Court Opinion

ID: 4472353
Source: CourtListenerOpinion
Date Created: 2020-01-13 23:23:42.936648+00
Date Added: 2024-06-11T08:48:26.181477
License: Public Domain

Halpern, J., concurring: I. Introduction I concur in the result reached by the majority. I write separately only because I think that the majority has unnecessarily looked too far to see whether petitioner husband (petitioner) was protected against loss within the meaning of section 465(b)(4). The majority has determined that, with respect to the long-term note, petitioner was protected against loss through an “other similar arrangement”, as that term is used in section 465(b)(4). Majority op. p. 129. In its analysis, the majority has totally disregarded the nonrecourse aspect to the long-term note and accorded only make-weight status to the rent guarantees. “Nonrecourse financing” and “guarantees” are specifically enumerated in section 465(b)(4). Because petitioners have conceded that petitioner was not at risk with respect to the nonrecourse portion of the long-term note ($163,750), and have argued that the rent guarantees should be disregarded in their entirety, I see no need to find or cumulate factors as the majority has done in order to determine whether petitioner was protected against loss through an arrangement that is similar to either nonrecourse financing, a guarantee, or a stop-loss agreement. Petitioners have failed to show that the protection against loss afforded petitioner by the nonrecourse financing and guarantees is insufficient to eliminate any risk otherwise attendant to petitioner’s investment of the proceeds of the long-term note. I would so hold. II. Nonrecourse Financing Where a note has been partially recourse, we have looked no further to determine that, to the extent of the nonrecourse portion of the note, the taxpayer was not at risk for purposes of section 465(b). See, e.g., B&A Distributing Co. v. Commissioner, T.C. Memo. 1988-589 (limited recourse promissory note); cf. Berger v. Commissioner, T.C. Memo. 1994-298 (attempt to add recourse feature to nonrecourse note). III. Guarantees A. The Guarantee Equilease, under the capitalization agreements, guaranteed Associates’ and C.V.’s obligations to pay rent to the tenants in common (including petitioner). To quote the majority: Equilease agreed “to make all necessary loans, advances or capital contributions to C.V. and Associates, respectively, to ensure the payment by C.V. and Associates” of rents to the tenants in common. Equilease’s obligations were contingent on Aardan’s continuing to make payments on its notes to Associates and C.V. for purchase of the Associates and C.V. equipment, respectively. [Majority op. p. 124.] B. Precedent There is no case in which we have explored the meaning of the term “guarantee”, as that term is used in section 465(b)(4). A dictionary definition includes the following: “A pledge that something will be performed in a specified manner. * * * A guaranty by which one person assumes responsibility for paying another’s debts or fulfilling another’s responsibilities.” American Heritage Dictionary of the English Language (3d ed. 1992). Nevertheless, guarantees and similar arrangements have played a role in our determining that a taxpayer was not at risk on account of section 465(b)(4). For example: In Thornock v. Commissioner, 94 T.C. 439, 451 (1990), rent guarantees were a primary factor leading us to find that “no realistic possibility existed that the * * * [taxpayers] would be ultimately liable to make any payments on * * * [their] debt obligations”. In Capek v. Commissioner, 86 T.C. 14 (1986), we dealt with a coal mining program that required the taxpayer in question to pay certain advance royalties. A mining company was to pay penalties to the taxpayer if the mining company failed to mine the land leased by the taxpayer. We stated that it was obvious from the facts of the case that “the effect of the penalty provision was to protect an investor from any loss on the recourse note executed by him in favor of * * * [a lender who advanced the required advance royalty payments]”. Id. at 52. We concluded that “the penalty provisions in the mining contracts were stop loss agreements or other similar arrangements within the meaning of section 465(b)(4).” Id. at 53. C. Eliminating the Risk of Default In Thornock v. Commissioner, supra, and Capek v. Commissioner, supra, we examined the guarantees there in question with an eye to determining whether the taxpayer had insured against his liability to repay borrowed funds contributed by him to the activity. Such a determination is appropriate because there is no doubt that, if a taxpayer borrows funds for use in a section 465 activity and obtains insurance against his personal obligation to repay those funds, he will