Opinion ID: 46232
Heading Depth: 2
Heading Rank: 1

Heading: Depreciation Deduction

Text: 10 Section 167 of the I.R.C. provides for a depreciation deduction for the exhaustion, wear and tear . . . (1) of property used in the trade or business, or (2) of property held for the production of income. 26 U.S.C. § 167(a). The issue is whether, for the purpose of being entitled to a depreciation deduction, Arevalo owned the payphones. In the context of a sale, when determining the ownership of an asset for tax purposes, courts look at many different factors indicative of ownership, not just the passage of bare legal title. Upham v. Comm'r, 923 F.2d 1328, 1334 (8th Cir.1991) (citing Bailey v. Comm'r, 912 F.2d 44, 47 (2d Cir.1990)); see also Crooks, 453 F.3d at 656 (discussing and applying the Upham factors). Among the factors are: 11 (1) Whether legal title passes; (2) the manner in which the parties treat the transaction; (3) whether the purchaser acquired any equity in the property; (4) whether the purchaser has any control over the property and, if so, the extent of such control; (5) whether the purchaser bears the risk of loss or damage to the property; and (6) whether the purchaser will receive any benefit from the operation and disposition of the property. 12 Upham, 923 F.2d at 1334 (quoting Houchins v. Comm'r, 79 T.C. 570, 591, 1982 WL 11155 (1982)). Additionally, where the transferor continues to retain significant control over the property transferred, the transfer of formal legal title will not operate to shift the incidence of taxation attributable to ownership of the property. Id. (citing Bailey, 912 F.2d at 47; Durkin v. Comm'r, 872 F.2d 1271, 1275 (7th Cir. 1989); Tolwinsky v. Comm'r, 86 T.C. 1009, 1041, 1986 WL 22132 (1986); Law v. Comm'r, 86 T.C. 1065, 1094, 1986 WL 22133 (1986)). Stated another way, if the benefits and burdens of ownership have not passed from the seller to the purchaser, then courts will disregard the transfer of formal legal title when determining ownership of an asset for tax purposes. Bailey, 912 F.2d at 47. The Supreme Court has repeatedly stressed that, in examining transactions for the purpose of determining their tax consequences, substance governs over form. See Frank Lyon Co. v. United States, 435 U.S. 561, 572-73, 98 S.Ct. 1291, 55 L.Ed.2d 550 (1978) (discussing the substance over form doctrine and referencing a number of cases where it has been applied). 13 Whether Arevalo had ownership of the payphones entitling him to a depreciation deduction is a factual issue that we review for clear error. Upham, 923 F.2d at 1334. The Tax Court listed eight reasons for its conclusion that the benefits and burdens of ownership had not shifted from Alpha Telecom to Arevalo in the act of sale. Among them, the Tax Court noted that Arevalo had no control over the phones, he never took possession of them, he did not know where they were located nor have identification information for them, and he did not have the authority to enter into any site agreements. Arevalo also bore almost no risk of loss; due to the buy-back election, Arevalo could sell the phones back to Alpha Telecom for their full value, minus a restocking fee if the election was made in the first three years. Alpha Telecom was additionally responsible for all maintenance of the phones. As a result, despite Arevalo's legal title to the phones, the Tax Court found that, for the purpose of being entitled to a depreciation deduction, Arevalo did not own the phones. 14 On appeal, Arevalo argues that he assumed the benefits and burdens of ownership. He points out, inter alia, that he did control the phones, since he had the right to sell them and he had to pay for repairs that were not part of the service contract. He maintains that he did bear the risk of loss because he lost all of the money when the company went bankrupt. Notwithstanding his arguments, we agree with the analysis of the Tax Court. Taxpayers bear the burden of proving their entitlement to deductions. INDOPCO, Inc. v. Comm'r, 503 U.S. 79, 84, 112 S.Ct. 1039, 117 L.Ed.2d 226 (1992) (citing Interstate Transit Lines v. Comm'r, 319 U.S. 590, 593, 63 S.Ct. 1279, 87 L.Ed. 1607 (1943)). Arevalo has not shown that he maintained substantial control over the payphones. See Upham, 923 F.2d at 1334. The purchase and service agreements indicate that Alpha Telecom was responsible for the installation, location selection, operation and maintenance of the phones. The company also retained the greatest potential for profit and bore the risk of loss if the phones did not generate sufficient revenue because Arevalo was guaranteed to be paid at least the lower of $58.34 or the entire revenue for the phone every month. See Crooks, 453 F.3d at 656 (concluding that, based on the Upham factors, the Tax Court properly declined to permit the depreciation deduction). We conclude that the finding of the Tax Court is not clearly erroneous.