t c no united_states tax_court norwest corporation and subsidiaries petitioner v commissioner of internal revenue respondent docket nos filed date i norwest bank nebraska n a a subsidiary of petitioner removed asbestos-containing materials from its douglas street building in connection with the building's renovation and remodeling on its return petitioner claimed a dollar_figure ordinary and necessary business deduction with respect to the asbestos-removal expenditures in the notice_of_deficiency respondent disallowed the deduction held the costs of removing the asbestos-containing materials must be capitalized because they were part of a general plan of rehabilitation and renovation that improved the douglas street building ii petitioner's subsidiary norwest bank minneapolis nbm owned blocked deposits at the central bank of brazil central bank consisting of principal repayments of dollar-denominated loans previously made to brazil in the ordinary course of nbm's banking business the central bank prevented petitioner from repatriating these deposits because brazil had insufficient hard currency u s dollars to make payments on the loans in order to reduce petitioner's blocked deposit holdings and decrease its foreign debt exposure petitioner entered into a debt-equity conversion_transaction in as follows dollar_figure of petitioner's blocked deposits was exchanged for a 361-percent interest in a brazilian company petitioner agreed to maintain the invested funds in brazil for years on its consolidated return p claimed a dollar_figure loss with regard to the debt-equity conversion_transaction in the notice_of_deficiency respondent disallowed petitioner's claimed loss on the grounds that petitioner did not establish that any deductible loss was sustained in held the step_transaction_doctrine is not applicable the central bank converted the full face value of petitioner's blocked deposits plus accrued interest at the official exchange rate without diminution or discount into cruzados which were used to pay a third party in exchange for its 361-percent interest in the brazilian company the exchange of the blocked deposits for the cruzados and the conversion of the cruzados into stock was not a transitory step but rather a substantive and significant element of the conversion petitioner's loss if any is measured by the difference between its basis in the blocked deposits and the fair_market_value of the cruzados it received 103_tc_59 supplemented by 106_tc_257 on appeal 5th cir date followed petitioner did not realize a loss because the basis of the blocked deposits and the fair_market_value of the cruzados were identical on the date of the transaction held further the 12-year repatriation restriction imposed on petitioner's invested funds warrants a 15-percent discount on the fair_market_value of the cruzados p received rendering a dollar_figure loss for petitioner's tax_year iii in norwest financial resources one of petitioner's affiliates acquired the lease portfolio and other assets of financial investment associates inc for dollar_figure on its return petitioner allocated dollar_figure of the dollar_figure purchase_price to the lease portfolio the purchase agreement provided that no part of the purchase_price is attributable to goodwill in the notice_of_deficiency respondent determined that petitioner overstated the fair_market_value of the lease portfolio by dollar_figure which amount should be allocated to goodwill going-concern value or other nonamortizable intangible assets the parties presented valued petitioner's lease portfolio the difference between the experts' valuations centers around the different discount rates they used respondent's expert used a 6-percent discount rate while petitioner's expert used an percent discount rate experts who held giving consideration to all the evidence presented percent is determined to be the appropriate discount rate mark alan hager joseph robert goeke thomas c durham david farrington abbott william albert schmalzl glenn a graff daniel a dumezich and scott gerald husaby for petitioner lawrence c letkewicz dana hundrieser and gary j merken for respondent contents page general findings issue i removal of asbestos-containing materials a the douglas street building b remodeling plans c use of asbestos-containing materials in the douglas street building d federal asbestos guidelines e testing at the douglas street building and decision to remove asbestos-containing materials f contractors and work performed g health concerns h liability issues i tax and accounting matters j petitioner's returns and petitions k notice_of_deficiency discussion l capital expenditures vs current deductions m general plan_of_rehabilitation_doctrine n the parties' arguments o analysis issue ii brazilian debt-equity conversion a the brazilian debt crisis deposit facility agreements and blocked deposits the cruzado plan moratorium on interest b petitioner's blocked deposits c papel e celulose catarinense s a pcc's expansion plans petitioner's internal analysis of a pcc investment petitioner's conclusions about the pcc investment d steps leading up to the conversion e the conversion_transaction f petitioner's tax and accounting treatment of the conversion g petitioner's return and petition h notice_of_deficiency i subsequent events discussion j respondent's arguments k petitioner's arguments l law and analysis issue iii allocation of purchase_price a fia b federal's acquisition of fia c petitioner's acquisition of fia d petitioner's return e notice_of_deficiency discussion f residual_value g expert witnesses petitioner's expert respondent's expert critique of experts h conclusion opinion jacobs judge in docket no respondent determined deficiencies in petitioner's and federal income taxes in the respective amounts of dollar_figure and dollar_figure as well as additional interest under sec_6621 for pursuant to an amended answer filed on date respondent increased the amount of the deficiency to dollar_figure in docket no respondent determined a deficiency in petitioner's federal_income_tax in the amount of dollar_figure respondent increased the amount of the deficiency to dollar_figure pursuant to an answer filed on date and further increased the deficiency amount to dollar_figure pursuant to a date amendment to answer these cases were consolidated for trial briefing and opinion the issues for decisions are whether petitioner is entitled to deduct the costs of removing asbestos-containing materials from its douglas street bank building whether petitioner realized a loss on a brazilian debt-equity conversion and whether any portion of the dollar_figure petitioner paid to acquire the assets of financial investment associates inc should be allocated to goodwill going-concern value or other nonamortizable intangible assets all section references are to the internal_revenue_code in effect for the years under consideration all rule references are to the tax_court rules_of_practice and procedure for convenience and clarity we have combined our findings_of_fact and opinion with respect to each issue some of the facts have been stipulated and are found accordingly the stipulations of facts and the attached exhibits are incorporated herein by this reference general findings norwest corporation hereinafter petitioner or norwest a delaware corporation had its principal_place_of_business in minneapolis minnesota at the time the petitions were filed norwest is the parent company of a group of corporations that filed with the exception of certain issues relating to foreign tax_credits and petitioner's claim for additional research credits all other issues have been resolved the increased deficiencies asserted in the answers and amended answers are not attributable to any issues before this court consolidated corporate_income_tax returns for the years under consideration through petitioner reports its income on a calendar-year basis employing the accrual_method of accounting petitioner timely filed its u s_corporation income_tax returns for and issue i removal of asbestos-containing materials the first issue is whether petitioner is entitled to deduct the costs of removing asbestos-containing materials from its douglas street bank building petitioner argues that the expenditures constitute sec_162 ordinary and necessary expenses respondent on the other hand contends that the expenditures must be capitalized pursuant to sec_263 alternatively respondent contends that the expenditures must be capitalized pursuant to the general plan_of_rehabilitation_doctrine a the douglas street building one of petitioner's subsidiaries norwest bank nebraska n a norwest nebraska owns a building pincite douglas street in omaha nebraska the douglas street building or building the douglas street building is a three-story commercial office building that occupies half a square block and has a lower level parking garage norwest nebraska constructed the building in at a dollar_figure cost during all relevant periods norwest nebraska used the douglas street building as an operations center as well as a branch for serving customers b remodeling plans in and norwest nebraska consolidated its back room operations at the douglas street building pursuant to that process norwest nebraska undertook to determine the most efficient means for providing more space to accommodate the additional operations personnel within the building the planning process indicated that the building needed a major remodeling the building had not been remodeled since its construction norwest nebraska usually remodels its banks every to years thus by the end of petitioner and norwest nebraska had decided to completely remodel the douglas street building in date both petitioner and norwest nebraska approved a preliminary budget of dollar_figure for carpet furniture and improvements c use of asbestos-containing materials in the douglas street building the douglas street building was constructed with asbestos- containing materials as its main fire-retardant material the local fire code required that buildings contain fireproofing material asbestos-containing materials were sprayed on all columns steel i-beams and decking between floors the health dangers of asbestos were not widely known when the douglas street building was constructed in and asbestos-containing materials were generally used in building construction in omaha nebraska a commercial office building's ventilation system removes existing air from a room through a return air plenum as new air is introduced the returned air is subsequently recycled through the building the area between the decking and the suspended ceiling in the douglas street building functioned as the return air plenum the top part of the return air plenum the decking was one of the components of the building where asbestos-containing materials had been sprayed during construction over time the decking suspended ceiling tiles and light fixtures throughout the building became contaminated this contamination occurred because the asbestos-containing fireproofing had begun to delaminate and pieces of this material reached the top of the suspended ceiling d federal asbestos guidelines in the 1970's and 1980's research confirmed that asbestos- containing materials can release fibers that cause serious diseases when inhaled or swallowed diseases resulting from exposure to asbestos can reach the incurable stage before detection and can cause severe disability or death asbestosis is a progressive and disabling lung disease caused by inhaling asbestos fibers that become lodged in the lungs persons exposed to asbestos may develop lung cancer or mesothelioma an extremely rare form of cancer on date the environmental protection agency epa designated asbestos a hazardous_substance the parties have stipulated that federal state and local laws and regulations at all relevant times did not require asbestos-containing materials to be removed from commercial office buildings if they could be controlled in place nevertheless building owners had to take precautions against the release of asbestos fibers the presence of asbestos in a building does not necessarily endanger the health of building occupants the danger arises when asbestos-containing materials are damaged or disturbed thereby releasing asbestos fibers into the air when they can be inhaled the department of labor occupational safety and health administration osha has established standards and guidelines for permissible levels of employee exposure to asbestos effective date the permissible exposure limit for employees was fiber longer than micrometers per cubic centimeter of air determined on the basis of an 8-hour time-weighted average at half of the permissible exposure limit fiber per cubic centimeter of air employers are required to begin compliance activities such as air monitoring employee training and medical surveillance moreover the epa has established standards and guidelines for the general public's exposure to asbestos the epa-recommended guideline for general occupancy and clearance of a building after in assessing the potential for fiber release the epa in recommended evaluating the current condition of asbestos- containing materials based on evidence of deterioration or delamination physical damage eg the presence of debris and water damage as well as the potential for future disturbance based on proximity to air plenum or direct air stream visibility accessibility and degree of activity as well as change in building use construction activities involving asbestos-containing materials is dollar_figure fiber per cubic centimeter of air asbestos removal must be performed by specially trained professionals wearing protective clothing and respirators the work area must be properly contained to prevent release of fibers into other areas containment typically requires barriers of polyethylene plastic sheets with folded seams complete with air locks and negative air pressure systems asbestos-containing materials that are removed must be wetted to reduce fiber release once removed the materials must be disposed of in leak-tight containers in special landfills e testing at the douglas street building and decision to remove asbestos-containing materials in date petitioner's general liability and property damage insurer the st paul property and liability insurance co st paul tested a bulk sample of fire-retardant material from the douglas street building's steel i-beams to determine whether the building contained asbestos the results indicated that the material contained to percent chrysotile asbestos the most common type of asbestos petitioner obtained its umbrella insurance policies through marsh mclennan which provided coverage over and above the st paul policies in date at marsh mclennan's request clayton environmental consultants inc clayton conducted more extensive testing for the presence of asbestos at norwest facilities in south dakota and nebraska including the douglas street building on date petitioner received notification that the january testing indicated that the sprayed-on fireproofing contained to percent chrysotile asbestos and the ceiling tiles on the parking level contained 26-percent chrysotile asbestos this confirmed the st paul results at the request of marsh mclennan clayton conducted extensive additional testing for airborne asbestos-fiber concentrations in