not be considered at risk with regard to those funds for purposes of section 465(b)(2). See sec. 465(b)(4).1 Presumably, the taxpayer will not be considered at risk because he has eliminated the economic risk to himself of a deficiency judgment against him should he default on his personal obligation. The economic risk that he has eliminated is the risk that, upon his default, he would be called upon to make up the difference between his indebtedness and the amount realized from a sale of the property securing that indebtedness. That risk (the risk of default) has been shifted to the insurer. Indeed, when the Commissioner has argued that a taxpayer is protected against loss with respect to a particular debt obligation, we have characterized our inquiry under section 465(b)(4) as follows: “who realistically will be the payor of last resort if the transaction goes sour and the secured property associated with the transaction is not adequate to pay off the debt[?]”. Levy v. Commissioner, 91 T.C. 838, 869 (1988). D. Assuring the Value of the Investment Most investments require at least some of the investor’s own funds (equity capital) in addition' to borrowed funds (debt capital). Section 465 clearly contemplates that an investor may be at risk with respect to equity capital. Compare sec. 465(b)(1)(A) with (B). Section 465(b)(4) just as clearly contemplates that an investor will not be considered at risk to the extent that his equity capital is protected against loss.2 Where an investment consists in whole or in part of debt capital, it is natural to look at the liability side of the balance sheet, and ask whether there is a realistic risk of default if the investment goes sour. Unless the debtor’s protection from the risk of default is blatant (e.g., he has obtained mortgage insurance or the debt is nonrecourse), it may be necessary to weigh numerous factors, including guarantees, to determine the reality of such risk. See, e.g., Thornock v. Commissioner, supra at 448-449 (to determine whether “other similar arrangements” effectively immunized highly leveraged investors from any realistic possibility of suffering an economic loss, we analyzed “the substance and commercial realities of all material aspects of the transaction.”)- Such an examination is perfectly appropriate. Nonetheless, in determining a taxpayer’s amount at risk, where asset value or investment return is directly protected against loss by a guarantee or other arrangement proscribed by section 465(b)(4), and focusing only on the effect of such guarantee or other arrangement, the character of the taxpayer’s investment — whether debt capital or equity capital— can have little (if any) consequence. Thus, in some cases, such as this, a guarantee of asset value or investment return may eliminate the need to consider additional factors, since the guarantee, itself, is sufficient to eliminate all risk of loss with respect to the amount (whether debt financed or equity financed) in question. Indeed, in Cooper v. Commissioner, 88 T.C. 84 (1987), we confronted certain lessor-borrowers who were personally liable with regard to purchase money indebtedness incurred to purchase the leased property, but who had options to put that property, which secured their indebtedness, to the lessee at the end of the lease term for amounts approximately equal to the remaining balances of their indebtedness. We said: These petitioners, through their put options, were protected from economic loss [the risk of default] from the inception of their transactions. * * * Therefore, their obligations under the notes may not be added to their amounts at risk. * * * [Id. at 112-113.] E. Rent Guarantees The principal financial obligation of a lessee is to pay rent. The financial value of a lease is the present value of the rent stream expected over the unexpired term of the lease. Generally, a guarantee of rent adds to the financial value of a lease. If the guarantee (1) can be relied upon and (2) is unconditional, then the financial value of the lease, together with the value of the guarantee (together, the guaranteed value of the lease), will equal the financial value of a lease to a lessee presenting no risk of lease default. The guarantee shifts the risk of lease default to the guarantor. Because of the guarantee, the lessor can disregard that risk in determining what his loss might be should the activity in which the leased property is used fail. If the leased property has been purchased with debt capital, and should the activity fail (e.g., because of the lessee’s default), then the guarantee assures that the guaranteed value of the lease will be available to repay the indebtedness before any charge need be made to capital. To the extent of the guaranteed value of the lease, the risk of default