) | ( 6662) | ( 6661) |
| Balance 1973 | (70982) | (79647) | (79648) | (79648) |
| 1974--Capital Contributed | ||||
| Schedule II | 39494 | 38735 | 38734 | 38735 |
| Loss - Ordinary | (57357) | (57358) | (57357) | (57358) |
| Draw - | ( 3500) | 0 | 0 | 0 |
| Balance 1974 | (92345) | (98270) | (98271) | (98271) |
| 1975--Capital Contributed | ||||
| Schedule IV | 11368 | 26363 | 26363 | 26369 |
| Loss - Ordinary | (78496) | (78496) | (78496) | (78497) |
| Balance 1975 | 159473 | 150403 | 150404 | 150399 |
| 1976--Capital Contributed | ||||
| Schedule V | 3500 | 8000 | 8000 | 8000 |
| Loss - Ordinary | (47711) | (47711) | (47711) | (47711) |
| Gain - Long term | 4395 | 4395 | 4395 | 4395 |
| Draw | (80767) | (80774) | (80773) | (80773) |
| Balance 1976 | 280056 | 266493 | 266493 | 266487 |
| CASH PAID IN | 91723 | 85537 | 85537 | 85537 |
| Ending Balance | 274460 | 270626 | 270626 | 270626 |
*678 J. Blair Jones, a partner in Chateau until about November 1, 1971, who supervised the construction of the buildings, received checks in the amount of $ 1,500 a month from Chateau which were also treated on the books of Chateau as partner's draw. The total amount received in 1971 by Mr. Jones from Chateau Partnership was $ 13,000. Chateau took no deduction for the draws it showed on its books of either petitioner or Mr. Jones. When Mr. Jones withdrew from the partnership about the first of November 1971 because of disagreements with petitioner, his partnership interests and accounts were settled.
Chateau claimed an interest deduction on its tax return of $ 114,887.39 for the year 1971. The records of Chateau show payments of this amount of interest. A letter from the Utah Mortgage Loan Corporation to an agent of respondent stated that during 1971 Chateau paid the Utah Mortgage Loan Corporation $ 106,696.70 and during 1972 paid it $ 117,206.05. Chateau of its 1972 partnership return of income claimed a deduction of $ 113,347.61 for interest paid. On its 1971 tax return Chateau claimed a deduction for legal and professional fees in the amount of $ 8,220.85.
The Chateau apartments*679 were constructed from pre-cut components. Some of the constructon was average and some below average. The buildings constructed in 1971 were mostly below average construction.
During the calendar year 1971 petitioner maintained jointly with his wife, Marie B. Hansen, the following bank accounts:
| Bank | Account No. | Type |
| Bank of Utah | 301804-0 | Savings |
| Ogden, Utah | ||
| Bank of Utah | 3-21-229-7 | Checking |
| Ogden, Utah | ||
| Davis County Bank | 8260 | Savings |
| Farmington, Utah | ||
| Davis County Bank | 7998 | Savings |
| Farmington, Utah | ||
| Davis County Bank | 101-10522-12 | Checking |
| Farmington, Utah |
Petitioner did not personally conduct any of the transactions at the Davis County Bank, Farmington, Utah, with respect either to the checking or savings accounts. All transactions in these three accounts were conducted by petitioner's wife, although checks made payable to petitioner were deposited in these accounts. A check for $ 2,500 to petitioner from Apartment was deposited in petitioner's checking account in the Davis County Bank on December 6, 1971. Petitioner received a check dated October 8, 1971, from Apartment for $ 1,000. On the face of the check there appeared in handwriting*680 "Payment for 60 day land option for Chateau Partnership." On October 9 this check was endorsed by petitioner to Dean Real Estate in Ogden, Utah. On the back of the check in handwriting appeared the following note:
Land Deposit for Evan Evans, Paul Naisbitt, Byron Naisbitt and Paul Hansen.
Land owned by Doug Stephens. Oakridge area.
Evan Evans, Paul Naisbitt, and Byron Naisbitt were doctors who owned an interest in Apartment and who were the other three partners in Chateau. The $ 1,000 was shown by Dean Real Estate on its books as earnest money. The ledger sheet reflecting the $ 1,000 check shows that the $ 1,000 was repaid by Dean Real Estate on April 12, 1972.