the douglas street building on date clayton collected air samples from the building on date it issued the results of its survey which indicated that the airborne asbestos fiber concentrations present during normal occupancy of the douglas street building ranged from to fiber per cubic centimeter of air the highest level of airborne fiber concentration at the douglas street building fiber per cubic centimeter of air did not exceed either the epa or osha guidelines there was however the expectation that the airborne asbestos-fiber concentrations would continue to increase moreover the asbestos-containing fireproofing at the douglas street building had characteristics that the epa had identified as warranting removal of the material such as evidence of delamination presence of debris proximity to an air plenum and necessity of access for maintenance after considering the circumstances petitioner decided to remove the asbestos-containing materials from the douglas street building other than the parking garage in coordination with the overall remodeling project indeed the remodeling could not have been undertaken without disturbing the asbestos-containing fireproofing thus because petitioner and norwest nebraska chose to remodel it became a matter of necessity to remove the asbestos- containing materials petitioner essentially decided that managing the asbestos in place was not a viable option given the extent of remodeling that would disturb the asbestos removing the asbestos-containing materials from the douglas street building at the same time as and in connection with the remodeling was more cost efficient than conducting the removal and renovations as two separate projects at different times it also minimized the amount of inconvenience to building employees and customers as late as date approximately months after asbestos removal began petitioner and norwest nebraska did not intend to remove the parking garage asbestos-containing materials no remodeling was planned for the garage and the materials were in sound condition however petitioner and norwest nebraska subsequently decided to remove the garage asbestos-containing materials as well on the basis of their expectation that the garage tiles would eventually deteriorate as well as the fact that it was financially advantageous to conduct this removal in connection with the ongoing abatement activity f contractors and work performed on date norwest nebraska hired hawkins construction co hawkins as general contractor to perform the remodeling work at the douglas street building on date norwest nebraska hired waste environmental technology wet to remove the asbestos-containing materials from the building norwest nebraska also hired atc environmental inc to perform on-site air monitoring during all asbestos-abatement activities at the building wet declared bankruptcy in and could not complete the project on date norwest nebraska hired michael t robinson associates inc robinson to replace wet and complete removal of the asbestos-containing materials from the douglas street building at that time norwest nebraska also replaced atc environmental inc with chart services ltd the asbestos removal and remodeling were basically performed in phases each phase involved a defined area of the douglas street building for each phase the asbestos-removal contractor removed the asbestos-containing materials before the general contractor began remodeling after setting up a containment area the asbestos removal contractor physically removed the walls floors ceilings and light fixtures where necessary to reach and remove the asbestos-containing materials once all the asbestos- containing materials had been removed from an area the air was tested for airborne-fiber concentration before the containment could be taken down and the general contractor could begin remodeling removing all the asbestos-containing materials from the douglas street building was a large project entailing an enormous amount of work nearly every suspended ceiling and light fixture on all four levels of the building had to be taken down asbestos- containing materials were removed from the entire building the asbestos fireproofing in the douglas street building was replaced with cafco a mineral wool material the ceiling tiles on the farnam4 parking level as well as the floor tiles in the customer lobbies were replaced with new asbestos-free materials hawkins' subcontractors installed the replacement fireproofing and tiling norwest nebraska representatives the asbestos-removal contractor hawkins and hawkins' subcontractors held meetings on a regular basis to coordinate the schedule for the remodeling work with the asbestos removal work petitioner had a financial interest in ensuring that the asbestos removal work was performed in a timely fashion and was properly coordinated with the remodeling work delays caused by the asbestos-removal contractor resulted at all relevant times cafco was not known to present any health hazards farnam is one of the streets adjacent to the douglas street building in additional costs to hawkins which passed those costs on to petitioner the removal of the asbestos-containing materials from the douglas street building was substantially completed by the end of date following completion norwest nebraska learned that the two elevator lobbies in the parking garage contained vinyl asbestos floor tile petitioner hired technical asbestos control to remove and replace these tiles the removal of the asbestos-containing materials from the douglas street building did not extend the building's useful_life g health concerns in addition to removing the asbestos-containing materials on account of the remodeling petitioner also considered the health and welfare of its employees and customers even though the level of airborne asbestos fiber concentrations in the douglas street building did not exceed osha or epa standards for exposure the presence of asbestos-containing materials in the return air plenum nonetheless increased the possibility for release of asbestos fibers into the air the flow of air through the return air plenum made surface erosion of the asbestos-containing materials more likely the asbestos-containing materials had already started to delaminate or flake off which was almost certain to become progressively worse and the necessity for working above the suspended ceiling in the return air plenum to replace light fixtures or computer cables created greater chances for disturbance of the asbestos-containing materials and made routine maintenance more expensive petitioner intended to create a safer and healthier environment for the building employees by removing the asbestos- containing materials the building indeed became safer after the asbestos-containing materials were removed h liability issues by removing the asbestos-containing materials from the douglas street building petitioner also intended to avoid or minimize its potential liability for damages from injuries to employees customers and workers resulting from asbestos exposure petitioner's general liability insurance policies in effect at all relevant times contained an exclusion for damages attributable to the discharge of pollutants such exclusion would include the circulation of asbestos fibers through the douglas street building's ventilation system some of petitioner's umbrella insurance policies contained an additional endorsement specifically excluding liability for damages caused by asbestos exposure injuries to douglas street building employees arising out of and in the course of their employment are not covered under petitioner's general liability or umbrella insurance policies before the asbestos removal and remodeling work began john cochran president of norwest nebraska wrote a memorandum dated date to the douglas street building employees assuring them that norwest nebraska wanted their work environment to be safe workmen's_compensation insurance is the only coverage available for such injuries it is unclear whether damages for injuries to the employees resulting from exposure to asbestos would be covered by workmen's_compensation insurance nevertheless petitioner was and continues to be at risk with respect to asbestos damage claims brought by douglas street building employees furthermore by removing the asbestos-containing materials from the building petitioner intended to avoid or minimize a potential increase in its premiums for workmen's_compensation insurance if asbestos damage claims filed by douglas street building employees were in fact covered by workmen's_compensation insurance the increase in petitioner's premiums could be sizable depending on the volume and magnitude of such claims i tax and accounting matters the total cost of renovating the douglas street building was close to dollar_figure million comprising nearly dollar_figure in remodeling costs and approximately dollar_figure million6 in asbestos removal costs according to a schedule petitioner prepared entitled norwest bank nebraska n a --payments related to the asbestos abatement petitioner's costs of removing the asbestos- containing materials from the douglas street building were as follows year amount dollar_figure dollar_figure dollar_figure total dollar_figure continued petitioner considered the cost of all demolition done by the asbestos removal contractors including the cost of removing the asbestos tiles as a removal cost for both book and tax purposes petitioner considered the cost of any demolition done by the general contractor or one of the subcontractors a remodeling cost for both book and tax purposes all construction-related remodeling costs were added to the basis of the building and depreciated on a straight-line basis over years the portion of the remodeling costs for furniture and fixtures was written off over years j petitioner's returns and petitions on its and returns petitioner claimed neither depreciation nor ordinary deductions with respect to the costs of removing the asbestos-containing materials from the douglas street building on its return however petitioner claimed a dollar_figure depreciation deduction and a dollar_figure ordinary and necessary business deduction with respect to such expenditures petitioner asserts in its petitions that it properly deducted the dollar_figure on its return in addition petitioner claims continued respondent agrees that these amounts properly represent the asbestos removal costs except for dollar_figure paid on date in settlement of a lien filed by a materialman we note however that petitioner's general ledger reflects a dollar_figure total incurred for the asbestos removal between and this amount does not include the cost of replacing the asbestos-containing materials with asbestos-free materials there is no explanation in the record for the discrepancy between the dollar_figure and the dollar_figure that it is also entitled to ordinary and necessary business deductions for the costs of removing the asbestos-containing materials from the douglas street building for tax years and in the respective amounts of dollar_figure and dollar_figure which amounts petitioner claims were inadvertently omitted from its and returns k notice_of_deficiency in the notice_of_deficiency respondent disallowed petitioner's dollar_figure ordinary and necessary deduction for asbestos-removal expenditures discussion at issue is whether petitioner's costs of removing the asbestos-containing materials are currently deductible pursuant to sec_162 or must be capitalized pursuant to sec_263 or as part of a general plan of rehabilitation l capital expenditures vs current deductions sec_263 requires taxpayers to capitalize costs incurred for permanent improvements betterments or restorations to property in general these costs include expenditures that add to the value or substantially prolong the life of the property or adapt such property to a new or different use sec_1_263_a_-1 income_tax regs in contrast sec_162 permits taxpayers to currently deduct the costs of ordinary and necessary expenses including incidental repairs that neither materially add to the value of property nor appreciably prolong its life but keep the property in an ordinarily efficient operating condition see sec_1_162-4 income_tax regs deductions are exceptions to the norm of capitalization 503_us_79 an income_tax deduction is a matter of legislative grace the taxpayer bears the burden of proving its right to a claimed deduction rule a 290_us_111 in illinois merchants trust co v commissioner 4_bta_103 which involved the cost of shoring up a wall and repairing a foundation needed to prevent a building from collapsing the board_of_tax_appeals drew the following distinctions for expenditures to repair is to restore to a sound state or to mend while a replacement connotes a substitution a repair is an expenditure for the purpose of keeping the property in an ordinarily efficient operating condition are distinguishable from those for replacements alterations improvements or additions which prolong the life of the property increase its value or make it adaptable to a different use the one is a maintenance charge while the others are additions to capital_investment which should not be applied against current earnings purpose that the distinction between repairs and capital improvements has also been characterized as follows the test which normally is to be applied is that if the improvements were made to 'put' the particular capital_asset in efficient operating condition then they are capital in nature if however they were made merely to 'keep' the asset in efficient operating condition then they are repairs and are deductible 831_f2d_833 9th cir revg tcmemo_1986_128 quoting 373_f2d_190 3d cir revg and remanding 45_tc_111 the court in 39_tc_333 articulated a test for determining whether an expenditure is capital by comparing the value use life expectancy strength or capacity of the property after the expenditure with the status of the property before the condition necessitating the expenditure arose the plainfield-union test moreover the internal revenue code's capitalization provision envisions an inquiry into the duration and extent of the benefits realized by the taxpayer see indopco inc v commissioner supra pincite whether an expense is deductible or must be capitalized is a factual determination plainfield-union water co v commissioner supra pincite courts have adopted a practical case-by-case approach in applying the principles of capitalization and deductibility 72_tc_1 the decisive distinctions between current expenses and capital expenditures are those of degree and not of kind welch v helvering supra pincite m general plan_of_rehabilitation_doctrine expenses_incurred as part of a plan of rehabilitation or improvement must be capitalized even though the same expenses if incurred separately would be deductible as ordinary and necessary 400_f2d_686 10th cir 266_f2d_374 3d cir affg tcmemo_1958_111 242_f2d_616 5th cir affg 24_tc_563 18_bta_997 unanticipated expenses that would be deductible as business_expenses if incurred in isolation must be capitalized when incurred pursuant to a plan of rehabilitation 19_tc_32 whether a plan of capital improvement exists is a factual question based upon a realistic appraisal of all the surrounding facts and circumstances including but not limited to the purpose nature extent and