on the loan has been shifted to the guarantor. To that extent, the guarantee may provide a sufficient basis for us to find that the taxpayer is not at risk with regard to borrowed funds used to purchase the leased property. See sec. 465(b)(4); Cooper v. Commissioner, supra; Capek v. Commissioner, 86 T.C. 14 (1986). F. Application to the Facts at Hand Petitioner was a borrower with regard to the activity here in question. He incurred a purchase money indebtedness to Aardan in connection with his acquisition of an interest in the Associates and C.V. equipment. The long-term note indebted petitioner to pay Aardan the principal amount of $488,750. The long-term note was not due until December 31, 1998. Nevertheless, prepayment was obligatory to the extent of fixed rent payments received from Associates and C.V. Petitioner’s indebtedness was secured by (1) his fractional interests in the computer equipment purchased from Aardan and (2) his rights under the agreements leasing that equipment to Associates and C.V. Aardan had the right to collect the rent due petitioner under those agreements. Under the capitalization agreements, subject to certain conditions, Equilease agreed “to make all necessary loans, advances or capital contributions to C.V. and Associates, respectively, to ensure the payment by C.V. and Associates” of rents to petitioner. A direct benefit to petitioner of the capitalization agreements was that some portion of the risk that Associates and C.V. would default on their obligations to pay rent was shifted from petitioner to Equilease. For reasons that I will make clear shortly, we may assume that Equilease was a reliable guarantor. Nevertheless, Equilease’s guarantee was conditional, and we should inquire as to what was the guaranteed value of the leases to Associates and C.V. To determine how much petitioner was, at any time, at risk on account of the long-term note, we should subtract from the then-remaining principal amount of that note the greater of (1) the guaranteed value of the leases or (2) the nonrecourse portion of petitioner’s obligation. Before making those inquiries, however, I will address certain additional arguments made by petitioners on brief as to why the capitalization agreements do not give rise to guarantees encompassed within the language of section 465(b)(4). G. Common Commercial Practice On brief, petitioners argue strenuously that Equilease’s guarantees of Associates’ and C.V.’s rental obligations constituted “a common commercial practice”, pursuant to which “it was clearly understood by all that Equilease was standing behind the [lessees].” Petitioners continue: For all intents and purposes the Tenants-in-Common contracted with the parent Equilease and not the subsidiaries. * * * It makes no sense for a parent’s guarantee of its shell subsidiary’s lease to be an impermissible guarantee where clearly there would be no violation of the “at risk” rule if the lease had been entered into with the parent directly. In at least one respect, petitioners undoubtedly are correct. Had the tenants in common done no more than enter into a direct lease with Equilease, the strength of Equilease’s credit alone would not have reduced the risk of nonpayment of rent to petitioner, so as to trigger the application of section 465(b)(4). See Gefen v. Commissioner, 87 T.C. 1471, 1503 (1986) (“nothing in section 465 * * * requires an owner of property to enter into a transaction with a party that is a poor credit risk in order to be ‘at risk’ within the meaning of section 465.”). Nevertheless, that is not how the present transaction was structured. In deciding the tax consequences of that transaction, we can only consider how the transaction was structured, and not how it might have been. In Van Roekel v. Commissioner, T.C. Memo. 1989-74, dismissed and remanded 905 F.2d 80 (5th Cir. 1990), we refused to disregard the separate legal identity of a corporate parent: Corporate law generally recognizes separate legal identities for the parent corporation and subsidiary, each responsible for its own debts even though both are part of a single business enterprise. Likewise, jurisdictions widely sanction the parent corporation’s guarantee of its subsidiary’s obligations, a credit device deemed to be in furtherance of the parent corporation’s purposes because of its stock ownership. Thus, for purposes of applying section 465(b)(4), there is no reason for distinguishing a valid guarantee where the guarantor and principal debtor are parent corporation and subsidiary from one where the guarantor and principal debtor are not related. [Citations omitted.] For the reasons stated in Van Roekel, I would not disregard the separate legal identities of Associates and C.V., on the one hand, and Equilease, on the other. Moreover, nothing