Court Opinion

ID: 4484999
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:17:06.564237+00
Date Added: 2024-06-11T14:53:45.925893
License: Public Domain

Cohen, Judge, dissenting: I respectfully dissent from the opinion of the majority insofar as it allows the taxpayer to circumvent the pre-opening expense rules that the majority acknowledges apply to a trade or business. There is no doubt that the taxpayer, here, intended to engage in the trade or business of operating an office building, and that he was utilizing the land subject to the ground lease for the purpose of constructing such a building. Indeed, most of his brief is devoted to the argument that he was engaged in that trade or business during the taxable year. He argues, and I agree, that operation of a single piece of rental real property may constitute a trade or business. Lagreide v. Commissioner, 23 T.C. 508 (1954); Hazard v. Commissioner, 7 T.C. 372 (1946). Under similar circumstances, this Court has held that a taxpayer cannot avoid the pre-opening expense rules by claiming a deduction under section 212. For example, in Graybeal v. Commissioner, T.C. Memo. 1979-506, the Court held that the taxpayers could not deduct expenses incurred in anticipation of opening of a recreational vehicle (RV) campground1 because the "petitioners were not yet, if ever, in the 'trade or business’ of operating an RV campground at the time the claimed expenses were incurred and are thus not entitled to deduct such expenses under section 162.” The Court stated: Petitioners argue on brief that, if the expenses are not deductible under section 162, then they are deductible under section 212 as expenses paid or incurred during the taxable year on property held for the "production of income”. We believe this argument to be without merit. Petitioner-husband specifically testified that the expenses here in issue were expenses in connection with the development of the facilities for the RV park. He further testified that they were not in connection with the farm rental property. Further the RV campground was not rental property until January 1974. While the property was apparently leased to the family corporation in 1973, rents were not charged during that year. Petitioners clearly had two separate activities occurring on the same piece of property. One part was the farm rental business and the second was the development of an RV park. The expenses here in issue, according to petitioner-husband’s testimony and the evidence presented, clearly were connected with the development of the RV park. Accordingly, the expenses by petitioners are capital expenditures and thus not deductible. Respondent’s determination as to this issue is sustained. Similarly, in Swigart v. Commissioner, T.C. Memo. 1980-379, after determining that expenses relating to a proposed mobile home camp were not deductible because the facilities were only in the preliminary stages of development during the years in question, the Court stated: Nor does the record contain sufficient evidence that the mobile homes were being held for the production of income, independently of the claimed trade or business in respect of camping and recreational facilities, so as to sustain a deduction under section 212. Indeed, if anything, the evidence points in the opposite direction, namely, that the mobile homes were intended to be an integral part of the aforesaid claimed trade or business or for the personal use of the [taxpayer’s] sons. * * * See also Frank v. Commissioner, 20 T.C. 511, 514 (1953). The expenses, here, were obviously not intended to be personal, but the lease was an integral part of the rental trade or business contemplated by the taxpayer at the time the expenses were incurred. I submit that this case is indistinguishable from Walker v. Commissioner, 145 F.2d 602, 605 (6th Cir. 1944), affg. a Memorandum Opinion of this Court. In that case, the taxpayer leased certain real property and attempted to deduct under the predecessor of section 212 certain expenses incident to that real property including rental paid under the lease. The Court of Appeals stated: The question narrows to whether petitioner held the leased property during the years involved for the production of income. The Tax Court decided that he had failed to so show and this holding has substantial support in the record. It is true that Sec. 9 of the lease sets out that it was understood that one of petitioner’s purposes in obtaining it was to establish and maintain a pleasure resort thereon, hut the court considered this feature in connection with petitioner’s testimony * * * and concluded that the expenditures were a part of a plan to acquire the * * * [property of the lessor corporation]. * * * The taxpayer in the Walker case had acquired the lease and was attempting to