value of the work done united_states v wehrli supra pincite an asset need not be completely out of service or in total disrepair for the general plan_of_rehabilitation_doctrine to apply for example in bank of houston v commissioner tcmemo_1960_ the taxpayer's 50-year-old building was in a general state of disrepair but still serviceable for the purposes used before during and after the work and was in good structural condition the taxpayer hired a contractor to perform the renovation which included nonstructural repairs to flooring electrical wiring plaster window frames patched brick and paint as well as plumbing repairs demolition and cleanup temporary barriers and closures were erected during work in progress the court recognized that each phase of the remodeling project removed in time and context might be considered a repair item but stated that the code however does not envision the fragmentation of an over-all project for deduction or capitalization purposes the court held that the expenditures were not made for incidental repairs but were part of an overall plan of rehabilitation restoration and improvement of the building n the parties' arguments petitioner contends that the costs of removing the asbestos- containing materials are deductible as ordinary and necessary business_expenses because the asbestos removal constitutes repairs within the meaning of sec_1_162-4 income_tax regs the asbestos removal did not increase the value of the douglas street building when compared to its value before it was known to contain a hazardous substance--a hazard was essentially removed and the building's value was restored to the value existing prior to the discovery of the concealed hazard although performed petitioner states in its opening brief that the law recognizes that removing an unsafe condition is a repair rather than an improvement citing 10_bta_1152 petitioner introduced the reports and testimony of two expert witnesses concerning the impact of the asbestos removal continued concurrently the asbestos removal and remodeling were not part of a general plan of rehabilitation because they were separate and distinct projects conceived of independently undertaken for different purposes and performed by separate contractors and using the principles of sec_213 which allows individuals to deduct certain personal medical_expenses that are capital in nature and sec_1_162-10 income_tax regs which allows a trade_or_business to deduct medical_expenses paid to employees on account of sickness the cost of removing a health hazard is deductible under sec_162 respondent on the other hand contends that the costs of removing the asbestos-containing materials must be capitalized because the removal was neither incidental nor a repair continued costs on the value of the douglas street building these experts opined that the discovery of asbestos as a health hazard in combination with the extent of asbestos present in the building resulted in an immediate diminution in the value of the building one of the experts testified that the building would be appraised as if it did not contain asbestos and then the amount it would cost to repair the condition would be deducted from the appraisal the expert testimony supports petitioner's argument that the asbestos removal merely restored the original value of the building ie without hazardous fireproofing but did not enhance its value petitioner also relies on revrul_79_66 1979_1_cb_114 which allows under limited circumstances a sec_213 deduction for an individual taxpayer's costs of removing and covering lead-based paint in a personal_residence to the extent the costs exceed the increase in the residence's value respondent contends that petitioner's reliance on schmid v commissioner supra is misplaced the board_of tax continued petitioner made permanent improvements that increased the value of the property11 by removing a major building component and replacing it with a new and safer component thereby improving the original condition of the building petitioner permanently eliminated the asbestos hazard that was present when it built the building creating safer and more efficient operating conditions and reducing the risk of future asbestos-related damage claims and potentially higher insurance premiums the asbestos removal and the remodeling were part of a single project to rehabilitate and improve the building the purpose of the expenditure was not to keep the property in ordinarily efficient operating condition but to effect a general restoration of the property as part of the remodeling and sec_213 and sec_1_162-10 income_tax regs are not analogous to the present case the parties also disagree as to whether the plainfield-union test is appropriate for determining whether petitioner's asbestos removal expenditures are capital petitioner contends that it is the appropriate test because the condition necessitating the continued appeals held that the funds expended by the taxpayer in that case were to maintain a store in a safe condition and may be properly classified as repairs and deductible as an expense b t a pincite respondent posits that the operative word leading to the board_of tax appeals' classification of the taxpayer's expenditures as deductible_repair expenses was maintain and not the words safe condition as petitioner suggests respondent did not introduce any expert testimony concerning the value of the douglas street building asbestos removal was the discovery that asbestos is hazardous to human health accordingly until the danger was discovered petitioner argues that the physical presence of the asbestos had no effect on the building's value only after the danger was perceived could the contamination affect the building's operations and reduce its valuedollar_figure petitioner points to revrul_94_38 1994_1_cb_35 which cites plainfield-union in addressing the proper treatment of costs to remediate soil and treat groundwater that a taxpayer had contaminated with hazardous waste from its business the ruling treats such costs other than those attributable to the construction of groundwater treatment facilities as currently deductible respondent on the other hand argues that the discovery that asbestos is hazardous and that the douglas street building contained that substance is not a relevant or satisfactory reference point respondent contends that the plainfield-union test does not apply herein because a comparison cannot be made between the status of the building before it contained asbestos and after the asbestos was removed since construction the building has always contained asbestos in cases where the plainfield-union test has been applied such as 47_tc_471 10_tc_361 in its reply brief petitioner states while in a metaphysical sense the douglas street building may have been contaminated in such contamination had no discernable impact until the hazard became known aff177_f2d_200 6th cir and illinois merchants trust co v commissioner 4_bta_103 respondent continues the condition necessitating the repair resulted from a physical change in the property's condition in this case no change occurred to the building's physical condition that necessitated the removal expenditures the only change was in petitioner's awareness of the dangers of asbestos accordingly respondent argues that the plainfield-union test is inapplicable and the court must examine other factors to determine whether an increase in the building's value occurred respondent also disagrees with petitioner's reliance on revrul_94_38 supra arguing that the present facts are distinguishable the remediated property addressed in the ruling was not contaminated by hazardous waste when the taxpayer acquired it the ruling permits a deduction only for the costs of remediating soil and water whose physical condition has changed during the taxpayer's ownership of the property under this analysis the taxpayer is viewed as restoring the property to the condition existing before its contamination thus respondent contends unlike revrul_94_38 petitioner's expenditures did not return the property to the same state that existed when the property was constructed because there was never a time when the building was asbestos free rather the asbestos-abatement costs improved the property beyond its original unsafe condition o analysis we believe that petitioner decided to remove the asbestos- containing materials from the douglas street building beginning in primarily because their removal was essential before the remodeling work could begin the extent of the asbestos-containing materials in the building or the concentration of airborne asbestos fibers was not discovered until after petitioner decided to remodel the building and a budget for the remodeling had been approved because petitioner's extensive remodeling work would of necessity disturb the asbestos fireproofing petitioner had no practical alternative but to remove the fireproofing performing the asbestos removal in connection with the remodeling was more cost effective than performing the same work as two separate projects at different times had petitioner remodeled without removing the asbestos first the remodeling would have been damaged by subsequent asbestos removal thereby creating additional costs to petitioner we believe that petitioner's separation of the removal and remodeling work is artificial and does not properly reflect the record before us the parties have stipulated that the asbestos removal did not increase the useful_life of the douglas street building we recognize as did petitioner that removal of the asbestos did increase the value of the building compared to its value when it was known to contain a hazard however we do not find as respondent advocates that the expenditures_for asbestos removal materially increased the value of the building so as to require them to be capitalized we find however that had there been no remodeling the asbestos would have remained in place and would not have been removed until a later date in other words but for the remodeling the asbestos removal would not have occurreddollar_figure the asbestos removal and remodeling were part of one intertwined project entailing a full-blown general plan of rehabilitation linked by logistical and economic concerns a remodeling project taken as a whole is but the result of various steps and stages bank of houston v commissioner t c memo 1960-dollar_figure in fact removal of the asbestos fireproofing in the douglas street building was part of the preparations for the remodeling project see id before remodeling could begin nearly every ceiling light fixture in the building was ripped down and crews removed all the asbestos-containing materials that had been sprayed on the columns i-beams and decking between floors as well as the floor tiles in the customer lobbies only then could the remodeling contractor perform its work as described above the while no remodeling was done in the parking garage the record indicates that it was financially advantageous to remove the asbestos-containing materials in the parking garage at the same time as the abatement activity throughout the building petitioner attempts to distinguish bank of houston v commissioner tcmemo_1960_110 from the present case by arguing that only one contractor was used in bank of houston while it used two we do not find that distinction to be of any significance two different contractors were necessary in this case because removing the asbestos-containing materials required special skills that the remodeling contractor did not possess entire project required close coordination of the asbestos removal and remodeling work clearly the purpose of removing the asbestos-containing materials was first and foremost to effectuate the remodeling and renovation of the building secondarily petitioner intended to eliminate health risks posed by the presence of asbesto sec_15 and to minimize the potential liability for damages arising from injuries to employees and customers in sum based on our analysis of all the facts and circumstances we hold that the costs of removing the asbestos- containing materials must be capitalized because they were part of a general plan of rehabilitation and renovation that improved the douglas street building issue ii brazilian debt-equity conversion the second issue is whether petitioner realized a loss on a brazilian debt-equity conversiondollar_figure according to petitioner the debt-equity conversion should be viewed under the step_transaction_doctrine as an exchange of petitioner's blocked deposits at the central bank of brazil with a basis of dollar_figure for we reject petitioner's argument regarding sec_213 sec_1_162-10 income_tax regs and revrul_79_66 1979_1_cb_114 these provisions and ruling cannot convert the costs of removing the asbestos-containing materials into current deductions simply because petitioner's concerns for the health and welfare of its employees partially motivated the removal a debt-equity conversion is also commonly referred to as a debt-equity_swap stock in a brazilian company with a fair_market_value of dollar_figure consequently the conversion produces a dollar_figure loss by utilizing the step_transaction_doctrine petitioner essentially ignores the conversion of the brazilian debt into cruzados and simultaneously the payment of the cruzados for the stock respondent on the other hand asserts that the step_transaction_doctrine is inapplicable to petitioner's debt-equity conversion according to respondent we should view the transaction as an exchange of petitioner's blocked deposits for cruzados which were then used to purchase stock in a brazilian company based on this scenario petitioner would recognize a loss on the exchange of the debt for the cruzados only to the extent its adjusted_basis in the debt exceeded the fair_market_value of the cruzados respondent contends that there was no excess and thus no loss in this case petitioner exchanged blocked deposits with a dollar_figure basis for cruzados with a dollar_figure fair_market_value as an alternative position respondent claims that assuming arguendo petitioner did realize a loss the loss did not exceed percent of the investment or approximately dollar_figure million a the brazilian debt crisis in the late 1970's latin american countries borrowed heavily abroad as part of its response to higher world oil prices the brazilian government embarked on a major program of import- substituting industrialization this development strategy involved the potential risk of higher external indebtedness the extensive borrowing made brazil vulnerable when international interest rates rose sharply in the early 1980's it was difficult for brazil to maintain sufficient foreign_currency such as the u s dollar to repay its foreign debts in mexico announced that it could not meet external debt payments and declared a moratorium on its external indebtedness a general cutback in credit to most latin american nations including brazil followed deposit facility agreements and blocked deposits brazil attempted to deal with its debt problems by negotiating with its foreign creditors to reschedule its indebtedness the negotiations resulted in various agreements including the and deposit facility agreements dfa's and a amendment to the dfa the dfa under the terms of these agreements the principal_amount of the loans made by international