DocketNumber: Docket Nos. 8111-12, 8112-12, 8113-12.
Judges: BUCH
Filed Date: 12/13/2016
Status: Non-Precedential
Modified Date: 4/18/2021
Decisions will be entered under
P1, P2, and P3 are treated as partnerships for Federal tax purposes and are in the business of farming almonds. Each P financed the purchase of land, all or a portion of which it used to plant and grow almond trees for use in its business. The financing was from third parties, except that P1 also borrowed funds from P2 and P3, which contemporaneously had borrowed those funds from a third party. P2 and P3 paid interest to the third party as to the funds they lent to P1, but P1 did not pay any interest to P2 or to P3. Ps deducted the interest that they paid to the third parties. P1 also deducted property taxes that it paid as to its land. R disallowed the *225 deductions on the grounds that
BUCH,
The entities were owned directly or indirectly by a group of individuals who were involved in the business of farming almonds. The entities separately purchased land before the subject years, and each entity thereafter planted and grew almond trees on its land. The entities paid interest relating to debt incurred to purchase the land, and*223 they deducted the interest during the subject years. For 2008 and 2009 WRP I also deducted property taxes that it paid as to its land.
*227 Respondent issued separate notices of final partnership administrative adjustment (FPAAs) to the tax matters partners (TMPs) of the entities, disallowing the deductions because, in respondent's view,
Interest | $792,645 | $564,932 |
Taxes | 117,232 | 141,022 |
61,313 | --- |
Interest | $951,023 | $1,220,004 |
765,975 | --- |
Interest | $80,855 | $652,142 | $223,563 |
239,935 | --- | --- |
*228 We must decide the correctness of these adjustments.*224 almond trees. Pursuant to the anti-abuse rule in
Each entity in these consolidated cases is treated as a partnership for tax purposes and uses the cash method for tax purposes. Each had its principal place of business in California when the petition relating to it was filed.
The entities are all owned directly or indirectly by one or more members of a common group of individuals and trusts. The individuals and trusts are Keith Gardiner, Jennifer T. Gardiner (wife of Keith Gardiner), Jeffrey H. Townsend, Carol S. Townsend (now Adamson, ex-wife of Jeffrey Townsend and sister of Keith Gardiner), the Mary D. King Trust, and the Gardiner Family Trust. We detail below the specific members who own each of the entities and other relevant connections that the members have to one another.
WRP I is a limited liability company registered in the State of California. WRP I is engaged in a farming business. WRP I was formed in 2007*225 and is owned 50% by the Gardiner Family Trust, 30% by Rosedale Farming Group, and 20% by the Mary D. King Trust.
Keith and Jennifer Gardiner are trustees of the Gardiner Family Trust, which in turn is the TMP for WRP I. Jeffrey and Carol Townsend equally own Rosedale Farming Group, a general partnership. Frank L. King, Jr., is the trustee of the Mary D. King Trust.
Rosedale Ranch is a general partnership registered in the State of California. Rosedale Ranch is engaged in a farming business. Rosedale Ranch was formed in 2002 and is equally owned by Rosedale Farming Group and by Gardiner Family, LLC.
Gardiner Family, LLC, is equally owned by Keith and Jennifer Gardiner. Rosedale Farming Group is the TMP for Rosedale Ranch.
K&G is a limited liability company registered in the State of California. K&G is engaged in farming and commercial real estate businesses. K&G was formed in 1995 and is equally owned by Keith Gardiner and by the Mary D. King Trust. Keith Gardiner is the TMP for K&G.
In early 2007 Jackson & Perkins listed for sale approximately 3,200 acres of farmland and other assets (collectively, Wasco property) in Wasco, California. Mr. Gardiner*226 believed that the farmland (Wasco land) was some of the best property in the world. Jackson & Perkins are famous for their roses, and they required that a buyer of the Wasco property let them finish growing and harvesting the roses that were already growing on the Wasco land, in exchange for which *231 Jackson & Perkins would pay rent. Along with the Wasco land, Jackson & Perkins required the buyer to purchase the other assets, consisting of several buildings on the property and a significant amount of equipment.