Petitioner received interest income in 1971 in the amount of $ 72.92 which was not reported on his Federal income tax return for that year. Petitioner, on his Federal income tax return for 1971 showed adjusted gross income as a loss of $ 16,083.40 computed as follows:
| Wages, salaries, tips, etc. | $ 17,328.58 |
| Interest | 167.38 |
| Income other than wages, dividends, and interest | (33,579.36) |
| Adjusted gross income | (16,083.40) |
The income other than wages, dividends, and interest was computed as follows: *681
| Professional Income | $ 39,183.41 |
| Expenses | 11,731.13 |
| Net Fees and Other Professional Income | $ 27,452.28 |
| Net Long Term Capital Loss | ( 235.77) |
| Partnership Loss from B & L Enterprises | (13,434.00) |
| Partnership Loss from Chateau Partnership | (43,780.64) |
| Norlang Estates Limited, Partnership Loss | ( 3,817.00) |
| Net Business Income or Loss | (33,579.36) |
The loss of $ 16,083.40 shown by petitioner on his 1971 return was carried back to 1968 to offset taxable income shown on that return of $ 10,332.94. On the basis of the loss carryback claim respondent refunded to petitioner the entire $ 2,035.24 tax paid by petitioner for the year 1968 plus interest. Attached to petitioner's 1971 return were letters from B & L, Chateau and Norlang setting forth the partnership losses and petitioner's prorata share thereof. The Chateau letter stated in part:
Taxpayer's share of the operating loss of Chateau Partnership for 1971 is $ 39,780.64 plus $ 4,000.00 1st year depreciation for a total operating loss of $ 43,780.64. * * *
Included in the business expenses shown on petitioner's return as connected with his professional income including his work as a Justice of the Peace*682 was $ 2,099.16 stated to be "Auto expenses, travel research, 18,324 miles 12" for 15,000 miles - 9" for 3,324 miles." Petitioner's tax return shows that he was entitled to six exemptions and that he had the following personal deductions: Contributions, $ 4,245, with a notation "No charitable contributions claimed--contributions carried over to 1972;" Taxes, $ 1,466.66; Interest expense, $ 2,296.25.
The Chateau partnership return for the year 1971 shows rental income for September, October, November and December totaling $ 5,967.55 and expenses of $ 165,090.13 resulting in a loss of $ 159,122.58, and additional first year depreciation of $ 16,000 resulting in a total loss of $ 175,122.58. The depreciation schedule on that return shows the following:
| Date acquired | July 1, 1971 Buildings |
| Cost | $ 574,900 |
| Method & Life | DDB 25 years |
| 1971 Reg. Dep. | $ 22,996 |
| 1971 Additional | |
| 1st Yr. Depreciation | $ 160,000 [sic] |
The schedule of the partners' share of loss in the Chateau partnership for the year 1971 shows each partner's share of the loss as $ 39,780.64 and that each partner's share of first year depreciation is $ 4,000, making a total loss for each of $ 43,780.64. *683 Included in the expenses deducted on the return was interest of $ 114,887.39 and legal and professional services of $ 8,220.85.
Respondent in his notice of deficiency to petitioner showed the taxable income as shown on petitioner's return as a loss of $ 23,896.31, total adjustments of $ 50,732.80, with a taxable income as revised of $ 26,836.49. The adjustments to petitioner's income were shown as follows:
| Partnership Income or (Loss) - ordinary - | |
| Norlang Estates Ltd. | 3,715.56 |
| Partnership Income or (Loss) - ordinary - | |
| B & L Enterprises | 7,904.00 |
| Partnership Income or (Loss) - ordinary - | |
| Chateau Partnership | 8,358.56 |
| Additional First Year Deprec. - Chateau | |
| Partnership | 4,000.00 |
| Section 1231 Loss - Chateau Partnership | |
| Capital Gains & Losses | (235.77) |
| Charitable Contributions | (4,245.00) |
| Other Income - Unexplained Deposits | 16,354.27 |
| Unreported Interest Income | 72.92 |
| Unreported Fees | 12,709.10 |
| Auto Expense | 2,099.16 |
In explanation of the first adjustment respondent showed a recomputation of the 1971 loss of Norlang reducing its reported loss of $ 320,711 to a loss of $ 8,524.47, with petitioners' distributive share of the revised loss being $ 101.44*684 rather than the claimed loss of $ 3,817. In the computation respondent disallowed management and consulting fees as a deduction and capitalized them, and reduced the purchase price of the Norlang apartments by $ 50,000 for a discount allowed. Respondent recomputed depreciation as claimed on the Norlang partnership return on the basis of his revised cost of the property arriving at allowable depreciation of $ 14,957.76 rather than the claimed $ 119,350. Other major adjustments resulting in this decrease in depreciation were an allocation of $ 1,584,900 of the price paid for the apartments to the buildings rather than the $ 1,271,000 allocated on Norlang's return and the allocation of $ 52,500 to furniture and fixtures rather than the $ 279,000 allocated on the return, a use of a 10-year useful life rather than the 6 years shown on the Norlang return for furniture and fixtures, a 40-year useful life rather than the useful life shown on the return for the buildings and a beginning date for depreciation of November 1, 1971, rather than July 1, 1971. Respondent disallowed claimed interest expense in the amount of $ 174,394.19, which represented basically the $ 175,000 paid by Norlang*685 to the seller and denominated in the contract of sale as construction interest. Respondent disallowed the claimed deductions for $ 26,400 management fees and $ 7,000 for consulting fees which amounts as heretofore stated were capitalized and added to the basis of the property acquired.