banks to brazilian financial institutions maturing in and would not be paid to creditors outside brazil but rather would be deposited with the central bank of brazil the central bank in dollar-denominated accounts on behalf of the respective creditors despite the lack of a formal renewal this arrangement was continued into the central bank is the principal banking regulatory agency in brazil as well as the agency in charge of implementing and enforcing national monetary policy regulating money supply and controlling foreign exchange these were called blocked deposits under the dfa's and the dfa the payment terms of the deposits were also rescheduled moreover under the terms of these agreements blocked deposits relating to loans maturing in and could be re-lent by the creditors to borrowers in brazil blocked deposits for loans maturing in such as the deposits at issue herein could not be re-lent but could be used for equity investments in brazilian companies this type of transaction is called a debt-equity conversion in a debt-equity conversion_transaction non-brazilian currency-denominated blocked deposits at the central bank are exchanged for cruzados at the official exchange rate and thereafter the cruzados are used as payment for equity interests in brazilian companies subject_to central bank guidelines and pursuant to the dfa's and the dfa such a transaction can take place only after negotiations with and agreement by the central bank blocked deposits at the central bank were bought and sold on a secondary market at a discount to their face amounts this secondary market originally reflected rates at which banks exchanged debt of one country against that of another attempting to diversify their portfolios ultimately the transactions on the secondary market involved sales of all types of claims by banks wishing to clear their portfolios of the specific loans throughout most of brazilian debt was trading in the secondary market pincite cents on the dollar declining to cents by date the date of the transaction herein discussed infra in date the majority of brazilian debt was not traded on the secondary market the brazilian government did not have access to the secondary market because the debt restructuring agreements such as the dfa's had sharing clauses requiring the recipient of any payments to share the proceeds with all of the other creditors that were parties to such agreements the cruzado plan in date brazil adopted the cruzado plan as part of an economic stabilization program to reduce the country's high inflation a price freeze took effect and the cruzado replaced the cruzeiro as brazil's currency on date the exchange was made at one cruzado czdollar_figure to big_number cruzeirosdollar_figure brazilian currency was not freely exchangeable through official brazilian channels into non-brazilian currency the cruzado plan was collapsing by late moratorium on interest on date brazil declared a moratorium on the payment of interest on its external indebtedness in response to on date the official exchange rate of cruzados to u s dollars was set at dollar_figure to czdollar_figure the average official exchange rate was dollar_figure to czdollar_figure4 the official rate was the dominant exchange rate in brazil a parallel rate also existed which was published in brazilian newspapers but was technically illegal and none of the hundreds of brazil's creditors including petitioner could exchange blocked deposits for cruzados in the parallel market the spread between the official rate and parallel rate typically was approximately percent this declaration some u s banks including petitioner announced that they would place a portion of their brazilian loans on nonaccrual status recording interest_income on such loans only as payments were received by date brazil resumed partial interest payments on its external indebtedness b petitioner's blocked deposits petitioner's subsidiary norwest bank minneapolis n a nbm owned blocked deposits at the central bank in and dollar_figure as described above these deposits consisted of principal repayments of dollar-denominated loans previously made to brazil in the ordinary course of nbm's banking business the central bank prevented petitioner from repatriating these deposits because brazil had insufficient hard currency u s dollars to make payments on the loans at petitioner's election the blocked deposits accrued interest at the u s domestic rate in late petitioner began investigating the possibility of using some of its brazilian blocked deposits to make an equity_investment in a brazilian company darin p narayana managed international banking for norwest at this time and was in charge of petitioner's brazilian blocked deposits a debt-equity conversion became attractive to petitioner because it would allow petitioner to regain control_over some assets by placing them because nbm was a subsidiary of petitioner for convenience we sometimes refer to petitioner as owner of the blocked deposits outside of brazil's debt-restructuring process increase the probability of repayment of a portion of its outstanding brazilian loans and reduce petitioner's obligation to make new loans to brazil sufficient to pay at least part of the interest due on old loans at this time and until date brazil's policies favored debt-equity conversion transactions creditors were permitted to use deposits to invest in brazilian companies if a creditor decided to make such an investment the central bank converted percent of the face value21 of the deposits plus accrued interest into cruzados at the official exchange rate pursuant to central bank circular the implementing measure concerning debt-equity conversions the creditor and the company in which it was investing pledged to keep the converted sums in brazil for the minimum period that may be established the debt-equity conversion policies benefited brazil by allowing it to extinguish its foreign debt by the amount of the debt converted thereby eliminating its foreign exchange obligation with respect to that portion of its debt the equity_investment acquired as a result of a debt-equity conversion was registered at the central bank as registered foreign capital in the currency originally brought into brazil by the creditor the amount registered could be increased annually by the amount of retained earnings registration entitled the creditor to in date the central bank ended the practice of converting blocked deposits at full face value remit profits and capital outside brazil at the official exchange rate avoid or reduce supplementary withholding taxes and upon the ultimate sale of the investment remit the proceeds of the sale free of tax up to the amount of registered foreign capital in date when brazil declared a temporary moratorium on interest payments on its debt foreign investors possessing a certificate of registration were still able to receive dividends outside brazil at the official exchange rate petitioner had several options with respect to its blocked deposits hold the blocked deposits and participate in the debt restructuring process sell the deposits on the secondary market to another party or convert the deposits into an equity_interest in a brazilian company pursuant to the central bank's debt- equity conversion program the only options that would reduce petitioner's blocked deposit holdings and decrease its foreign debt exposure were selling the debt on the secondary market for cash or swapping the debt for equity in a brazilian company c papel e celulose catarinense s a petitioner decided to engage in a debt-equity conversion and in that regard began examining investment possibilities in brazilian companies in date petitioner received an information petitioner could only use deposits to participate in the debt-equity conversion at issue in this case these deposits were governed by the and dfa's memorandum23 regarding a brazilian company papel e celulose catarinense s a pcc prepared by banco bozano simonsen de investimento s a banco bozano and morgan grenfell co ltddollar_figure the international finance corporation ifc a world bank affiliate engaged these firms to market it sec_28 7-percent interest in pccdollar_figure ifc's asking price for it sec_28 7-percent interest in pcc was dollar_figure million pcc headquartered in san paulo was a subsidiary of industrias klabin papel e celulose s a ikpc a brazilian corporation incorporated in ikpc was the largest pulp and paper producer in south america and among the largest in the world prior to the transaction at issue herein pcc's stock was owned as follows ikpc--70 percent ifc--28 percent and pcc's administration the information memorandum did not by its terms limit the offering to prospective purchasers who intended to engage in a debt-equity conversion at the time petitioner was considering an investment in pcc it was also reviewing a possible investment in medtronic do brazil as well as the purchase of mellon bank' sec_12 5-percent interest in banco bozano ifc aids in the development of private sector projects in developing countries such as providing seed capital to private ventures and projects ifc focuses its assistance on those projects which while economically and financially attractive cannot by themselves attract enough managerial technical or financial resources to be implemented once these projects reach success and maturity ifc expects to divest and redeploy its assets to assist the development of new attractive ventures pcc was ifc's oldest equity_investment dating back to the late 1960's by ifc had decided that pcc's operational and financial maturity warranted the sale of its interest council-- percent pcc stock was not publicly traded whereas ikpc stock was listed on the brazilian stock exchanges pcc was engaged in the production of unbleached and bleached kraft paper and bleached fluff pulp as well as multiwall paper bags and envelopes pcc's management and the management of its principal subsidiaries were fully integrated with that of its parent ikpc pcc's directors had all been in the klabin group for more than years paper consumption is closely linked to economic activity consequently swings in economic activity place pulp and paper manufacturers at risk prior to pcc had been consistently profitable for example its net_income was dollar_figure from through pcc paid dividends averaging approximately percent of its net profits in pcc was cash rich and had only a small amount of long-term indebtedness as of date pcc had cash and short-term financial investments totaling dollar_figure long-term loans totaled dollar_figure pcc's shareholders' equity at the end of was approximately dollar_figure million pcc's expansion plans the brazilian pulp and paper industry operated at or close to full capacity in and additional investments in productive capacity were needed to meet brazil's 7-percent annual growth in paper demand pcc planned to expand its production capacity from big_number to big_number tons per year in order to meet expected demand by early the cost of pcc's planned expansion was dollar_figure million pcc intended to finance this expansion with a dollar_figure million loan from the brazilian national development bank a dollar_figure million loan from ifc and dollar_figure million from internally generated cash_flow on date pcc acquired percent of bates' stock one of its principal brazilian competitors the purchase_price was approximately dollar_figure million the bates acquisition enabled pcc to expand its capacity in the multiwall-paper-bag market petitioner's internal analysis of a pcc investment at the request of nbm's international department norwest corporate finance27 evaluated ifc' sec_28 7-percent equity_interest in pcc at the beginning of the evaluation resulted in a date study corporate finance study at this time nbm was contemplating the acquisition of ifc's entire 7-percent interest norwest corporate finance reviewed the forecast prepared by pcc's management and found it reasonable based on the available information it found that the projected level of sales and profitability from the planned increase in capacity was reasonable and concluded that pcc was not underperforming in comparison with its brazilian competitors the corporate finance study used both the market and income approaches to value ifc's interest in pcc the market approach norwest corporate finance was responsible for the corporation's policies with regard to the deployment of its assets and liabilities involved the application of a price earnings ratio based on u s companies in the pulp and paper industry to a 3-year weighted average of historical earnings while the income approach discounted pcc's expected dividends to present_value at a 24-percent rate the corporate finance study concluded that ifc' sec_28 7-percent interest in pcc had a value of dollar_figure under the market approach and dollar_figure under the income approach in attempting to harmonize the two methods the study accorded the income approach twice the weight of the market approach and concluded that the 7-percent interest in pcc had a dollar_figure value the study did not consider the repatriation restriction or the foreign exchange political risks associated with owning a brazilian investment as holder of more than percent of pcc's share capital petitioner would be entitled as a matter of brazilian law to elect a representative to each of the two councils responsible for pcc's management the council of administration and the fiscal council petitioner anticipated receiving fees for each of the two seats on pcc's management councils in the amount of dollar_figure per month in cruzados or the cruzado equivalent of dollar_figure annually by date petitioner had revised its value for ifc' sec_28 percent interest in pcc to dollar_figure million by adding the director's fees from one board seat to projected dividends from pcc under the corporate finance study's income approach petitioner's conclusions about the pcc investment petitioner concluded that the acquisition of a 361-percent equity_interest in pcc rather than the entire 7-percent interest was an attractive investment it based its conclusions on pcc's strong professional management solid financial condition history of profitability and dividends dominant position in the markets for its products growth potential and relationship with ifc both past and future as of date petitioner could have sold dollar_figure of its brazilian debt on the secondary market for percent of face value and received dollar_figure million in return but it chose not to do so petitioner believed that a 361-percent equity_interest in pcc through a debt-equity conversion in which it would receive cents on the dollar was more profitable than the cash it could have received on the secondary market d steps leading up to the conversion on date nbm sent to banco bozano a proposal to purchase dollar_figure percent of pcc's equity for a purchase_price not to exceed dollar_figure milliondollar_figure the other percent was to be acquired by the bank of scotland and its affiliate balmoral industria e comercio ltda balmoral as a result of a debt-equity conversion the proposal states that the purchase is to be effected by means of a conversion of blocked deposits with a dollar_figure million face value which would occur simultaneously with petitioner's debt-equity conversion petitioner negotiated