Court Opinion

ID: 4482861
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:15:44.831649+00
Date Added: 2024-06-11T14:27:53.951797
License: Public Domain

Wilbur, J., dissenting: The majority opinion founders on an artificial “either-or” dichotomy, and the decision reached suffers from hardening of the categories. The logic proceeds this way: either the transaction must be a sale or exchange; it can’t be an exchange as the lease has no capital value; therefore it must be a sale.1  This conclusion enables petitioner to immediately write off 25 percent of the costs of acquiring the right to use a building for one-half a century that was constructed for its own special purposes.2 This does not accord with my understanding of the applicable law. The expenditure at issue here was clearly incurred for the leasehold interest of 50 years. The majority concedes this by stating that Leslie “would not have entered into the sales part of the transaction without the guarantee of the leaseback;” that the leaseback “was a necessary condition of the sale;” and that “it was only because of the leasehold that petitioner was willing to spend $3,187 million,” (thus incurring the loss). This is indeed an ineluctable conclusion, since petitioner constructed the building for Prudential at cost, could not hope to make a profit,3 but could very well incur a loss in view of the upper limit of $2.4 million on Prudential’s investment commitment. Additionally, petitioner had for several years been planning a new facility, had purchased a site, had plans designed for the facility, and had sought financing from several sources. The arrangement with Prudential brought these goals to fruition; and petitioner’s sole motivation for entering into this agreement was to acquire the right to use the building for 50 years. This was the only right Leslie acquired when the first contract with Prudential was signed. The “loss” was purely and simply incurred to acquire the leasehold interest. The majority ignores the consequences of its own findings by concluding the lease had no capital value.4 If the thinly supported findings as to fair market value require the conclusion that a loss was incurred, in view of the above analysis, why must the loss be attributed to the construction of the building (for cost on which no gain was possible) rather than to the acquisition of the leasehold, which was petitioner’s only objective? The answer of the majority is two-fold. Since Prudential didn’t receive property whose value exceeded the $2.4 million it paid, the leasehold interest must therefore have been worth nothing. Additionally, since the leasehold contemplated fair “rental,” it was in fact worth nothing. But this clearly begs the question, since, according to the majority it was petitioner who expended money in excess of the consideration received, and thus incurred the loss here in issue. The question is what was the “loss” attributable to? On this record, the “loss” is clearly attributable to the acquisition of the right to use the property at a fixed rental (diminishing substantially after 30 years) over one-half a century.5  The majority also fragments the transaction into component parts that are completely incompatible with its findings that “the sale and leaseback was merely successive steps of a single integrated transaction,” and that the leaseback was “an integral part of the transaction.” It is also incompatible with recognized principles of tax law. As we stated in George A. Roesel, 56 T.C. 14, 25-26(1971): the economic substance of a transaction must govern for tax purposes rather than the time sequence or form in which such transaction is cast. Gregory v. Helvering, 293 U.S. 465. And it is well established that where a series of closely related steps are taken pursuant to a plan to achieve an intended result the transaction must be viewed as an integrated whole for tax purposes. Redwing Carriers, Inc. v. Tomlinson, (C.A. 5) 399 F. 2d 652, and cases cited therein. This fragmentation is also wholly at odds with the underlying economic realities. In analyzing respondent’s argument that the loss was incurred to acquire the leasehold interest, the majority notes that this “seems to comport with the economic realities.” Indeed it does, and the general rule, as noted in the above quotation, is that taxation is predicated upon the economic realities. Prudential clearly looked upon this venture as a financing transaction providing the opportunity to invest $2.4 million at a reasonable interest rate with minimal risks to principal during the period of principal amortization. Petitioner was willing to incur the risk that construction costs would exceed the maximum of $2.4 million Prudential agreed to invest, since the risk was more than offset by the right to use the property for 50 years into the future at a fixed annual rental that was not only precluded from increasing, but was reduced substantially at the end of 30 years.6 - While I believe the economic realities the majority refers to should control, this case does not really require the application of metaphysical concepts like substance over form, or any similar esoteric principles. In both substance and form petitioner contracted at the outset with Prudential for a long-term lease. The contract between the parties contemplated from the beginning— before the first brick was laid — that Prudential would own the land and the building and gave petitioner the right to a half-century of occupancy in return for the agreed rental and the risk of construction cost overruns. Petitioner could not possibly realize a profit on construction and was required7 to convey title to Prudential as soon as the building was completed. The fact that transitory title was lodged in petitioner briefly along the way does not obscure the inexorable destination of the trip. In summary, the amount here in controversy was both in substance and in form clearly incurred to acquire the leasehold interest, not to make a profit on construction, which was impossible under the terms of the contract involved. The “sale” was merely a “step” in an “integrated transaction,” in the majority’s own words. We should not view events the parties have telescoped into one package from the reverse end of the telescope. Tannenwald and Hall, JJ., agree with this dissent.   