Respondent in his notice of deficiency determined that petitioner's loss from B & L in 1971 was $ 5,530 rather than the claimed $ 13,434. The loss reported by B & L on its 1971 return was $ 233,752. Respondent adjusted this claimed loss by disallowing $ 50,000 claimed to be deductible as mortgage interest expense and $ 100,166.76 of the claimed depreciation expense deduction. The $ 50,000 mortgage interest expense represented the two $ 25,000 payments of amounts denominated as interest referred to in the contract with respect to the purchase of the Bellevue Estates apartments. In making this adjustment respondent determined that the basis of the building of the Bellevue Estates was $ 1,402,285.50 rather than the $ 1,105,500 shown by B & L on its partnership return of income and that the basis of furniture and fixtures was $ 83,475 rather than $ 304,500.
With respect to the Lynnview apartments,*686 respondent determined that the basis of the building was $606,683.69 rather than $ 506,182 shown on the B & L partnership return and the basis of the furniture and fixtures was $ 47,651.94 rather than the $ 93,818.
Respondent further determined that the useful life of each of these buildings was 37 years rather than the 25 years shown on the B & L return and that the useful life of the furniture and fixtures in each building was 5 years rather than the 6 years shown on the return. Respondent also determined that the furniture and fixtures should be depreciated on the declining balance rather than on the double declining balance basis and that the date the apartments were acquired was January 1, 1971, rather than October 1, 1970, as shown on the return so that there was no depreciation allowed or allowable for prior years.
Respondent in his notice of deficiency determined that petitioner's share of the ordinary loss of the Chateau partnership was $ 31,422.08 rather than the $ 39,780.64 claimed and that petitioner as a member of the Chateau partnership was entitled to no first year depreciation. The adjustments made by respondent in arriving at the reduction in petitioner's partnership*687 loss from Chateau was a reduction in the depreciation deduction claimed by the partnership of $ 17,022.72, a reduction in interest expense deduction of $ 8,190.69 and a disallowance of the deduction claimed for legal and professional services of $ 8,220.85, making a total reduction in the loss reported by Chateau on its 1971 return of partnership income of $ 33,434.26. Respondent in computing depreciation for Chateau at $ 5,973.28 rather than the $ 22,996 shown as depreciation other than first year depreciation on the return, computed depreciation from September 1971 on Building D and from October 1971 on Building E and the clubhouse. Respondent's computation of depreciation for 1971 and 1972 is as follows:
| KIND OF | ||
| PROPERTY | COST OR | |
| (If buildings, | ||
| state type of | OTHER BASIS | |
| construction. | ||
| Exclude land | DATE | (Less |
| and salvage value | ||
| from basis) | ACQUIRED | exclusions) |
| Building D | 9/71 | $ 135,535 |
| Furniture & | ||
| Fixtures | ||
| Bldg. D | 9/71 | 5,442 |
| Building E | 10/71 | 135,535 |
| Furniture & | ||
| Fixtures | ||
| Bldg. E | 10/71 | 5,442 |
| Building T | 1/72 | 135,535 |
| Furniture & | ||
| Fixtures Bldg. | ||
| T | 1/72 | 5,442 |
| Building F | 2/72 | 135,535 |
| Furniture & | ||
| Fixtures Bldg. | ||
| F | 2/72 | 5,442 |
| Building A | 4/72 | 142,587 |
| Furniture & | ||
| Fixtures Bldg. | ||
| A | 4/72 | 5,725 |
| Building G | 5/72 | 135,536 |
| Furniture & | ||
| Fixtures Bldg. | ||
| G | 5/72 | 5,441 |
| Building H | 7/72 | 135,536 |
| Furniture & | ||
| Fixtures Bldg. | ||