the purchase of ifc's pcc stock at arm's length once the parameters of the acquisition had been established nbm wrote to the central bank on date seeking its consent to engage in a debt-equity conversion pursuant to central bank circular sec_1 and central bank resolution and the dfa that would enable the use of blocked deposits with a face_amount of approximately dollar_figure million to acquire big_number shares of pcc common_stock the 361-percent equity_interest in order to execute the transaction on date petitioner formed a wholly owned cayman islands subsidiary minnetonka overseas investment ltd moil which in turn formed a wholly owned brazilian subsidiary minnetonka representacoes comerciais ltda mrc moil and mrc are controlled_foreign_corporations within the meaning of subpart_f of the internal_revenue_code petitioner chose this arrangement in order to allow it the maximum flexibility in the future disposition of its investment also on date moil notified the central bank that nbm's blocked deposits would be converted into mrc risk capital this capital would be used to purchase the pcc stock the conversion was to occur on date petitioner through mrc requested that the central bank register mrc's investment as registered foreign capital within days of the investment moreover nbm moil and mrc agreed to maintain the invested funds in brazil for a period of twelve years which was the period to which funds relative to deposits made in were subject on date nbm and moil instructed the central bank to transfer dollar_figure of blocked deposits to the name of mrc e the conversion_transaction on date ifc nbm moil mrc the bank of scotland and balmoral executed a share purchase agreement purchase agreement in relevant part the purchase agreement states as follows each of the purchasers shall pay to the seller at the place and to the person or account in brazil designated by the seller the purchase_price for the relevant purchaser's shares equal to the brazilian cruzado equivalent of usdollar_figure without or withholding whatsoever obtained by converting brazilian sovereign debt deduction cruzados setoff into any under the purchase agreement ifc was entitled to either the immediate remittance in dollars in new york of dollar_figure million or the deposit of the sale proceeds in a dollar-denominated account satisfactory to ifc at the central bank we note that dollar_figure of the dollar_figure was used to pay legal expenses and the buy sell foreign exchange rate differential as contemplated petitioner's blocked deposits totaling dollar_figure million were converted on date at the official exchange rate of cruzados to one u s dollar into czdollar_figure mrc in turn transferred the cruzados to ifc in consideration for percent of ifc's equity_interest in pcc some big_number shares ifc provided mrc a receipt acknowledging this paymentdollar_figure this transaction extinguished the dollar_figure million debt moreover petitioner agreed to maintain its equity_investment in brazil for years also on date ifc and moil entered into a repatriation guarantee agreement whereby ifc guaranteed that in the event moil sold the pcc stock and was unable to repatriate the the receipt states in relevant part as follows in this form international finance corporation ifc acknowledges receipt of czdollar_figure0 two hundred ninety five million two hundred thousand cruzados equivalent to usdollar_figure twelve million five hundred thousand dollars as of this date of april at the exchange rate of czdollar_figure from minnetonka representacoes comerciais ltda minnetonka for the sale to the latter of big_number shares from the capital stock of papel e celulose catarinense s a of which shares ifc is the legal owner for which receipt ifc hereby grants minnetonka total general and irrevocable quittance for said sale of shares sale proceeds ifc would purchase for u s dollars outside of brazil moil's share holding in mrc equal to moil's remittance interest up to dollar_figure million this guaranty would be reduced by any earlier sale or disposition of any part of the shares and would apply only during the convertibility period the 18-month period beginning on the 12th anniversary of the pcc purchase petitioner's blocked deposits at the central bank had no such guaranty following the debt-equity transaction ikpc held percent of pcc's voting capital and mrc and balmoral each held percent the three parties entered into a shareholders agreement on date whereby ikpc and balmoral had a right_of_first_refusal with respect to the sale of petitioner's pcc stock due to the manner in which petitioner arranged the transaction it could sell its investment indirectly through the sale of moil at any time and without restriction for u s dollars outside brazil the buyer would have to maintain the invested funds in brazil for whatever portion of the 12-year waiting_period remained but it would be free to dispose_of the investment indirectly in the same manner as petitioner moreover petitioner could dispose_of the investment by causing moil to sell the stock of mrc without restriction to a buyer in brazil for cruzados the cruzado proceeds would remain subject_to the same prohibition on repatriation until date f petitioner's tax and accounting treatment of the conversion nbm's chief financial officer and comptroller phil williams reviewed and analyzed the corporate finance study two days after the conversion he concluded that the estimated fair_market_value of petitioner's 361-percent equity_interest in pcc was between dollar_figure million and dollar_figure million mr williams arrived at this conclusion by using the price equity ratio and discounted cash-flow approaches as well as adding a third approach based on the net_book_value of pcc he then weighted the three approaches equallydollar_figure mr williams recommended that the investment be recorded at par in date mr narayana who was in charge of petitioner's brazilian blocked deposits agreed with mr williams' conclusion mr williams determined the fair_market_value of petitioner's interest in pcc as follows numbers are in thousands method total company norwest's share price earnings ratio dollar_figure x dollar_figure discounted cash-flow big_number x big_number net_book_value 1big_number x big_number weighted average dollar_figure dollar_figure discounted percent norwest's international department was responsible for monitoring the value of petitioner's pcc investment on a quarterly basis petitioner periodically reviewed all of its lesser_developed_country debt on date mr williams wrote a memorandum on behalf of international management reassessing the value of petitioner's pcc equity_interest based on a date proposed practice bulletin issued by the american institute of certified public accountants and its own analysis that the true fair_market_value of the debt surrendered would be percent of par petitioner decided to write down its pcc investment to approximately dollar_figure million based on a 15-percent discount at the end of petitioner again reduced the value of the pcc investment to dollar_figure million for financial purposes this value was based on the secondary market_value of the dollar_figure debt and on petitioner's tax department's analysis of the tax implications resulting from the debt-equity transaction g petitioner's return and petition on its federal_income_tax return petitioner claimed a dollar_figure loss the difference between its dollar_figure of blocked deposits and dollar_figure million the secondary market price for the dollar_figure of brazilian debt as well as petitioner's final valuation for book purposes of the pcc stock received in the debt- equity conversion petitioner asserted in its petition since the pcc stock was valued at dollar_figure when it should have been valued at dollar_figure petitioner is entitled to an additional loss deduction of dollar_figure for h notice_of_deficiency in the notice_of_deficiency respondent disallowed petitioner's claimed dollar_figure loss the notice explains that petitioner did not establish that any deductible loss was sustained in i subsequent events petitioner attempted to sell its interest in pcc several weeks after the conversion then in or petitioner engaged eden international to assist in the sale of its pcc stock on date petitioner entered into a deferred stock sale agreement with tiquie s a a subsidiary of ikpc located in uruguay agreeing to sell the moil shares to tiquie for dollar_figure consisting of dollar_figure in cash and a dollar_figure note plus interest on the outstanding balance of the purchase_price by selling its entire_interest in moil petitioner indirectly sold the 361-percent equity_interest in pcc as well as cash equivalents of approximately dollar_figure petitioner incurred dollar_figure in closing costs petitioner sold its remaining blocked deposits for cents on the dollar in date discussion j respondent's arguments respondent contends that petitioner did not realize a loss on the debt-equity conversion because it simply exchanged blocked deposits in which it had a dollar_figure basis for cruzados worth the same amount respondent relies upon revrul_87_124 1987_2_cb_205 and 103_tc_59 supplemented by 106_tc_257 on appeal 5th cir date to support its position in revrul_87_124 supra a u s commercial bank holds dollar-denominated debt at the central bank of a foreign_country the foreign_country has a program that allows the commercial bank to exchange the debt for local currency if it uses the local currency to invest in a company the foreign company organized and engaged in business in the foreign_country in situation the commercial bank delivers the dollar-denominated debt to the central bank the central bank credits the account of the foreign company and the foreign company in turn issues its capital stock to the commercial bank respondent contends that the facts herein are similar except that petitioner paid the local currency cruzados to a third party ifc in exchange for the stock the ruling treats the commercial bank as if it received local currency from the central bank in exchange for the debt and then contributed the local currency to the foreign company in exchange for its stock the commercial bank also recognizes a loss on the exchange of the debt for the local currency to the extent of the excess of its adjusted_basis in the debt over the fair_market_value of the local currency the ruling assumes that the fair_market_value of the stock is equal to the fair_market_value of the foreign_currency for which it was exchanged by applying the test enunciated in this ruling respondent argues that petitioner did not realize a loss on its exchange of blocked deposits for cruzados because it received local currency cruzados equal in value to its basis in the blocked deposits moreover respondent contends that petitioner recognizes no gain_or_loss on the exchange of the cruzados for the pcc stock because the ruling assumes that the value of the cruzados and the value of the stock are identical respondent also contends that g m trading corp v commissioner supra supports its position g m trading involved a u s taxpayer that participated in a mexican debt-equity_swap in order to participate in the transaction the taxpayer a u s company formed a mexican subsidiary procesos the u s company then purchased a previously issued dollar_figure million mexican government debt from an unrelated bank for dollar_figure which reflected the market_discount rate of approximately percent of the debt's principal face_amount t c pincite the taxpayer exchanged the dollar_figure million debt for big_number pesos mexdollar_figure and the mexican government deposited the pesos in procesos' restricted bank account the pesos were to be used to build a lambskin processing plant procesos issued shares of its stock to the mexican government which in turn transferred the shares to the taxpayer the u s company surrendered the debt to the mexican government which then canceled it id pincite the court rejected the taxpayer's view that the transaction was a tax-free contribution to the capital of the mexican subsidiary the court declined to disregard the taxpayer's exchange of u s dollar- denominated debt for mexican pesos and held that the taxpayer realized a dollar_figure gain on the exchange equal to the difference between the taxpayer's basis in the debt dollar_figure and the fair_market_value of the pesos for which the debt was exchanged mexdollar_figure with a fair_market_value of dollar_figure on the date of the transaction id pincite by analogy to g m trading respondent asserts that in the instant situation we should decline to disregard petitioner's the mexdollar_figure had a dollar_figure fair_market_value at the official exchange rate the dollar_figure million debt had a fair_market_value of dollar_figure because of a 13-percent discount rate of the debt's face value 103_tc_59 supplemented by 106_tc_257 on appeal 5th cir date exchange of blocked deposits for cruzados accordingly respondent claims we should hold that petitioner's exchange of blocked assets for cruzados created no loss because the basis of the blocked assets and the fair_market_value of the cruzados were identical k petitioner's arguments at trial and on brief petitioner contends that the conversion produced a dollar_figure loss petitioner argues that it exchanged dollar_figure of blocked deposits which had a secondary market_value of dollar_figure for brazilian stock worth dollar_figure petitioner first argues that revrul_87_124 supra supports its position rather than that of respondent petitioner claims that because the value of the stock is presumed to equal the value of the local currency given in exchange petitioner is justified in looking to the fair_market_value of the stock it received in determining the extent of its loss petitioner also argues that we should not follow the analysis and reasoning of g m trading because the facts therein are distinguishable petitioner entered into the debt-equity conversion as a means of cutting its losses on a deteriorating investment not as the first step in making a profitable new investment as in g m trading the cruzados petitioner received were used to acquire stock in a brazilian company while the pesos the taxpayer received in g m trading were used to acquire land and construct a plant and petitioner was committed to retain the pcc investment for years while no similar mandatory holding_period existed in g m trading moreover petitioner contends that unlike g m trading the step_transaction_doctrine applies herein thus the exchange of debt for cruzados and the cruzados conversion into stock should be ignored therefore according to petitioner the gain_or_loss should be measured by the difference between the basis in the debt and the fair_market_value of the stock received in order to place a value on the stock petitioner submitted the expert report of nancy czaplinski who valued petitioner's interest in the pcc stock as of the transaction date at dollar_figure petitioner also submitted the expert report and testimony of steven j sherman who valued the same interest at approximately dollar_figure milliondollar_figure finally petitioner claims that the value of its blocked deposits on the secondary market is directly relevant to the value of its equity_interest in pcc according to petitioner the dollar_figure of blocked