in section 465(b)(4) leads me to believe that, because it may be a “common commercial practice” for a parent to guarantee the obligations of a subsidiary, such guarantees are removed from concern under section 465(b)(4). Simply put, I cannot read into section 465(b)(4) a distinction between “bad” and “good” rent guarantees. Financial risk, not motive, is the determinative factor. Section 465 was added to the Code by section 204(a) of the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1520, 1531. In the Senate, S. Rept. 94-938 (1976), 1976-3 C.B. (Vol. 3) 49, accompanied H.R. 10612, 94th Cong., 2d Sess. (1976), which became the Tax Reform Act of 1976. S. Rept. 94-938 simply indicates that insurance against casualties or tort liability is not of a piece with insurance that immunizes an investor from his liability for debt capital contributed to a section 465 activity. S. Rept. 94-938, supra, 1976-3 C.B. (Vol. 3) at 88. The principal financial risk associated with the activity petitioner engaged in (leasing) is the nonreceipt of rent. Clearly, that is the type of risk that Congress intended an investor to bear in order to be considered at risk with regard to a leasing activity. Finally, petitioners argue that, because no consideration was paid for Equilease’s guarantee, Equilease was not an independent third party, on whose credit the tenants in common relied, independent of their reliance on Associates and C.V. (admittedly not superb credit risks). All petitioners are saying, however, is that the deal was priced (rent was determined) as if the lease were with Equilease rather than with Associates and C.V. The short answer to petitioners’ claim is that we have decided not to engage in that fiction. From an economic point of view, the tenants in common are in the same position that they would have been had they (1) relied solely on the credit of Associates and C.V. (supposedly Equilease’s subsidiaries) in pricing each lease and (2) paid Equilease to bear the risk of nonpayment of rent.3 Petitioners have advanced no cogent reasons why Equilease’s guarantees are not encompassed within the language of section 465(b)(4). Admittedly, I would, in effect, draw a line between lessors who rely solely on the credit of their lessees and lessors who rely in part on the credit of a third party. Cf. Gefen v. Commissioner, supra. That distinction, however, merely reflects the line that Congress drew in prohibiting guarantees and similar loss limitations in the first place: Under this concept, an investor is not “at risk” if he arranges to receive insurance or other compensation for an economic loss after the loss is sustained, or if he is entitled to reimbursement for a part or all of any loss by reason of a binding agreement between himself and another person. [S. Rept. 94-938, supra, 1976-3 C.B. (Vol. 3) at 87.] H. Value of the Guarantees As stated, petitioner agreed to pay $543,750 for his interest in the activity. Petitioner could have lost money if the value of his interest declined below that amount. The amount he could have lost, however, was subject to certain limitations. The long-term note was only partially recourse. The nonrecourse portion was $163,750. Petitioner does not claim that he would have suffered any additional loss had the value of his interest in the activity declined (at least initially) below $163,750. Petitioner’s potential for loss was, thus (initially), limited to $380,000. That sum ($380,000) is the difference between the amount he had agreed to pay ($543,750) and the nonrecourse portion of the long-term note ($163,750). Put another way, until petitioner had paid down some of the long-term note (reducing the nonrecourse portion), any further decline in the value of petitioner’s interest in the activity below $163,750 would not have increased his potential for loss. The nonrecourse portion of the long-term note was a floor that limited the risk to petitioner of a fall in the value of his interest in the activity. Petitioner may have been subject to even less risk, however, because of Equilease’s guarantee. Equilease’s guarantee may have raised the level of the floor. If the guaranteed value of the leases exceeded $163,750, then the risk petitioner bore would have been less than $380,000. Thus, for instance, if the guaranteed value of the leases were $500,000, petitioner would initially have been at risk only to the extent of $43,750. With regard to determining the guaranteed value of the leases, S. Rept. 94-938 instructs us: Similarly, if a taxpayer is personally liable on a mortgage but he separately obtains insurance to compensate him for any payments which he must actually make under such personal liability, the taxpayer is at risk only to the extent of the uninsured portion of the personal liability