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Parties Involved:
Dortha S. Ames
Appellant
Henry B. Ames
Appellant
Commissioner of Internal Revenue
Appellee

Document Text:

FILED 

OHITED STATES COURT OF APPEALS 

FOR THE TENTH CIRCUIT 

United Stlrft Court of Appeals 

Tenth Circuit 

JUL - 8 1991 

HENRY B. AMES; DORTHA S. AMES, ) 

) 

Petitioners-Appellants, ) 

) 

v. ) 

) 

COMMISSIONER OF INTERNAL REVENUE, ) 

) 

Respondent-Appellee. ) 

ORDER .AND JUDGMENT* 

.ROBERT L. HOECKER 

Clerk 

No. 91-9000 

(T.C. No. 32613-83) 

Before .ANDERSON, TACHA, and BRORBY, Circuit Judges. 

After examining the briefs and appellate record, this panel 

has determined unanimously that oral argument would not materially 

assist the determination of this appeal. See Fed. R. App. P. 

34(a); 10th Cir. R. 34.1.9. 

submitted without oral argument. 

The cause is therefore ordered 

The tax court denied a claimed interest expense deduction and 

taxpayers appeal. 

* This order and judgment has no precedential value and shall not 

be cited, or used by any court within the Tenth Circuit, except 

for purposes of establishing the doctrines of the law of the case, 

res judicata, or collateral estoppel. 10th Cir. R. 36.3. 

Appellate Case: 91-9000 Document: 010110128848 Date Filed: 07/08/1991 Page: 1 
I 

The facts are fully set forth in the opinion of the tax 

court1 and for that reason will not be repeated. A brief and 

generalized summary of the significant facts reveals taxpayers 

purchased a time share unit in a vacation home located near a Utah 

ski resort, which in this case was the right to occupy the 

2 vacation home for one day each year. The sales transaction was 

reduced to writing. The purchase price was $2,775. Taxpayers 

paid $650 down, which left an unpaid principal balance of $2,125, 

and agreed to pay $465 per year for ten years. These ten annual 

payments were to be applied to interest. No further principal or 

interest payments were required until thirty years from the 

purchase date when taxpayers could either forfeit their interest 

in the time share unit or pay approximately $70,000 and become the 

owners of the time share unit. 3 The sales contract required all 

payments to be first applied to interest, which for the first 

fourteen years was 188 per cent per year and for the remaining 

sixteen years was 47 per cent per year. The debt was nonrecourse. 

1 The tax court first sustained the Commissioner's Motion for 

Partial Summary Judgment by opinion dated August 22, 1985. See 

T.C. Memo 1985-443. Taxpayers' case was then consolidated for 

trial with six similar cases. The tax court decision appealed is 

reported by Ames v. Commissioner, T.C. Memo 1990-87 (February 26, 

1990). 

2 In order to avoid Utah usury law, sellers required taxpayers to 

form a partnership, which they did. The partnership then elected 

to utilize the accrual method of accounting. The partnership then 

claimed the interest accrued as its interest expense deduction. 

3 The unit purchased was originally a tenancy in common but 

subsequently converted to a mere license to occupy the home. 

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was 

Appellate Case: 91-9000 Document: 010110128848 Date Filed: 07/08/1991 Page: 2 
Taxpayers deducted $3,995 for each of the tax years 1980 and 

1981. Ames v. Commissioner, No. 1990-87, at 2. This deduction 

was derived by multiplying $2,125 (the unpaid principal) times 188 

per cent (the annual interest rate). The Commissioner determined 

that taxpayers' method of accounting (the accrual method) did not 

properly and correctly reflect income and disallowed the 

deduction. Id. Taxpayers filed suit in tax court. Id. 