deposits had a dollar_figure value on the respondent's appraisal experts scott hakala and william cline valued the interest at dollar_figure million and dollar_figure million respectively secondary market which represents a ceiling on the value of petitioner's pcc equity interestdollar_figure l law and analysis the loss from a sale of property is the excess of the property's adjusted_basis over the amount_realized sec_1001 an equal exchange results in neither gain nor loss because debt is considered property in the hands of the holder an exchange of debt for other_property is usually treated as a sec_1001 taxable_exchange 499_us_554 g m trading corp v commissioner t c pincite federal tax law principles require that foreign_currency be considered property fnma v commissioner 100_tc_541 sec_1_1001-1 income_tax regs the step-transaction doctrine is a rule_of substance over form that treats a series of formally separate steps as a single transaction if they are in substance integrated interdependent and geared toward a specific result 92_tc_1165 the step-transaction doctrine is a manifestation of the more general tax law principle that formal distinctions cannot obscure the substance of a transaction id respondent counters by arguing that the value of the blocked deposits on the secondary market is irrelevant because petitioner chose to partake in a debt-equity conversion rather than sell the debt on the secondary market like petitioner herein the taxpayer in g m trading argued that its exchange of debt for foreign_currency should be ignored under the step_transaction_doctrine the court in g m trading rejected the taxpayer's argument in its supplemental opinion as follows a step in a series of transactions or in an overall transaction that has a discrete business_purpose and a discrete economic significance and that appropriately triggers an incident of federal taxation is not to be disregarded further the simultaneous nature of a number of steps does not require all but the first and the last or the start and finish to be ignored for federal_income_tax purposes t c pincite we likewise refuse to apply the step_transaction_doctrine herein we agree with respondent that the substance of petitioner's transaction was consistent with its form the central bank converted the full-face value of petitioner's debt plus accrued interest into czdollar_figure at the official exchange rate without diminution or discount mrc received the cruzados from the central bank exchanged at the official exchange rate and paid the cruzados to a third party ifc in exchange for its 361-percent equity_interest in pcc contrary to petitioner's contention the exchange of the debt for the cruzados and the conversion of the cruzados into stock did not constitute a transitory step but rather a substantive and significant element of the conversion having a discrete business_purpose and economic significance petitioner needed the cruzados to pay the agreed purchase_price to ifc and pay its other transaction expenses the central bank was entitled to extinguish approximately dollar_figure million of brazil's foreign debt the central bank did not need to use its limited supply of u s dollars at this time the central bank received petitioner's assurance that its equity_investment would remain in brazil for years and ifc could use the cruzados without restriction thus taking into account the cruzados' independent economic significance petitioner's exchange of blocked deposits for cruzados and the conversion of the cruzados into stock cannot be ignored under the step_transaction_doctrine accordingly we follow the analysis in g m trading35 and hold that petitioner's loss if any is measured by the difference between its basis in the blocked deposits dollar_figure and the value of the cruzados dollar_figure before any discount see infra on the date of the transaction because we hold that the step_transaction_doctrine is inapplicable herein we need not determine the fair_market_value while we agree with petitioner that the facts in 103_tc_59 are not identical to those herein the legal propositions stated in g m trading are nonetheless applicable herein of petitioner's 361-percent equity_interest in pcc including any possible marketability discount attributable to that interest we reject petitioner's argument that revrul_87_124 1987_2_cb_205 supports its position at this point we must address petitioner's argument that the dollar_figure of blocked deposits had a secondary market_value of dollar_figure we agree with respondent that the value of the blocked deposits on the secondary market is irrelevant to this case petitioner did not engage in a transaction on the secondary assuming arguendo that the step_transaction_doctrine applies we would hold that the pcc stock had a dollar_figure million fair_market_value on date based upon the following after considering for several months whether to invest in pcc petitioner concluded that the 361-percent equity_interest was worth dollar_figure million petitioner negotiated the purchase of the pcc stock with ifc an unrelated party which has a strong institutional incentive to charge a fair price at arm's length even though the latin american debt crisis placed petitioner in a position with limited options petitioner was not under a compulsion to buy in fact two of petitioner's experts testified that if we find that ifc sold its stock in an arm's- length transaction and petitioner was not under a compulsion to buy the price at which the transaction occurred would provide the best evidence of fair_market_value the amount_paid for property generally is probative evidence of its fair_market_value see eg 411_us_546 just days after petitioner acquired the interest in pcc phil williams nbm's chief financial officer concluded that the fair_market_value of the pcc stock was between dollar_figure and dollar_figure million he reached this conclusion after analyzing and revising the study prepared by norwest corporate finance we consider petitioner's subsequent reductions in value for financial reporting purposes not relevant to the purchase-date fair_market_value of the pcc stock market it chose to participate in the government repurchase market where the central bank paid full face value for the debt our task is to decipher the events that did occur rather than those that could have occurred mr narayana petitioner's officer charged with overall responsibility for the debt-equity conversion testified that petitioner considered the conversion more beneficial than a sale of the debt on the secondary market furthermore as the court's supplemental opinion in g m trading acknowledges a creditor is motivated to engage in a debt-equity conversion by the additional value the transaction creates above and beyond the secondary market sale of the debt if not for this added value a creditor would have no reason to spend the time and resources necessary to complete the transaction t c pincite- it is clear that petitioner engaged in the debt-equity conversion because it concluded after extensive investigation and analysis of the investment that a 361-percent equity_investment in pcc was worth more than the approximately dollar_figure million cash petitioner could have received from a secondary market sale contrary to petitioner's argument the value of the blocked deposits on the secondary market is not relevant to the value of petitioner's pcc equity_interest and does not represent a ceiling on that value while we acknowledge that had petitioner sold the blocked deposits on the secondary market it probably would have been obligated to make new loans to brazil petitioner anticipated receiving a better deal through the debt-equity conversion our analysis does not however end here we must now determine whether any discount should be applied to the fair_market_value of the cruzados petitioner received on account of the restrictions in this case two restrictions existed with regard to petitioner's debt- equity conversion the first required petitioner to invest the cruzados in a brazilian company this restriction has no greater significance than the restrictions placed upon the taxpayer's use of the pesos by the mexican government in g m trading the court in g m trading declined to discount the value of the pesos received in exchange for the debt on the grounds that the mexican government restricted their use to the construction of the processing plant the court held that this restriction was consistent with the parties' purpose and objective and was not substantially different from disbursements of loan proceeds by financial institutions t c pincite in other words the restriction only reflected the foreign currency's intended use t c pincite in fact the restriction served as an enhancement to the value of the pesos by opening business opportunities for the taxpayer in mexico t c pincite we acknowledge that due to the brazilian debt crisis petitioner had limited options with regard to its blocked deposits however once petitioner decided to engage in a debt- equity transaction it was free to use its blocked deposits to invest in any brazilian company moreover the value of the cruzados here was enhanced because petitioner's investment was made at the official exchange rate entitling it to the benefits of registered foreign capital in sum as in g m trading we hold that the restriction on use of the cruzados herein does not require a discount the second restriction involved the 12-year repatriation restriction it is clear from the record before us that this restriction was a preexisting limitation as articulated in central bank circular and the dfa it was not a result of negotiations or bargaining by the parties the restriction reduced the value of petitioner's property right by prohibiting petitioner from repatriating its capital for years despite the manner in which petitioner arranged the transaction with the creation of moil and mrc we believe that the 12-year restriction warrants a discount on the fair_market_value of the cruzados petitioner received reflecting the preexisting restriction see eg 7_tc_12 the court imposed a discount on the value of south african pounds reflecting preexisting restrictions imposed upon foreign exchange by south africa accordingly we will present the analyses of the parties' experts regarding the effect of the 12-year restriction respondent argues that assuming arguendo petitioner realized a loss as a result of its debt-equity conversion the loss did not exceed percent of its investment approximately dollar_figure million on account of the 12-year restriction this argument is based upon the report and testimony of respondent's expert dr william r cline dr cline received a ph d in economics from yale university in is a senior fellow at the institute for international economics and has approximately years' experience in the area of international debt particularly latin american and brazilian debt dr cline concluded that petitioner realized no loss on its debt-equity conversion however he recognized that petitioner may be entitled to a small discount on the fair_market_value of the cruzados it received attributable to its agreement to maintain its equity_investment in brazil for years despite its creation of moil and mrc in order to minimize the effects of the 12-year restriction dr cline determined a discount on account of the restriction by considering the spread between the interest rates on a 3-month u s treasury bill and a 10-year u s treasury bond between and for this period the average annual interest rate on 10-year u s treasury bonds exceeded the rate on 3-month u s treasury bills by percent this is the annual premium for short-term liquidity versus illiquidity over a 10-year period dr cline determined that the differential if compounded over a 12-year period amounts to a multiple of and that the general market preference for liquidity means that the 12-year encumbrance is worth a 3-percent discount he then decreased the 3-percent discount to percent based on his belief that the spread between the bill and the bond represented not only a liquidity premium but also a risk premium for interest rate fluctuations petitioner introduced a rebuttal witness dr kenneth froot of the national economic research associates inc dr froot received a ph d in economics from the university of california at berkeley in he has no direct experience with brazil petitioner also introduced nancy czaplinski a chartered financial analyst and an engagement director with american appraisal associates inc ms czaplinski has an m b a in finance from the university of wisconsin at milwaukee and is a c p a dr froot first criticized dr cline's use of u s treasury bills and bonds because they are both highly liquid instruments ms czaplinski also criticized dr cline's use of the interest rate spread between the bill and the bond between and because it was significantly less than the actual spread at the valuation_date the average spread for and the average spread for through after correcting the spread used in dr cline's analysis ms czaplinski used dr cline's formula to arrive at a 25-percent discount solely attributable to liquidity in the u s treasury market on the valuation datedollar_figure dr froot also insisted that dr cline's 10-percent discount was too low froot concluded that a total 5-percent discount was more appropriate for the following reasons the swap equity was akin to restricted_stock which trades pincite- to percent discounts a significant discount is applicable because the official and parallel exchange rates could be expected to merge over a period of time so that petitioner would not have the benefit of a favorable cruzado-to-dollar exchange rate at the end of the 12-year waiting_period and a discount rate in response to the criticism of both dr froot and ms czaplinski dr cline testified that even though the 10-year bond is highly liquid the buyer faces the same waiting_period before maturity as the seller and his discount represents an inherent penalty for the waiting_period at the time of the transaction the official exchange rate wa sec_23 cruzados to one u s dollar while the parallel rate wa sec_32 cruzados to one u s dollar dr froot opined that if a convergence of the official and parallel brazilian exchange rates occurred petitioner would pay a million cruzado penalty upon entering the debt-equity continued adjustment was necessary for the risk associated with the official rate premium we believe that the 12-year waiting_period was not a restriction on sale but rather a restriction on repatriation of dollars out of brazil even if petitioner could not take the sale proceeds out of brazil in dollars it could sell mrc at any time to a buyer in brazil paying cruzados petitioner could also sell moil for dollars outside brazil petitioner's pcc equity_investment was not equivalent to restricted_stock by focusing on dr froot's opinion that the fair_market_value of the cruzados should be determined by reference to the parallel market exchange rate petitioner attempts to escape the tax consequences of its bargaindollar_figure while we agree with dr froot continued conversion because it was forced to use the official exchange rate and would receive none of this penalty back if the official and parallel rates converged prior to the end of the year period dr froot believed that the spread was likely to narrow in date