acquire stock of the lessor corporation with the ultimate intention of developing land owned by the corporation. Section 212 is not a catchall for deduction of all nonpersonal expenses. Section 212 is coextensive in most respects with section 162. Trust of Bingham v. Commissioner, 325 U.S. 365 (1945) (discussing predecessors of the two sections); and petitioner may not deduct expenses under section 212 that could not be deducted under section 162(a) were they connected to a trade or business. Beck v. Commissioner, 15 T.C. 642, 669 (1950), affd. per curiam 194 F.2d 537 (2d Cir. 1952). As this Court recently noted: "except for the requirement of being incurred in connection with a trade or business,” * * * a deduction under section 212 "is subject * * * to all the restrictions and limitations that apply in the case of the deduction under * * * [section 162(a)] of an expense paid or incurred in carrying on any trade or business.” Estate of Davis v. Commissioner, 79 T.C. 503, 507 (1982), quoting H. Rept. 2333, 77th Cong., 2d Sess. (1942), 1942-2 C.B. 372, 430, and S. Rept. 1631, 77th Cong., 2d Sess. (1942), 1942-2 C.B. 504, 571, the legislative history to the predecessor of section 212. The phrase "carrying on” in section 162 is the language that creates the timing requirement therein; only the "trade or business” requirement of section 162 is missing in section 212. A temporal requirement is implied in section 212 by the requirement that the property be "held” for the production of income at the time the expense is incurred. Thus, in applying section 212 in other contexts, we have said: There is a basic distinction between allowing deductions for expenses in connection with taxable income or income-producing property in which one already has an existing interest or right, on the one hand, and expenses incurred in an attempt to obtain income by the creation or acquisition of some new interest, on the other hand. Frank v. Commissioner, 20 T.C. 511, 514 (1953); Beck v. Commissioner, 15 T.C. 642, 670 (1950), affd. per curiam 194 F.2d 537 (2d Cir. 1952), cert. denied 344 U.S. 821 (1952). Contini v. Commissioner, 76 T.C. 447, 452 (1981). Petitioner’s announced intention, ultimately carried into effect in this case, was to acquire an interest in an office building constructed on leased land and to operate the office building as a business. He was required to build a building under the terms of the lease; obtaining the lease and paying the rental were merely preliminary steps. He did not, during the tax year in question, "hold” the lease for the purpose of producing income; he was fulfilling his part of the contract and constructing an asset that later would be used in the rental trade or business. . The majority here seems to believe that ground rents are somehow unique, inasmuch as they are recurring and are designated as rentals incurred for particular time periods. It is inaccurate and not conclusive of the issue to say that "the rent paid during 1976 did not produce any equity that survived a year beyond the time that the payment was made.” Payments on a lease are payments for acquisition of an "estate-for-years” in the land. See C. Moynihan, Introduction to the Law of Real Property 64 (1962). Each payment is necessary to the acquisition of the whole interest. Long-term ground leases are in many localities the only means of acquiring land. In California, where this property was located, 55 years, the original term of the subject leqse, is the maximum legal term of a lease of property held by, or under management and control of, a municipal body. Cal. Civ. Code sec. 718 (West 1981). The lease payments thus are essentially equivalent in this respect to payments of interest and principal in purchasing the land. See section 1.1031(a)-l(c), Income Tax Regs., wherein a lease of more than 30 years is treated the same as a fee interest in real property. See also note 5 infra. We have rejected the contention that items that cannot be expected to provide benefits beyond the taxable year are not subject to the pre-opening expense rules, which require capitalization of rents,2 salaries,3 and other "ordinary and necessary” expenses clearly deductible on a current basis once the business has commenced.4 Moreover, any idea that such items cannot be considered capital should have been abandoned after the Supreme Court opinion in Commissioner v. Idaho Power Co., 418 U.S. 1 (1974), which reversed a Ninth Circuit holding to the contrary and reinstated this Court’s determination that depreciation of equipment used to self-construct capital improvements for use in the taxpayer’s trade or business had to be capitalized as part of the cost of the improvements. The Court stated in part: There can be little question that other construction-related expense items, such as