Court Opinion

ID: 9466345
Source: CourtListenerOpinion
Date Created: 2023-08-05 01:12:54.965016+00
Date Added: 2024-06-11T17:39:40.785963
License: Public Domain

POLITZ, Circuit Judge,
dissenting:
I respectfully dissent. The rejection of the Burgess1 “exception” is not justified. *1037The majority opinion ascribes undue emphasis to the source of the funds used to make the interest payments, finding same came from the lender of the principal loan. A single factor should not dominate, but rather the totality of the circumstances should control deductibility of interest payments under 26 U.S.C. § 163(a). This decision hangs an ominous question mark over interest deductions in every instance in which a borrower secures, from the same lender, a subsequent loan equal to or greater than the interest paid in that tax year. I recognize that there must be very careful safeguards in this area or there will be abuses. But we need not hunt hummingbirds with shotguns.
I fully endorse the rules of law collated and enunciated by the majority to the effect that for an interest deduction to be allowed the payment must be in cash or its equivalent, a note alone, evidencing a future obligation is not enough, a sham exchange is to be ignored and a superficial payment structure created solely to reap undue benefits under § 163(a) is not to be given force and effect. However, the factual situation before us, as found by the Bankruptcy Judge and affirmed by the District Court is not inconsistent with these general rules and upon the facts so found .(which are essentially not disputed) the interest deductions were appropriate and should be allowed.
My concern is heightened by the realization that if the taxpayers had borrowed the funds needed for the interest payments from another lender the deduction would probably not have been challenged, and if challenged, would apparently have been approved by the majority.
For over 30 years the Burgess explication of a particular application of § 163(a) has been a part of the jurisprudence. As the majority notes, it has been both followed and criticized. I believe it more worthy of support than criticism. The rule of Burgess and its progeny is of value and ought to be available to taxpayers in this circuit.
The material facts found by the Bankruptcy Court are not contested. Barry Battelstein and Jerry Battelstein entered into a loan agreement with Gibraltar Savings Association in January 1971 in order to finance the purchase and development of a piece of property. The Battelsteins and other owners intended to develop the property which, at time of purchase, did not have utilities. The Association agreed to make future loans to the owners to carry the cost of the property. In return the Association was to receive, in addition to repayment of its loans, a 19% interest in the net proceeds of sale of the property.
The loan agreement contained this salient language:
After execution of the agreement Gibraltar will, pursuant to the terms thereof, from time to time, advance to Owners . an additional sum or sums of money equal to the Owners’ actual out-of-pocket costs incurred and paid on said property subsequent to the execution of the agreement, including, but not being limited to debt services, taxes . . . ”
The Association, pursuant to this provision, made subsequent advances (loans) to the owners, at higher interest rates than the original acquisition loan, with different maturity dates and secured by additional liens on the property. During 1973 and 1974 additional loans were made to the Battelsteins for sums equal to ad valorem taxes they paid and for debt service or interest charges they owed the Association and timely paid. The IRS challenged the deductibility of the interest payments and the ad valorem tax payments on the same grounds, that the source of the funds was the Association and thus no deduction could be taken because no payment had been made. The bankruptcy and district courts rejected the challenges to deduction of both the interest payments and the ad valorem tax payments. No appeal was taken to the rejection of the challenge to the deduction for ad valorem taxes. That issue leaves the case, presumptively because the IRS concluded that challenge was not well founded.
*1038Jerry Battelstein claimed the interest deduction for both tax years at issue, 1973 and 1974. Barry Battelstein claimed the interest deduction for 1973 but capitalized the expense in 1974 under § 266 of the Internal Revenue Code.
These further facts were found. The Battelsteins were not obliged to borrow the additional sums from Gibraltar. Further, in each of the eight challenged instances of payment (quarterly during the two year period) they had sufficient funds in their general bank accounts (maintained with another institution, not Gibraltar) to cover the payments for interest and taxes or very ample resources from which the taxes and interest could have been paid. During the years 1973, 1974 and 1975 Jerry Battelstein’s average monthly checking account balances were $24,000, $75,000 and $35,000, respectively. Barry Battelstein’s monthly averages during those years were $36,000, $44,000 and $40,000. Jerry Battelstein’s approximate net worth exceeded four million in 1973 and was over five million in 1974. Barry Battelstein had substantial assets upon which to draw for payments, for example in 1973 he had $1,300,000 in Certificates of Deposit readily available. The interest payments during the period fluctuated between $4,991.06 and $48,728.10. It cannot be gainsaid that the Battelsteins had adequate funds to pay the interest independent of the funds received from Gibraltar.