In 2007 Mr. Gardiner and his business associates formed WRP I and Wasco Real Properties II, LLC (WRP II), for the purpose of acquiring the Wasco property.*227 contributed by WRP I came from the following sources: two direct loans totaling $12,300,000 from an independent third party, Farm Credit West (FCW); two loans totaling $7,350,000 from Rosedale Ranch; and two loans totaling $4,900,000 from K&G. Rosedale Ranch and K&G contributed to *232 the acquisition of the Wasco property to allow the related entities to pool their almond crops, which would allow them to obtain premium pricing and generally give them more leverage in negotiations.
WRP I used the entire $12,300,000 in loans from FCW to purchase the Wasco property.
In 2007 WRP I did not pay any interest to FCW with respect to the borrowing of the $12,300,000, and accordingly, WRP I did not claim a deduction for any interest relating to that borrowing on its tax return for 2007. In 2008 and 2009 WRP I paid interest to FCW on the underlying loans and claimed deductions for the corresponding total interest that it paid to FCW during each of those years on its tax returns for 2008 and 2009.
The $7,350,000 loan to WRP I from Rosedale Ranch consisted of $1,470,000 of its own cash plus the proceeds of a $5,880,000 loan it received from FCW.
Rosedale Ranch*228 obtained the FCW loan on April 24, 2007, and immediately lent the $5,880,000 to WRP I to use to purchase the Wasco property. Because of an oversight, WRP I and Rosedale Ranch did not execute a promissory note for the *233 loan until April 2008. WRP I did not pay any interest to Rosedale Ranch during the subject years because the Wasco property did not generate income sufficient for WRP I to pay the interest due. In July 2010 Rosedale Ranch and WRP I amended the promissory notes to defer the payments of accrued interest and principal until January 1, 2016, when WRP I's almond trees were expected to produce income sufficient for it to pay the interest.
In 2007 Rosedale Ranch did not pay any interest to FCW with respect to the $5,880,000 loan, and accordingly, it did not claim a deduction for any interest relating to that loan on its tax return for 2007. In 2008 and 2009 Rosedale Ranch paid interest to FCW and claimed deductions for the corresponding interest that it paid to FCW during each of those years on its tax returns for 2008 and 2009.
On April 24, 2007, K&G borrowed $980,000 from a line of credit that it had with FCW and also obtained from FCW an unrelated loan of $3,943,000.*229 K&G loaned $4,900,000 of the $4,923,000 ($980,000 + $3,943,000) to WRP I, as discussed above. WRP I did not make any of the scheduled interest payments. On July 1, 2010, WRP I and K&G amended the promissory notes to defer the payments of the accrued interest and principal until January 1, 2016, when *234 WRP I's almond trees were expected to produce income sufficient for WRP I to pay the interest.
In 2007 K&G paid interest to FCW on the line of credit loan. K&G claimed a deduction for the interest on its tax return for 2007. In 2008 and 2009 K&G paid interest to FCW on both the line of credit loan and the $3,943,000 loan and claimed deductions for the corresponding total interest that it paid to FCW during 2008 and 2009 on its tax returns for those years.
The Wasco land did not have any almond trees on it when WRP I purchased its portion of that land in 2007. At the time of that purchase the Wasco land had row crops growing on it, including roses, corn, wheat, and carrots. Row crops are nonpermanent crops that have a specific growing season.
WRP I endeavored to use at least its portion of the Wasco land to grow almond trees. To finance the costs associated*230 with planting and growing almond trees, WRP I incurred additional debt. In 2007 Treehouse Almonds (Treehouse) provided a revolving line of credit with a $3.5 million limit. With one exception, WRP I's production expenditures were financed entirely by debt. The exception is that $111,147 of expenditures was paid through rental income in 2007. For each *235 of the subject years in issue, WRP I capitalized the corresponding interest paid on the Treehouse line of credit loan.
During 2007 WRP I began the first of three phases to grow almond trees on 254.1 acres of its Wasco land.*231 land while cycling out its roses. Gardiner Farms leased from WRP I Gardiner *236 Farms' portion of the Wasco land to grow row crops. WRP I leased a portion of the Wasco land to Gardiner Farms, in lieu of WRP I's planting its own crops on that land, because the rent that WRP I received on that lease provided it with a necessary cashflow. WRP I also did not have the proper equipment to plant its own row crops.
In 2008 WRP I was growing almond trees on 2,034.61 acres of the Wasco land and was growing row crops on other parts of the Wasco land. Jackson & Perkins and Gardiner Farms continued to lease the remaining portions of WRP I's Wasco land to grow row crops. For 2008 WRP I's production debt exceeded its production expenditures.