This is known as the fallacy of the unextended middle. That there was a middle not considered in this case is clearly spelled out in n. 4 of Judge Tannenwald’s dissenting opinion. But more importantly, the majority opinion begs the question, ignoring both the form and substance of the transaction, as indicated later in this opinion.    The majority found that the initial agreement provided for the execution of a lease including a rejectable offer to purchase at specified prices after 15, 20, 25, and 30 years. The lease however, did not give Prudential the right to sell the property to Leslie for the specified prices at these intervals, but simply provides that Leslie, at its option, may offer to purchase the property for the specified prices at these intervals, and if Prudential rejects the offer, the lease will terminate. Thus, Leslie had the right under the lease to a 50-year term (at a predetermined fixed rent), a term equal to the useful life Prudential claimed for depreciation purposes, and nearly twice the useful life stipulated to by the parties. According to testimony offered by both parties, there was every expectation Leslie would use the building for this period.    Par. 1 of the Oct. 30,1967, letter agreement states that “the sales price shall not exceed $2,400,000 or the actual cost of the land, building, and other improvements erected thereon, whichever is less." (Emphasis added.)    This is a questionable conclusion. The record makes it abundantly clear that Prudential viewed its role as financier rather than landlord, with the opportunity to invest a fixed amount ($2.4 million) recoverable over 30 years with minimal risk to principal. Net “rent” was a percentage of the amount Prudential invested — 7.94 percent of $2.4 million for the first 30 years, providing both a fixed interest equivalent and principal amortization. After the first 30 years (when Prudential expected to recover its investment), the “rent” was reduced to 3 percent of the original amount Prudential invested, because in the words of the Prudential official responsible for the transaction, “it was adequate after our initial 30-year period. It covered depreciation and et cetera.” If the “rent” charged pursuant to Prudential’s financing objectives bore any relation to the rent an owner of the premises not involved in this type of financing would charge, it was purely coincidental. I seriously doubt the coincidence occurred. Such expert testimony as there is appears directed to the rentals charged for similar space at the time of the lease. In this case the “rent” for valuable real estate in a major metropolitan area could not be increased for one-half a century, and the “rent” for the last 20 years actually decreased to a little more than one-third of the “rent” charged during the first 30 years. Granted it was a net lease, it is still hard to believe that, aside from this package transaction and Prudential’s financing role, an owner of real estate in this area would agree to a fixed “rent” for years nearly a half century in the future equal to 3 percent of the property’s current value. It may have been adequate to Prudential’s financing objectives, but there are real doubts it represented fair rental value over the half-century term of the lease.    For this reason I don’t deal with the issue of whether or not the leasehold interest may have had some subjective value to petitioners different from its objective or fair market value. Since under the facts here present the expenditure or “loss” was incurred as an integral part of the agreement to acquire the leasehold, rather than to liquidate a prior investment of considerable duration, this case is clearly distinguishable from Jordan Marsh Co. v. Commissioner, 269 F.2d 453 (2d Cir. 1959), nonacq. Rev. Rul. 60-43, 1960-1 C.B. 687, revg. a Memorandum Opinion of this Court. It is also distinguishable because Leslie could not hope, under the terms of its agreement to realize any profit from construction of the building or its transitory ownership of the property. It is, however, puzzling that the majority, after making its findings of fair rental value, specifically rely on Jordan Marsh Co. for its conclusion that there was a sale rather than an exchange, yet it claims it is unnecessary to consider the possible conflict between Jordan Marsh Co. and Century Electric Co., 15 T.C. 581 (1950), affd. 192 F.2d 155 (8th Cir. 1951), cert. denied 342 U.S. 954 (1952).    A substantial but unspecified portion of petitioner’s “loss” was attributable to special features presumably for Leslie’s particular needs that should have been amortized in any event. Leslie did, in fact, amortize the entire “loss” on its books.    Failure to convey title would have imposed substantial liquidated damages and probably caused petitioner to either default on their construction period loan or pay substantially higher interest rates to obtain alternative financing, or both.