Taxpayers' theory before the tax court was the time share 

unit was worth the purchase price and it would appreciate, due to 

predicted inflation, from 12.7 per cent to 23 per cent per year 

during the life of the contract, thereby making the purchase a 

sound business investment by rendering the property as valuable as 

the payoff. Id. at 36. The tax court was not impressed with the 

testimony of taxpayers' expert witnesses in this regard and 

rejected their opinions. Id. at 43, 51. The expert witness for 

the IRS also failed to impress the tax court. Id. at 55. The tax 

court, using the methodology advocated by one of taxpayers' 

experts, determined the fair market value of the time share unit 

at the time of purchase was $791.80 and then decided, given the 

contract interest rate, the time share unit would never be worth 

the payoff. Id. at 56-60, 62-64. 

On appeal, taxpayers argue the tax court committed reversible 

error by: (1) valuing the time share unit lower than any of the 

three expert witnesses; (2) wrongfully refusing to allow its 

expert witness to testify on likely appreciation rates; and (3) 

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7 

• finding the nonrecourse debt secured by the time share unit was 

without economic substance. Taxpayers argue alternatively that 

the interest deduction was allowable under the rationale of 

Pleasant Summit Land Corp. v. Commissioner, 863 F.2d 263 (3d Cir. 

1988), cert. denied, 110 S. Ct. 260 (1989), to the extent that the 

property could be expected to have value when the nonrecourse debt 

was due_ to be paid. 

I 

The Internal Revenue Code provides for the deduction of "all 

interest paid or accrued within the taxable year on indebtedness." 

26 u.s.c. § 163(a). The application of this statutory provision 

is simple when the underlying debt in fact exists. A somewhat 

different situation exists when the debt is nonrecourse. When the 

debtor has the choice of abandoning the property that secures the 

debt rather than make payment, courts have allowed an interest 

deduction only in those situations where the debtor has an 

economic incentive to satisfy the obligation. Odend'hal v. 

Commissioner, 748 F.2d 908, 913 (4th Cir. 1984), cert. denied, 471 

U.S. 1143 (1985); Estate of Franklin v. Commissioner, 544 F.2d 

1045, 1047 (9th Cir. 1976). It therefore follows where the amount 

of a nonrecourse obligation bears no reasonable relationship to 

the value of the property securing payment of the debt, the debt 

will not ordinarily be recognized for tax purposes as in such 

circumstances it is unlikely the obligation will be paid. See, 

~, Odend'hal, 748 F.2d at 912 ("If, as a matter of fact, the 

fair market value of the property is less than that financed by a 

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nonrecourse loan, the authorities hold that the principal of the 

nonrecourse loan which exceeds fair market value does not 

represent a real investment in the property by a taxpayer and he 

may not include the nonrecourse amount in his basis for 

depreciation.") 

In the case before us, the tax court found the time share 

unit had a fair market value of $791.80 on the date it was 

purchased, which was far less than the purchase price of $2,775. 

Ames v. Commissioner, No. 1990-87, at 60. The tax court was not 

impressed with any of the expert opinions as to this value and 

consequently accepted one of taxpayers' expert's opinion 

concerning rental value of the unit and utilized this same 

expert's methodology to arrive at the valuation. Id. Concerning 

the time share unit's future value, the tax court reasoned that as 

the debt is increased yearly by the interest rate (188 per cent 

per year for the first fourteen years and 47 per cent per year for 

the final sixteen years), and as taxpayers' experts opined the 

property would appreciate in value only up to 23 per cent per 

year, the payoff would always be much larger than the fair market 

value. Id. at 63-64. The record well supports this conclusion. 

In short, the tax court concluded it would be highly unlikely that 

the obligation would ever be paid. The only economic incentive to 

retain this time share unit was the hoped-for ability to deduct 

from federal taxes far more interest than would ever be paid. 

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~ 

I 

Taxpayers first contend the tax court erred in excluding the 

conclusion of its expert, Mr. Longstaff, as to the expected 

appreciation in value of the time share unit. We need not address 

this contention as Mr. Longstaff's most optimistic scenario was an 

increase in value due to appreciation of 17.38 per cent per year. 