Another cogent consideration is whether the subsequent loans had any economic utility other than to serve as the basis of a claimed tax deduction. The trier of fact found that such utility existed. I fully agree. The loan agreement was intended to keep the Battelsteins and the other owners in a position where Gibraltar carried the full cost of acquisition and development of the property. The money was available. Jerry Battelstein testified that he subscribed to the theory that money could be made with borrowed money. This gave the. Battelsteins added financial flexibility. And this must be viewed in light of the fact that Gibraltar would receive a 19% interest in the .net proceeds of sale. These subsequent loans had an obvious economic utility.
The majority opinion assigns substantial import to the sequencing of checks between the Battelsteins and Gibraltar. It is said that in each instance the Battelsteins sent their respective checks for the quarterly interest payments at which point Gibraltar sent the Battelsteins a like check which the Battelsteins deposited in their general bank accounts. I find this significant, but reach a conclusion exactly opposite from that of the majority. When Gibraltar received the Battelsteins’ checks there is more than simply the Battelsteins’ promise to pay (such as would be evidenced by a note). They had indeed paid. The facts show that in some instances sufficient funds were on deposit in the Battelsteins’ accounts to fully cover these checks and in every instance more than adequate resources existed for payment. Gibraltar sent its checks and they were deposited in the general bank accounts of the Battelsteins in another institution and commingled and utilized for whatever purpose. It cannot be claimed that the subsequent loan proceeds were used exclusively for payment of the quarterly interest payments for the facts do not support that conclusion.
The Burgess requirements, as subsequently refined, establish adequate safeguards to avoid the very real possibilities of abuse in dual loan transaction situations. In essence it is necessary that: (1) there be valid and legitimate reasons for the second loan other than to repay interest on the first loan, (2) proceeds of the second loan are commingled with the taxpayer’s other funds, (3) the taxpayer have funds or available resources to cover the interest payment, and (4) the lending institution loses control of the proceeds of the second loan. Burgess; Burck v. Commissioner, 63 T.C. 556 (1975), aff’d on other grounds, 533 F.2d 768 (2d Cir. 1976); Wilkerson v. Commissioner, 70 T.C. 240 (1978).
The factual grounding of many “dual loan” eases precludes the taxpayer from *1039taking the deduction under Burgess, however the Tax Court has consistently recognized the rule’s applicability in proper cases. Heyman v. Commissioner, 70 T.C. 482 (1978); Alan A. Rubnitz, 67 T.C. 621 (1977); Nat Harrison Associates, Inc., 42 T.C. 601 (1964).2
I am convinced that all four of the above noted requirements are met in this case. I believe the Burgess test to be fair and workable. I would apply it. I see a vast difference between a carefully fashioned financial program, one intentionally designed to maximize valid tax advantages, and an artfully devised scheme to evade taxes. The latter is to be abrogated. To reject an instance of the former is a policy judgment only the Congress should make in the quest for tax reform.
For these reasons I would affirm the decisions of the bankruptcy and district courts allowing the interest deductions and I, therefore, respectfully dissent.

. Burgess v. Commissioner, 8 T.C. 47 (1947).

. In Goodstein v. C.I.R., 267 F.2d 127 (1st Cir. 1959), the First Circuit affirmed a Tax Court holding which characterized a transaction within the Cleaver mold, thereby denying the taxpayer the interest deduction. The court, somewhat cryptically said, “Taxpayer cites Newton A. Burgess, . . which would seem to hold to the contrary but to us the reasoning of the dissenting members of the court is more persuasive.” Goodstein at 131. This waffling rejection of Burgess should be scrutinized in light of the facts before the court. Both the Tax Court and the Court of Appeals determined the Goodstein transaction was devoid of economic substance beyond the purpose of obtaining an interest deduction. Indeed, the plan in that case was devised by an accountant who contacted the IRS to test whether the pre-conceived plan would result in a tax deduction. Goodstein is, therefore, distinguishable from the present case; it ignores the first noted test in the Burgess exception, perhaps because the transaction in that case-was undeserving of the exception. In writing the Burck affirmance for the Second Circuit, Judge Oakes states in fn. 3 that he disagreed with the Burgess majority. Judge Oakes expressed these reservations “for himself only;” the Burgess rule was not the subject-of review.