In 2009 WRP I was growing almond trees on 2,259.61 acres of the Wasco land and was growing row crops on other parts of the Wasco land. That year WRP I began phases 2 and 3 of growing almond trees. Phase 2 included planting almond trees as well as general maintenance. Phase 3 included additional tree planting and various other maintenance activities. For 2009 WRP I's production debt exceeded its production expenditures.
WRP I paid $61,313, $117,232, and $141,022 in property taxes on the Wasco land during 2007, 2008, and 2009, respectively. WRP I claimed corresponding deductions for these payments on its tax returns for those years.
In 2006 Rosedale Ranch leased and paid rent for a portion of land (Weidenbach property) that includes approximately 240 acres in Shafter, California. Rosedale Ranch owned a piece of property adjacent to the Weidenbach property that it was attempting to develop. If another buyer had purchased the Weidenbach property, it might have affected Rosedale Ranch's access to the property it already owned. Rosedale Ranch began growing almond trees on the Weidenbach property during 2006, and it used the land only for growing almond trees.
On February 13, 2007, Rosedale Ranch purchased the Weidenbach property using the proceeds of a loan from FCW of $16,828,000. Rosedale Ranch paid interest to FCW as to the $16,828,000 loan in 2007, 2008, and 2009. Rosedale Ranch claimed deductions for the corresponding interest that it paid to FCW for those years.
In May 2005 K&G purchased approximately 1,685 acres of land (Wood Stone property) from Wood*233 Stone Ranches, LLP. Almond trees were already planted on the Wood Stone property in 2005, and K&G eventually planted the Wood Stone property with almond trees and pistachio trees. The seller financed $2,534,675 of the purchase price, and the principal and interest were payable over 10 years. K&G paid interest on the debt during 2006, 2007, 2008, and 2009. K&G claimed deductions for the interest expense on its tax returns for those years.*239 V. On January 9, 2012, respondent issued a total of seven FPAAs to the entities' TMPs. Two FPAAs related to WRP I. Two other FPAAs related to Rosedale Ranch. The final three FPAAs related to K&G. The two FPAAs issued to the TMP of WRP I included one for 2008 and one for 2009. The FPAA for 2008 disallowed most of the property tax expense deduction, disallowed most of the interest expense deduction, made a The two FPAAs issued to the TMP of Rosedale Ranch included one for 2008 and one for 2009. The FPAA for 2008 disallowed most of the interest expense deduction, made a The three FPAAs issued to the TMP of K&G included one for 2007, one for 2008, and one for 2009. The FPAA for 2007 disallowed a portion of the interest expense deduction, made a We enter the vast and complex world*235 of uniform capitalization, in a setting of various passthrough entities that purchased land on which they planted and grew almond trees as part of their businesses of farming almonds. The parties' dispute rests not on whether the property taxes and the interest are deductible. Their dispute focuses instead on when those costs may be deducted. Respondent determined that the entities were not entitled to deduct currently any of the property taxes or interest in dispute. As to the taxes respondent argues, because WRP I used its land to grow its almond trees, WRP I must capitalize the *241 taxes related to the land rather than deduct those taxes currently. As to the interest, respondent argues, the fact that each entity used its land to grow its almond trees means that the land and the almond trees are sufficiently related to each other to be considered a single unit of property the basis of which includes the amount of the interest that the entity paid to finance its purchase of the land. Respondent adds that Rosedale Ranch and K&G also must capitalize the interest that they paid on the funds that they borrowed and then lent to WRP I because their loans to WRP I were related party transactions*236 subject to the anti-abuse rule in Federal income tax law distinguishes between a payment that is currently deductible as an expense and a payment that is capitalized as a capital expenditure. Capital expenditures are not exhaustively enumerated in the Code. Deductions, on the other hand, are exceptions to the norm of capitalization and require a specific statutory provision. "In exploring the relationship between deductions and capital expenditures, * * * [the Supreme] Court has noted the 'familiar rule' that 'an income tax deduction is a matter of legislative grace and that the burden of clearly showing the right to the claimed deduction is on*237 the taxpayer.'" The distinction between a current expense and a capital expenditure is important in that it affects the timing of a taxpayer's cost recovery of the payment. "While business expenses are currently deductible, a capital expenditure usually is amortized and depreciated over the life of the relevant asset, or, where no specific asset or useful life can be ascertained, is deducted upon dissolution of the enterprise." Congress promulgated The statutory provisions for capitalization that are relevant to our analysis are Congress eventually supplemented After the enactment of former Congress repealed former Congress instructed the Secretary to prescribe regulations to carry out the purposes of The taxes