tools, materials, and wages paid construction workers, are to be treated as part of the cost of acquisition of a capital asset. The taxpayer does not dispute this. Of course, reasonable wages paid in the carrying on of a trade or business qualify as a deduction from gross income. Sec. 162(a)(1) of the 1954 Code, 26 U.S.C. sec. 162(a)(1). But when wages are paid in connection with the construction or acquisition of a capital asset, they must be capitalized and are then entitled to be amortized over the life of the capital asset so acquired. * * * Construction-related depreciation is not unlike expenditures for wages for construction workers. The significant fact is that the exhaustion of construction equipment does not represent the final disposition of the taxpayer’s investment in that equipment; rather, the investment in the equipment is assimilated into the cost of the capital asset constructed. Construction-related depreciation oh the equipment is not an expense to the taxpayer of its day-to-day business. It is, however, appropriately recognized as a part of the taxpayer’s cost or investment in the capital asset. * * * By the same token, this capitalization prevents the distortion of income that would otherwise occur if depreciation properly allocable to asset acquisition were deducted from gross income currently realized. [418 U.S. at 14; citations omitted.] The Court went on to discuss "an additional pertinent factor,” i.e., that of maintaining tax parity between taxpayers. If the taxpayer, here, had acquired the land on the basis of purchase, incurring interest and principal payments during the period of construction, he would be required to capitalize the greater portion of such payments.5 No demands of equity suggest that this taxpayer should be treated more favorably than such purchaser. The majority found that petitioner qualified for a deduction under section 212 "by virtue of his ownership of the lease.” But I do not see how this contractual interest is property superior to the contractual interests held by the taxpayers in the pre-opening expense cases (e.g., Goodwin v. Commissioner, 75 T.C. 424 (1980), affd. without published opinion 691 F.2d 490 (3d Cir. 1982) (partnership agreement; financing agreements); Madison Gas & Electric Co. v. Commissioner, 72 T.C. 521 (1979), affd. 633 F.2d 512 (7th Cir. 1980) (joint venture agreement; construction permit issued by the Nuclear Regulatory Commission); Bennett Paper Corp. v. Commissioner, 78 T.C. 458 (1982), affd. 699 F.2d 450 (8th Cir. 1983) (membership applications and deposits); or Kennedy v. Commissioner, T.C. Memo. 1973-15 (pharmaceutical license)). In almost all new businesses, taxpayers enter into leases or suppliers’ contracts or contracts with potential customers or obtain franchises or exclusive agency agreements. To say that the contract is the income-producing asset and the expenses relating to that are deductible is to create chaos among those attempting to decide cases on principle rather than on the level of imagination utilized by the taxpayer. In my opinion, the approach of the majority will create new "incongruities in this area of the law,” which can only constitute a renewed inducement to controversy and an impediment to settlement of litigation.6  Tannenwald, Featherston, Irwin, Wilbur, Chabot, Nims, and Hamblen, JJ., agree with this dissenting opinion.  The claimed loss consisted of the following items: Depreciation . $618.00 Repairs . 74.61 Salaries and wages . 48.00 Insurance . 282.00 Interest on business debt . 2,016.67 Other (telephone, etc.) . 2,453.83 5,493.11 Other labor . 495.34 Total loss . 5,988.45   E.g., Bennett Paper Corp. v. Commissioner, 78 T.C. 458 (1982), affd. 699 F.2d 450 (8th Cir. 1983); Kennedy v. Commissioner, T.C. Memo. 1973-15.   E.g., Madison Gas & Electric Co. v. Commissioner, 72 T.C. 521 (1979), affd. 633 F.2d 512 (7th Cir. 1980).   See Goodwin v. Commissioner, 75 T.C. 424, 434 n.8 (1980), affd. without published opinion 691 F.2d 490 (3d Cir. 1982).   Sec. 189, I.R.C. 1954, as amended, has contravened statutes permitting deduction of interest and taxes by requiring amortization of construction period interest and taxes. A special transitional rule applied to 1976 that permitted a deduction of 50 percent of the expenses that previously had been deductible in full. Sec. 189(f). The balance would be amortizable at 16% percent per year.   The Senate Finance Committee stated, as its reason for the enactment of section 195, that: "The committee believes that the provision for the amortization of business startup and investigatory expenses will encourage formation of new businesses and decrease controversy and litigation arising under present law with respect to the proper income tax classification of startup expenditures [S. Rept. 96-1036, at 11 (1980).]”