to which he is exposed.6 * * * Thus, we should not concern ourselves with Equilease’s financial condition or the possibility that it will not fully honor its guarantee. See Capek v. Commissioner, 86 T.C. at 52-53; Klagsbrun v. Commissioner, T.C. Memo. 1988-364. Nevertheless, we should not disregard the fact that Equilease’s guarantee was conditional. The guarantee was conditional on Aardan’s continuing to make payments on its notes to Associates and C.V. Thus, the guaranteed value of the leases was somewhat less than the financial value of leases presenting no risk of lease default.4 How much less, however, I cannot say. Petitioners have made the tactical choice to argue that the guarantee is to be disregarded in its entirety; that clearly is not the proper course, however. As a result of petitioners’ failure of proof, they have left us without guidance as to the guaranteed value of the leases. Lacking sufficient information to make our own estimate, cf. Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930), I would conclude that respondent is correct that, for the years in issue, on account of the guarantee, the guaranteed value of the leases was at least $488,750. On the facts before us, petitioner was protected against a decline below $488,750 in the value of his interest in the activity. Of the $543,750 that petitioner agreed to pay for his interest in the activity, petitioner was at risk only to the extent of his cash contribution ($11,250) and the principal amount of the two short-term notes ($43,750). I would so find. Rule 142(a). Accordingly, I would sustain respondent’s determination that petitioner was not at risk during the years in issue with respect to his $488,750 long-term note to Aardan. CHABOT, J., agrees with this concurring opinion.   Sec. 465 was added to the Code by sec. 204(a) of the Tax Reform Act of 1976, Pub. L. 94— 455, 90 Stat. 1520, 1531. In the Senate, S. Rept. 94-938 (1976), 1976-3 C.B. (Vol. 3) 49 (S. Rept. 94-938), accompanied H.R. 10612, which became the Tax Reform Act of 1976. In pertinent part, S. Rept. 94-938 states: if a taxpayer is personally liable on a mortgage but he separately obtains insurance to compensate him for any payments which he must actually malee under such personal liability, the taxpayer is at risk only to the extent of the uninsured portion of the personal liability to which he is exposed. * * * [1976-3 C.B. (Vol. 3) at 88; fn. ref. omitted.)    S. Rept. 94-938, supra, 1976-3 C.B. (Vol. 3) at 87, confirms the application of sec. 465(b)(4) to equity capital: Also, under these rules, a taxpayer’s capital is not “at risk” in the business, even as to the equity capital which he has contributed!,] to the extent he is protected against economic loss of all or part of such capital by reason of an agreement or arrangement for compensation or reimbursement to him of any loss which he may suffer. * * * In livestock feeding operations, for example, some commercial feedlots have offered to reimburse investors against any loss sustained on sales of the fed livestock above a stated dollar amount per head. Under such “stop loss” orders, the investor is to be considered “at risk” (for purposes of this provision) only to the extent of the portion of his capital against which he is not entitled to reimbursement. Similarly, in some livestock breeding investments carried on through a limited partnership, the partnership agrees with a limited partner that, at the partner’s election, it will repurchase his partnership interest, at a stated minimum dollar amount (usually less than the investor’s original capital contribution). In situations of this kind, the partner is to be considered “at risk” only to the extent of the portion of the amount otherwise at risk over and above the guaranteed repurchase price. [Fn. ref. omitted; emphasis added.]    S. Rept. 94-938 indicates that, in such situation, the tenants in common would be in no different at risk position with regard to the guarantee of rental payments (viz, not at risk), but would be able to add to their amount at risk any payments from their own funds made to Equilease for such guarantee. 1976-3 C.B. (Vol. 3) at 88.    For purposes of this rule, it will be assumed that a loss-protection guarantee * * * or insurance policy will be fully honored and that the amounts due thereunder will be fully paid to the taxpayer. The possibility that the party making the guarantee to the taxpayer * * * will fail to carry out the agreement (because of factors such as insolvency or other financial difficulty) is not * * * material * * * [S. Rept. 94-938, 1976-3 (Vol. 3) C.B. 49, 88 (emphasis added).]   I.e., the present value of the rent stream expected over the unexpired term of the lease, assuming a discount rate appropriate for a risk-free lease.