and interest in dispute generally relate to the land on which the entities planted and grew their almond trees. Accordingly, the entities must capitalize the property taxes and the interest to the extent stated herein. Petitioners argue that The entities' growing of the almond trees is a production of those trees within the reach of Petitioners focus on the fact that the taxes and the interest directly relate to the ownership and the purchase of the land, respectively, to conclude that these expenses may be capitalized only if the land is being produced. Petitioners' focus is blurred. The entities grow almond trees as part of their businesses, and the almond trees grow on the land. The land itself need*244 not be produced in that the land and the almond trees are sufficiently intertwined in the sense that the almond trees cannot grow without the underlying land and the entities' placing in service of the almond trees requires that the entities also place in service the underlying land. Thus, while the property taxes and the interest may have been more closely connected with the land than with the almond trees, the payment of those costs, to be sure, was both necessary and indispensable to the growing of the almond trees so as to be considered a cost of producing those trees. Our finding that the land is *251 a necessary and indispensable part of the growing of the almond trees is further demonstrated by WRP I's phase 1 land preparation costs. That phase, in part, included analyzing the soil, ripping and deep ripping the soil, trenching, and leveling the land. We also are mindful of As to the property taxes in dispute, we do not read the regulations on "direct costs" to include those taxes. For direct costs, *256 Petitioners argue further that the property taxes neither directly benefited WRP I's almond trees nor were incurred as to those trees in that the taxes relate directly to the Wasco land, which WRP I did not produce. Petitioners add that the property taxes would be due regardless of whether the entities were growing almond trees. We are unpersuaded by petitioners' argument. The Wasco land was used to grow the almond trees, and the property taxes assessed as to that land directly benefit the almond trees in that the taxes were incurred*250 in the course of WRP I's using the land to grow the almond trees. WRP I is obligated to pay the property taxes on its portion of the Wasco land, given that WRP I is the owner of that land for which the tax is assessed. In addition, WRP I could have been precluded from growing the almond trees on the land if the property taxes were not paid. We also bear in mind that the Court has previously required real estate developers to capitalize property taxes as indirect costs properly allocable to their properties. *257 We conclude that WRP I must capitalize the property taxes that it paid as to its Wasco land to the extent that the taxes relate to the portion of the land on which WRP I grew its almond trees. To the extent that the property taxes did not relate to the portion of the land on which WRP I grew its almond trees, those taxes are not allocable to the land (and thus are not allocable to the almond trees) for purposes of While We have held that the almond trees are real property that the entities produced and*252 that the pre=productive period of the almond trees exceeds two years. For the reasons that we have previously discussed, this holding applies equally to the interest costs and to the other costs (here, the property taxes). Given our holding, we conclude that the almond trees also are "designated property" within the context of The "production period" is the period "beginning on the date on which production of the property begins" and "ending on the date on which the property is ready to be placed in service or is ready to be held for sale." WRP I began physical production activities for its almond trees in 2007 when it started the first of its three phases of growing the trees. Specifically, in that phase, WRP I began ripping and deep ripping the soil, trenching, leveling the land, and planting almond trees. Each entity continued using its land to grow almond trees throughout the subject years, and the record contains no evidence from which we find that the production period for any of the entities ended before the close of the subject years. Second, a taxpayer must capitalize and assign to the property the "interest on any other indebtedness * * * to the extent that the taxpayer's interest costs could have been reduced if production expenditures (not attributable to indebtedness described in The land does not have to be the property that is being produced to bring interest on a financing of the land within the reach of The entities' land is not a direct cost of their growing of the almond trees under the general rules for capitalization. Rosedale Ranch grew only almond trees on its land, and K&G grew only almond trees and pistachio trees on its land. All of the interest that they paid as to their financing of that land, therefore, is attributable to their growing of their almond trees and pistachio trees. We sustain respondent's determination that Rosedale Ranch and K&G must capitalize all of the interest that they paid on their financing of the purchases of their land. Each party likewise urges us to take an all-or-nothing approach as to WRP I's payment of interest. Respondent asks us to find that WRP I must capitalize the interest paid on the entire portion of its Wasco property (including the land that was used to grow row crops) because, he states, the entire land is considered part of a unit of property. Petitioners argue that the land cannot be *265 viewed as a single unit because planting one tree should not necessarily require the entire portion of interest on the land to be capitalized. Petitioners conclude that WRP I is not required to capitalize any of the interest*259 that it paid. We conclude that WRP I must capitalize some, but not all, of the interest that it paid. The history of Given that WRP I used a portion of its land for row crops during 2008 and 2009, the cost of the portion of land growing row crops is not a cost of growing almond trees. Accordingly, the interest that WRP I paid as to its part of financing of the purchase of that portion of the Wasco land is not required to be capitalized. The remainder of the interest paid for 2008 and 2009, attributable to the purchase of land on which almond trees were growing, must be capitalized as "interest on any indebtedness directly attributable to production expenditures with respect to such property". WRP I's debt exceeded its production expenditures for 2008 and 2009. The interest capitalization*262 rules contained in Respondent determined that the anti-abuse rule requires that Rosedale Ranch and K&G capitalize the interest they paid to FCW on their borrowings from FCW, which Rosedale Ranch and K&G contemporaneously lent to WRP I to purchase the Wasco property. According to respondent, the anti-abuse rule applies because WRP I avoided capitalizing additional interest costs by borrowing from its related parties who did not require current interest payments. *269 Petitioners argue that Rosedale Ranch and K&G are not required to capitalize additional interest under the anti-abuse rule because they lacked the requisite intent to abuse the interest*263 capitalization rules. As petitioners see it, Petitioners' reliance on But The entities are related parties in that Keith and Jennifer Gardiner own directly or indirectly 50% or more of each entity. The primary distinction between classifying a payment as a deductible expense or as a capital expenditure concerns the timing of the taxpayer's cost *272 recovery. The duty of consistency is well established in the Ninth Circuit, the circuit in which these cases are appealable (absent the parties' stipulation to the contrary). As we understand petitioners' argument, they contend that the duty of consistency trumps the applicability of the statute. They are mistaken. Congress has mandated through its enactment of Respondent's To reflect the foregoing,
1. Cases of the following petitioners are consolidated herewith: Rosedale Ranch, A General Partnership, Rosedale Farming Group, Tax Matters Partner, docket No. 8112-12; and King and Gardiner Farms, LLC, Keith Gardiner, Tax Matters Partner, docket No. 8113-12.↩
2. Unless otherwise indicated, section references are to the Internal Revenue Code (Code) in effect for the subject years. Rule references are to the Tax Court Rules of Practice and Procedure.↩
3. Respondent also made other adjustments, none of which we need or do decide. We do not list these other adjustments.↩
4. WRP II is owned equally by Rosedale Farming Group and the Gardiner Family Trust. WRP II was formed because the Mary D. King Trust did not want to take part in purchasing the commercial buildings.↩
5. As evidence of when the entities planted almond trees on specific tracts of land, petitioners included two exhibits. One is annual maps of the lands with incomplete notations of when almond trees were planted. The other is a table listing when almond trees were planted on specific tracts of land. That table, however, was prepared after the fact and for accounting purposes. We find the maps to be more reliable. Accordingly, we have determined when almond trees were planted on various tracts of land by using information on the maps. Where the information on the maps is incomplete, we have looked to the subsequently prepared table.↩
6. For 2008 K&G mistakenly deducted $129,268 of the principal payments as an interest expense. K&G concedes that this amount is not deductible. Respondent concedes that the interest that K&G paid during 2009 is deductible because any preproductive period would have ended on December 31, 2008. Additionally, for 2009 K&G also deducted an interest expense of $57,877 that was due to an accrual to cash adjustment reversal. K&G concedes that this is not a deductible expense.↩
7. Respondent advances an alternative argument in support of his view that each entity must capitalize the interest that it paid. The alternative argument is that each entity is a producer of real property that failed to perform the avoided cost method calculation that
8. Former
9. Growing crops and plants are real property only if the pre-productive period of the crop or plant exceeds two years.
10. Petitioners also argue that
11. Generally stated, the avoided cost method requires that interest be capitalized to the extent that the interest would theoretically have been avoided if accumulated production expenditures had been used to repay or reduce the taxpayer's outstanding debt.
12. Respondent argues that
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