dr cline would have predicted that the spread between the official exchange and parallel rates was likely to continue for a considerable period of time because brazil had imbedded indexation as a result of chronic inflation also mr narayana believed that a spread would persist for a long time in the absence of drastic action by the brazilian government in fact a spread still existed in see g m trading corp v commissioner t c pincite where the taxpayer was unsuccessful in attempting to disavow the price that the mexican government had agreed to pay and the taxpayer had agreed to accept in exchange for the debt that petitioner could have obtained more cruzados at the parallel market rate than at the official rate the central bank required that the conversion take place at the official exchange rate this was not a penalty it was a requirement of engaging in the debt-equity conversion as part of the conversion terms petitioner agreed that blocked deposits would be converted into cruzados at the official exchange rate on date petitioner also agreed as part of the purchase agreement that it would pay ifc in exchange for the pcc stock the cruzados equivalent of dollar_figure million without any deduction setoff or withholding whatsoever obtained by converting brazilian blocked deposits into cruzados at the official exchange rate ifc acknowledged receipt of this cruzado payment and the fact that it was the equivalent of dollar_figure million at the official exchange rate on date thus we reject dr froot's recommendation of a discount on account of the official and parallel rate differentials as an after-the-fact attempt to revalue a transaction contrary to its agreed-upon terms moreover investments made in brazil at the official exchange rate were entitled to the benefits of registered foreign capital status investments made at the parallel rate were not in this sense the czdollar_figure that petitioner obtained by converting its blocked deposits could easily have the same if not greater value than an identical amount of cruzados obtained on the parallel market for fewer u s dollars finally we agree with dr cline that no discount should be applied for the possible elimination of the official rate premium at the end of the 12-year waiting_period foreign investors such as petitioner who received dividends from their registered investments would continue to receive the benefits of a favorable cruzado-to-dollar exchange rate during the years that the official rate premium was shrinking dr cline believed that a narrowing of the spread between the official and parallel market rates would likely be accompanied by an overall improvement in economic conditions which would have a positive impact on the value of equity investments in this regard dr cline testified that he would forgo a 25-percent exchange rate premium for a 100-percent increase in the value of his investment determining an appropriate discount rate with mathematical precision is impossible valuation is necessarily an approximation it is not necessary that the value arrived at be a figure as to which there is specific testimony if it is within the range of figures that may properly be deduced from the evidence 250_f2d_242 5th cir affg in part and remanding in part tcmemo_1956_178 see also estate of barudin v commissioner tcmemo_1996_395 while we find dr cline's analysis generally sound based on all of the evidence before us we believe and accordingly hold that the 12-year repatriation restriction warrants a 15-percent discount rendering a dollar_figure loss for petitioner's tax_year issue iii allocation of purchase_price the final issue concerns the value of a lease portfolio petitioner acquired from financial investment associates inc fia in this regard we must determine whether any portion of the dollar_figure petitioner paid in to acquire the assets of fia should be attributed to goodwill going-concern value or other nonamortizable intangible assets petitioner contends that none of the dollar_figure it paid for fia's assets should be allocated to goodwill going-concern value or other nonamortizable intangible assets respondent on the other hand contends that dollar_figure of the dollar_figure should be allocated to nonamortizable intangible assets a fia fia a medical equipment_leasing company was founded by fred rafanello in at fia's incorporation mr rafanello was its sole owner president and chief_executive_officer ceo fia's principal executive offices were located in northfield illinois fia specialized in the leveraged purchase and leasing of high-tech diagnostic medical equipment to hospitals and clinics fia's leases typically ran for months which was less than the estimated_useful_life of the leased equipment fia financed its equipment purchases using a combination of debt and equity debt which generally represented approximately percent of the cost of equipment was typically in the form of a 60-month nonrecourse loan from a money-center bank prior to fia's acquisition by commercial federal corp discussed infra fia obtained equity financing from syndications assembled by investment bankers fia customarily received an up-front fee or commission from the syndications out of which the investment bankers received their fee at the expiration of the lease_term the debt incurred to acquire the equipment being leased was retired and the syndications' investors owned the equipment outright high-tech medical diagnostic equipment particularly of the type leased by fia tends to have higher residual values than most other kinds of leased equipment fia projected the residual_value of the equipment it leased to be in the range of to percent fia was a general_partner in the syndications and received additional remuneration by sharing in the residual_value of the leased equipment with the syndications' investors of the equipment's cost but in fact the equipment's residual values generally exceeded the amounts projecteddollar_figure fia converted the equipment's residual_value into cash at the end of the lease in a number of ways sale or renewal of the lease to the original lessee sale or lease to another generally smaller hospital or return of the equipment to the manufacturer as a trade-in fia's experience was that to percent of the equipment was purchased or released by the original lessee in this regard approximately to percent of the leases were renewed which was more profitable for fia than a sale of the equipment to the original lessee or a sale or lease to another hospital the amount of revenue that fia could earn after the lease expiration depended largely on the residual_value of the equipment the residual_value of the equipment was the source for over two-thirds of fia's cash-flow before expenses and represented the principal source of fia's profit thus the equipment's residual_value was the key to fia's business b federal's acquisition of fia commercial federal corp federal the holding_company of commercial federal savings loan association cfsla was one of through date fia achieved gains of percent over book residual values the largest retail financial institutions in the midwest on date federal through another of its subsidiaries commercial federal investment associates inc commercial acquired all of fia's outstanding_stock from mr rafanello the purchase_price approximately dollar_figure million included a 25-percent premium over fia's book valuedollar_figure after the acquisition fia operated its business affairs with no significant changes mr rafanello remained fia's president and ceo at this time fia had to employees and financed dollar_figure million of new equipment leases per yeardollar_figure federal became fia's source of equity financing making funds available in the form of short-term intercompany loans fia had a dollar_figure million line of credit with cfsla which it used to obtain funds for the purchase of equipment loans made under this credit line were secured_by the equipment and the lease revenues fia achieved higher residual values after its acquisition by federal than prior to the acquisition c petitioner's acquisition of fia on date norwest leasing inc nli one of petitioner's affiliates made an exploratory proposal to purchase mr rafanello testified that the 25-percent premium was paid for fia's intangible assets by fia financed more than dollar_figure million of new equipment leases fia's assets the proposal contemplated a purchase_price premium of dollar_figure to dollar_figure million above fia's net asset value44 which at the time was approximately dollar_figure million the proposal also stated that nli would pay fia's dollar_figure million intercompany debt to federal by early date petitioner had decided it was willing to pay only a dollar_figure million premium above book_value for fia's assets petitioner thereafter negotiated an additional price reduction of dollar_figure due to fluctuations in the bond market which increased the cost of funding the acquisition finally on date norwest financial resources nfr another of petitioner's affiliates entered into a purchase agreement the march agreement with fia and commercial in which it agreed to acquire substantially_all of fia's receivables and assetsdollar_figure nfr specifically agreed to acquire fia's approximately the term net asset value refers to the book_value or stockholders' equity of a company that appears on its balance_sheet net asset value is a reference for determining how much a potential buyer might be willing to pay for assets on a going- concern basis the march agreement defines receivables and assets as follows the term receivables shall mean the operating leases and the underlying equipment or other_property subject_to such operating leases owned by the company on the closing date the leasing receivables including leases fair_market_value leases and direct finance leases conditional sale contracts secured loans and other commercial finance receivables of the company on continued dollar_figure million worth of equipment held under operating leases and leasing and other commercial finance receivables and to assume the nonrecourse indebtedness and other liabilities of approximately dollar_figure million to which such assets were subject the acquired assets represented over percent of fia's total assets continued the closing date and any instruments or collateral securing the same and any equipment or property leased or otherwise financed and files and other records owned or in the possession of the company or any of its affiliates relating thereto such receivables shall include but not be limited to all lease agreements conditional sale contracts notes evidences of indebtedness personal guarantees corporate guarantees letters of credit and other documents representing or backing up such receivables receivables shall not in any event include excluded assets the term assets shall mean the receivables equipment or other_property held in inventory for future sale or lease all furniture fixtures equipment and the company's rights in leasehold improvements leasing and lending transactions in process for prospective lessees or borrowers and the related files applications and other documentation the company's general_partnership interests in partnerships and co-ownership interests in participation or like arrangements its rights to receive fees distributions and other revenues therefrom in the future and any rights it has under management or supplier agreements related thereto and any other assets owned by the company on the closing date other than excluded assets the excluded assets that nfr did not acquire consisted solely of notes receivable and any other_amounts due fia from its affiliates and other related parties as of the closing date as of date notes receivable were dollar_figure and amounts due fia from its affiliates or other related parties were dollar_figure the march agreement included the following provision with regard to goodwill the goodwill provision it is understood that there is no good will sic or similar intangible assets included in the purchase and sale covered by this agreement and that no part of the purchase_price shall be attributed or allocated in any way to good will sic in addition the march agreement allowed nfr to designate an affiliate or affiliates to complete the purchase nfr designated nli and dial bank dial nfr's state banking subsidiary consequently on date nli and dial completed the purchase from fia and commercial in an arm's-length transactiondollar_figure nli and dial paid dollar_figure and dollar_figure respectively for a total purchase_price of dollar_figure the purchase_price was calculated as follows stockholder's equity based on historical balance_sheet values before purchase_accounting adjustments - excluded assets fia notes payable to commercial or its affiliates income taxes as shown on historical balance_sheet other liabilities nfr did not specifically assume dollar_figure dollar_figure for use of trade_name and dollar_figure for noncompete agreement ___________________________________________________ total purchase_price per purchase agreement while nfr actually entered into the march agreement and designated nli and dial to complete the purchase these entities were affiliates of petitioner and for convenience we sometimes refer to petitioner as the purchaser of fia's assets petitioner paid dollar_figure in consideration for the right of nfr or its affiliates to use the fia name or any similar name for a period of years and dollar_figure for a covenant_not_to_compete by fia and commercial also for a period of years pursuant to an agreement separate from the march agreement petitioner made a dollar_figure payment to mr rafanello in consideration for his agreement not to compete for a period of yearsdollar_figure moreover petitioner was given the opportunity to employ some of fia's marketing staff and equipment experts many of whom had or more years of experience in the medical equipment_leasing industry as of date of fia' sec_65 employees became nli employees mr rafanello did not become an employee of nli or any of its affiliates after the acquisition petitioner intended to fund the acquisition by issuing commercial paper funds so obtained were to be transferred by petitioner to nli as intercompany debt and to dial as a combination of debt and shareholder equity petitioner calculated that the lease revenues would provide a 15-percent rate of return on the amount petitioner provided to dial as shareholders' equity plus a profit from the cost of money it lent to nli and dial as intercompany debt petitioner expected the overall yield on the any amortization deductions petitioner claimed with respect to the dollar_figure the dollar_figure and the dollar_figure are not in dispute fia leases to be dollar_figure percent annually the purchase_price set forth in the march agreement was subject_to reduction in the event that the yield on the leases computed as of date was less than dollar_figure percent the purchase_price was to be reduced by the amount needed to produce an 49-percent yielddollar_figure however no purchase_price adjustments were subsequently needed d petitioner's return on its return petitioner allocated dollar_figure of the dollar_figure it paid for fia's assets to the lease portfolio none of the purchase_price was allocated to goodwill the present dispute centers around the correctness of petitioner's allocation e notice_of_deficiency respondent determined that petitioner overstated the fair_market_value of and thus its basis in the lease portfolio by dollar_figure which respondent determined should be allocated to goodwill going-concern value or other nonamortizable intangible assets the required yield of dollar_figure percent meant that lease rents plus book residual values less nonrecourse debt payments when discounted to present_value of dollar_figure percent had to equal dollar_figure if the discounted_present_value using dollar_figure percent was less than dollar_figure the purchase_price was to be reduced by the amount of the difference discussion preliminarily we note that we are not bound by the representation made in the goodwill provision of the march agreement namely that petitioner did not acquire any goodwill in its purchase of fia's assets it is well established that the substance of a transaction rather than its form governs the tax consequences 80_tc_491 citing 324_us_331 see also 293_us_465 54_tc_742 affd 445_f2d_985 10th cir f residual_value the parties agree that the residual_value method under sec_1060 is appropriate in this case under sec_1060 consideration is allocated to four classes of assets in descending order of priority class i eg cash and demand deposits class ii eg certificates of deposit federal securities readily marketable_stock and securities and foreign_currency class iii eg accounts_receivable equipment buildings land and covenants not to compete and class iv goodwill and going-concern value sec_1_1060-1t a b d temporary income_tax regs fed reg date dollar_figure after being reduced by the amount of class_i_assets consideration is allocated among assets in class ii in proportion to the fair market values of such assets on the purchase date then among class_iii_assets in proportion to the fair market values of such assets on that date sec_1_1060-1t d temporary income_tax regs supra the amount of consideration so attributed to an asset in classes i through iii may not exceed the fair_market_value of the asset on the purchase date all remaining consideration or residual consideration must be allocated to class_iv_assets see eg east ford inc v commissioner tcmemo_1994_261 petitioner did not allocate any portion of the purchase_price to class_iv_assets if we determine that petitioner overvalued the fia lease portfolio on its tax_return then the difference between the fair market of the lease portfolio and the purchase_price must be allocated to class_iv_assets petitioner claims it neither acquired a trade_or_business when it purchased fia's assets nor paid a premium for fia's assets nor acquired goodwill respondent on the other hand contends that this temporary_regulation was amended on date see fed reg date because the amended regulation is effective for asset acquisitions completed on or after date it is inapplicable herein petitioner acquired a trade_or_business paid a premium and acquired goodwill the parties presented expert witnesses to value the lease portfolio and thereby determine whether petitioner paid for any goodwill or going-concern value when it purchased fia's assets g expert witnesses as the trier of fact we must weigh the evidence presented by the experts in light of their demonstrated qualifications in addition to all other credible_evidence 480_f2d_171 9th cir affg 54_tc_493 however we are not bound by the opinion of any expert witness when that opinion is contrary to our judgment 227_f2d_753 6th cir affg tcmemo_1954_139 84_tc_722 we may accept or reject expert testimony as we find appropriate in our best judgment 304_us_282 102_tc_149 petitioner claims that the value of the lease portfolio is dollar_figure while respondent contends that the value is respondent points to the fact that in its application to the board_of governors of the federal reserve system petitioner sought approval to acquire substantially_all of the assets and assume substantially_all of the liabilities to unrelated parties of a going concern emphasis added dollar_figure the dollar_figure difference between the parties' valuations is explained by the different discount rates used by their experts respondent's expert used a 6-percent discount rate while petitioner's expert used an 5-percent discount rate petitioner's expert petitioner's expert peter s huck of american appraisal associates has an m b a from marquette university and is a senior member of the american society of appraisers he wrote a direct report and testified regarding the fair_market_value of fia's lease portfoliodollar_figure using the discounted cash-flow method he determined a dollar_figure value for the fia lease portfolio on date by taking the sum of scheduled lease payments and book residual values less third-party debt service payments and then discounted the final amount to present_value using an 5-percent ratedollar_figure to the result of that calculation dollar_figure mr huck added the principal balance of the debt associated with the leases for a at trial mr huck acknowledged that the transaction herein involved a lease portfolio but included a business-- aspects of a business in selecting an 5-percent discount rate mr huck relied upon the following the annual percentage rate apr on fia lease transactions for the first and second half of the relationship between the leases' apr and 5-year government bonds the 49-percent yield specified in the march agreement and the rates used in other lease transactions in the marketplace at the time of the transaction total value of dollar_figure mr huck testified that the percent discount rate he determined was based on the receivable yield amount or receivable yield in his view the 5-percent discount rate is consistent with the 49-percent yield on the leases discussed in the march agreement mr huck based his analysis on financing for the net receivables with both debt and equity he concluded that under the residual_method the purchase_price dollar_figure was less than the sum of the fair_market_value of the lease receivables and the other tangible assets acquired dollar_figure and hence no portion of the purchase_price should be allocated to goodwill or going-concern value respondent's expert respondent's expert david n fuller of business valuation services inc has an m b a from southern methodist university he is a chartered financial analyst and an accredited senior appraiser certified by the american society of appraisers mr fuller wrote a rebuttal report54 and testified regarding the fair mr huck initially made a mathematical error of approximately dollar_figure with regard to cash inflow but subsequently corrected the error mr fuller only prepared a rebuttal report because he believed the information petitioner provided contained insufficient and questionable data to determine a precise value for the lease portfolio based on the record we believe the continued market_value of the fia lease portfolio he determined that the fair_market_value of fia's lease portfolio as of date did not exceed dollar_figure dollar_figure less than mr huck's valuation consequently mr fuller attributed dollar_figure of the purchase_price to goodwill mr fuller arrived at the value for the lease portfolio through his sensitivity analysis by applying a 6-percent rate to discount the same cash-flow mr huck used lease payments plus book residual values less nonrecourse debt service payments the 6-percent rate represented the cost of equity_capital which mr fuller computed using the capital_asset pricing model this analysis was based on the assumption that with regard to a hypothetical buyer the portion of the lease portfolio not financed by nonrecourse debt would be financed entirely by equity mr fuller opined that hi sec_15 6-percent rate compares favorably with the 15-percent rate of return on equity that fia continued information provided to both experts may have been to a certain extent unreliable mr fuller believed that the value of fia's lease portfolio could be less than dollar_figure but was unable to refine this belief due to lack of data as discussed supra note his value of dollar_figure for the fia lease portfolio when added to the agreed value of dollar_figure for fia's other assets acquired by petitioner the noncompete agreement with fia and commercial the license to use the fia name and the other assets totals dollar_figure or dollar_figure less than the purchase_price generally exceeded both before and after its acquisition by federal and the 15-percent rate of return on equity that petitioner projected its proposed acquisition of fia would produce in sum mr fuller testified that mr huck overvalued fia's lease portfolio by approximately dollar_figure to dollar_figure million which results in approximately dollar_figure to dollar_figure million in intangible assets critique of experts not unexpectedly each expert criticized his colleague's analysis the following points highlight these disparate perspectives mr fuller opined that mr huck simply used the portfolio's expected yield the rate at which petitioner expected the portfolio to earn income as the appropriate discount rate use of the portfolio's expected yield he insisted assumes that no other assets are necessary to realize that yield and treats the portfolio as the equivalent of a fixed-income instrument according to mr fuller mr huck ignored the fact that petitioner purchased a going concern the purchase included the fia portfolio in addition to other fia assets and the right to hire fia's expert personnel who originated the equipment leases and turned the residual_value into profits the presence of these other business_assets in mr fuller's opinion was necessary to produce income at the yield rate mr fuller contended that the 49-percent yield required by the march agreement while providing a mechanism for a downward adjustment to the purchase_price was not indicative of the appropriate discount rate mr huck countered these arguments by reiterating that he did not simply rely on the expected yield rate but used several factors enumerated supra note to reach his conclusion these factors he believed clearly indicate that an 5-percent discount rate represents the current market rate for comparable assets mr fuller also believed that instead of using a cash inflow analysis mr huck should have used a cash-flow analysis referring to the net cash-flow generated after considering all expenses and necessary adjustments and according to mr fuller mr huck erred by not using the capital_asset pricing model to determine the appropriate discount rate to be applied to cash-flow attributable to invested capitaldollar_figure finally mr fuller criticized mr huck for failing to include capital charges in his analysisdollar_figure mr huck testified that he did not use the capital_asset pricing model because he considered it inappropriate herein mr fuller testified that the premise of a capital charge is that other assets besides the asset being valued such as the lease portfolio herein are necessary to produce the business cash-flow capital charges take into account the presence of these other assets by assigning a portion of the cash-flow to them leaving only the cash-flow attributable to the asset being valued mr fuller did not take this approach in his report which would have had the effect of reducing the value of continued mr huck criticized mr fuller's rebuttal report claiming rather than doing an independent valuation mr fuller merely used mr huck's analysis and applied an incorrect discount rate equity rate of return to those numbers mr fuller did not consider recourse_debt in determining cash-flow but rather assumed that any portion of the purchase_price not funded with nonrecourse debt would be funded with equity and a typical buyer of the lease portfolio would finance its acquisition with a combination of nonrecourse debt recourse_debt and equity while mr huck discounted gross cash-flows net only of nonrecourse debt based on the market rate for such assets which reflected the required blended cost of capital mr fuller discounted the same cash-flows using an equity rate these cash-flows did not consider recourse_debt service operating_expenses and taxes because mr fuller did not apply his equity rate against equity cash-flows mr huck believes that mr fuller's analysis is seriously flawed simply put mr huck claims that mr fuller used an equity rate for purposes of discounting the lease portfolio's cash-flows whereas those cash-flows included a return on debt in mr huck's view mr fuller should have based his discount rate on the market receivable yield which accounts for the expected debt leveraging continued the portfolio below dollar_figure because he did not believe he had sufficient information to do so mr fuller acknowledged at trial that normally a purchaser would not finance the acquisition of a lease portfolio with percent equity he admitted that if a mixture of debt and equity were used he would be forced to lower the 6-percent discount rate he had determined however mr fuller believed that the net cash-flow from fia's lease portfolio is for the most part an equity cash-flow to the holder of the net equity_investment in the portfolio which requires an equity rate of return to properly discount it to present_value finally petitioner criticized mr fuller's use of the percent premium commercial paid in as another basis for determining the value of fia's intangible assets in petitioner first complains that mr fuller ignored industry practice which is intended to reflect the negotiated value of intangible assets as an amount over and above net asset value and second petitioner maintains circumstances were different in and because when commercial purchased fia in it acquired the services of mr rafanello fia's most important employee whereas petitioner did not acquire mr rafanello's services in h conclusion we have considered the qualifications and experience of the parties' experts as well as the substance and reasoning of their reports the difference in their respective valuations of fia's leasehold portfolio is explained by the different discount rates they used percent by respondent's expert mr fuller percent by petitioner's expert mr huck as discussed above both expert reports are susceptible to criticism while we find mr huck's analysis generally sound mr fuller established that mr huck' sec_11 5-percent discount rate should be adjusted upward both experts admitted at trial the inexactitude of their methodologies mr huck conceded that in light of the imprecise nature of valuing assets the appropriate discount rate herein could be anywhere from to percent and mr fuller conceded that hi sec_15 6-percent discount rate could be reduced somewhat to properly reflect debt and equity financing thus in consideration of all the evidence presented and in light of both experts' forthright flexibility we adopt percent as the appropriate discount rate hereindollar_figure because other issues remain to be resolved in these consolidated cases appropriate orders will be issued we expect the parties' rule_155_computations to utilize the 13-percent discount rate to determine the exact value of the lease portfolio and any remaining value to be attributed to goodwill or going-concern value we expect the parties to correct in their rule_155_computations any overstatement of cash inflows and mathematical errors mr huck made