Id. at 37. As the interest would increase in multiples of Mr. 

Longstaff's prediction, it would make no difference had the tax 

court accepted Mr. Longstaff's conclusions. The result would 

still be the same -- it would cost far more to pay the debt than 

the property would be worth. We also note the tax court rejected 

the conclusions after finding Mr. Longstaff was no expert at the 

time his report was prepared, a fact that finds support in the 

record. Id. at 34-35. 

Taxpayers next contend the tax court disregarded the 

admission of the Commissioner's expert, who testified the 

inflation rate (and therefore, presumably, the time share's value) 

would increase 12 per cent per year. Taxpayers' contention in 

this regard is not persuasive. The trier of fact is not bound to 

accept an expert opinion as to future value. Here, the tax court 

utilized the methodology advocated by taxpayers' own expert and 

commenced the calculation using this same expert's opinion as to 

the rental value of the time share unit. Again, had the tax court 

accepted this growth rate, the appreciation would still never 

approach the increase in debt. The tax court carefully considered 

the testimony of all the expert witnesses and set forth in detail 

its reasoning. It was the responsibility of the tax court to 

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• determine value from all evidence, and this it did in an 

objectively reasonable manner. 

II 

Taxpayers argue they had the right to use the accrual method 

of accounting. This contention is not correct. The Commissioner 

determined taxpayers' method of accounting did not properly and 

accurately reflect income. As the Commissioner has broad 

discretion in determining whether the accounting method used by a 

taxpayer clearly reflects income, the tax court committed no error 

when it determined the Commissioner's decision in this regard was 

neither unlawful or arbitrary. In the case before us, the cash 

and accrual methods of accounting do not achieve a substantial 

identity of results. As the time share unit was never rented, it 

produced no income. The relevant inquiry is whether the 

Commissioner abused his discretion. Taxpayers have failed in 

their burden of persuasion. Taxpayers argue the Commissioner has 

ignored his own published position set forth in Revenue Ruling 68-

643, 1968-2 C.B. 76, which is inapposite. This ruling states, in 

essence, that taxpayers employing the accrual method of accounting 

must deduct interest ratably over the period of the loan, 

irrespective of when paid. In the case before us, it is clear 

that taxpayers' method of accounting materially distorts income. 

Taxpayers have not been allowed to utilize the accrual method of 

accounting for this reason. Under 26 u.s.c. S 446, the 

Commissioner has exercised his discretion. Given the facts of 

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' 

this case, Commissioner's determination cannot be said to be 

arbitrary. See,~, Ames v. Commissioner, No. 1985-443, 8-10. 

In Pleasant Summit the Third Circuit held a taxpayer, who has 

acquired property subject to nonrecourse indebtedness far larger 

than property's fair market value at the time of acquisition, was 

entitled to deduction for interest and depreciation attributable 

to nonrecourse indebtedness to the extent of the collateral's fair 

market value. 863 F.2d at 276-77. Taxpayers have failed to state 

in their brief where this contention was raised before the tax 

court. We are not obligated to search the record. Consistent 

with our rule that we will not consider an issue for the first 

time on appeal, we decline to address this contention. 10th Cir. 

R. 28.2(d). 

In an appendix to their brief, taxpayers contend the 

applicability of various Revenue Procedures. Again, taxpayers 

have failed to cite in their brief where these issues were raised 

before the tax court and where in the record the tax court decided 

such issues. Due to this failure, we do not address these issues. 

Id. 

Alternatively, we agree with the Commissioner that it is not 

necessary to reach these issues because of our holding that the 

indebtedness in this case is not genuine. 

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The judgment of the tax court is AFFIRMED. This case is 

REMAHDED to the tax court for such other and further proceedings 

as may be necessary. The mandate shall issue forthwith. 

Entered for the Court: 

WADE BRORBY 

Circuit Judge 

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