| H | 7/72 | 5,441 |
| Building B | 7/72 | 142,588 |
| Furniture & | ||
| Fixtures Bldg. | ||
| B | 7/72 | 5,725 |
| Building C | 8/72 | 142,588 |
| Furniture & | ||
| Fixtures Bldg. | ||
| C | 8/72 | 5,725 |
| Clubhouse | ||
| Building | 10/71 | 81,719 |
| Clubhouse | ||
| Furniture & | ||
| Fixtures | 10/71 | 3,281 |
| Total Depreciation Expense Allowable on Items Changed | ||
| Depreciation Expense Claimed on Items Changed | ||
| Adjustment - Increase/(Decrease) | ||
| REMAINING | |||
| COST OR OTHER | |||
| KIND OF | |||
| PROPERTY | DEPRECIATION | BASIS TO BE | |
| (If buildings, | |||
| state type of | ALLOWED OR | RECOVERED | |
| construction. | |||
| Exclude land | ALLOWABLE IN | ||
| and salvage | |||
| value from | |||
| basis) | PRIOR YEARS | (Date) | METHOD |
| Building D | $ 0 | $ 135,535 | DB |
| Furniture & | |||
| Fixtures Bldg. | |||
| D | 0 | 5,442 | DB |
| Building E | 0 | 135,535 | DB |
| Furniture & | |||
| Fixtures Bldg. | |||
| E | 0 | 5,442 | DB |
| Building T | 0 | 135,535 | DB |
| Furniture & | |||
| Fixtures Bldg. | |||
| T | 0 | 5,442 | DB |
| Building F | 0 | 135,535 | DB |
| Furniture & | |||
| Fixtures Bldg. | |||
| F | 0 | 5,442 | DB |
| Building A | 0 | 142,587 | DB |
| Furniture & | |||
| Fixtures Bldg. | |||
| A | 0 | 5,725 | DB |
| Building G | 0 | 135,536 | DB |
| Furniture & | |||
| Fixtures Bldg. | |||
| G | 0 | 5,441 | DB |
| Building H | 0 | 135,536 | DB |
| Furniture & | |||
| Fixtures Bldg. | |||
| H | 0 | 5,441 | DB |
| Building B | 0 | 142,588 | DB |
| Furniture & | |||
| Fixtures Bldg. | |||
| B | 0 | 5,725 | DB |
| Building C | 0 | 142,588 | DB |
| Furniture & | |||
| Fixtures Bldg. | |||
| C | 0 | 5,725 | DB |
| Clubhouse | |||
| Building | 0 | 81,719 | DB |
| Clubhouse | |||
| Furniture & | |||
| Fixtures | 0 | 3,281 | DB |
| Total Depreciation Expense Allowable on Items Changed | |||
| Depreciation Expense Claimed on Items Changed | |||
| Adjustment - Increase/(Decrease) | |||
| KIND OF | |||
| PROPERTY | RATE | DEPRECIATION ALLOWABLE | |
| (If buildings, | |||
| state type of | (%) OR | YEAR ENDED (or Period) | |
| construction. | |||
| Exclude land | LIFE | ||
| and salvage | |||
| value from | |||
| basis) | (YEARS) | 12/31/1971 | 12/31/1972 |
| Building D | 40 | $ 2,258.92 | $ 6,108.49 |
| Furniture & | |||
| Fixtures Bldg. | |||
| D | 8 | 453.50 | 1,143.20 |
| Building E | 40 | 1,694.19 | 6,134.37 |
| Furniture & | |||
| Fixtures Bldg. | |||
| E | 8 | 340.12 | 1,169.18 |
| Building T | 40 | 6,212.02 | |
| Furniture & | |||
| Fixtures Bldg. | |||
| T | 8 | 1,247.13 | |
| Building F | 40 | 5,647.29 | |
| Furniture & | |||
| Fixtures Bldg. | |||
| F | 8 | 1,133.75 | |
| Building A | 40 | 4,752.90 | |
| Furniture & | |||
| Fixtures Bldg. | |||
| A | 8 | 954.17 | |
| Building G | 40 | 3,953.13 | |
| Furniture & | |||
| Fixtures Bldg. | |||
| G | 8 | 793.48 | |
| Building H | 40 | 2,823.67 | |
| Furniture & | |||
| Fixtures Bldg. | |||
| H | 8 | 566.77 | |
| Building B | 40 | 2,970.58 | |
| Furniture & | |||
| Fixtures Bldg. | |||
| B | 8 | 596.35 | |
| Building C | 40 | 2,376.47 | |
| Furniture & | |||
| Fixtures Bldg. | |||
| C | 8 | 477.08 | |
| Clubhouse | |||
| Building | 40 | 1,021.49 | 3,698.63 |
| Clubhouse | |||
| Furniture & | |||
| Fixtures | 8 | 205.06 | 704.90 |
| Total Depreciation Expense Allowable on Items | |||
| Changed | $ 5,973.28 | $ 53,463.56 | |
| Depreciation Expense Claimed on Items Changed | 22,996.00 | 0 | |
| Adjustment - Increase/(Decrease) | 17,022.72 | (53,463.56) | |
*689 In explanation of "Other income - unexplained deposits" of $ 16,354.27 for the year 1971 set forth in the notice of deficiency respondent stated as follows: