Lead Opinion
OPINION
Section 162(a) of the Internal Bevenue Code of 1954 allows as a deduction “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including — * * * (3) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.” (Emphasis added.) Thus, a taxpayer who owns or has an “equity” in property used in his trade or business, though he is entitled in appropriate cases to depreciate the cost of that property over its useful life, sec. 167, I.R.C. 1954, and to deduct the ordinary and necessary expenses of maintaining it, sec. 162, supra, may not claim in place of or in addition to such amounts a deduction for its fair rental value, or any other sum, as rent. Though this proposition seems obvious enough, some taxpayer-owners have sought to avoid its impact through the now familiar technique of the sale and leaseback, which, in the intrafamily context such as that involved herein, often becomes the “gift” and leaseback. The mere transfer of legal title to property, however, is not conclusive for Federal income tax purposes, for the “sale” that lacks economic reality and business purpose, and the “gift” that leaves the donor with substantially the same control over the property that he had before, will simply be disregarded. See, e.g., W. H. Armston Co. v. Commissioner,
The basic approach to be followed in cases such as this, involving intrafamily transfers in trust which divest the grantor of little more than bare legal title to the property transferred, and even that only temporarily, was outlined by the Supreme Court over 25 years ago in Helvering v. Clifford,
Technical considerations, niceties of the law of trusts or conveyances, or the legal paraphernalia which inventive genius may construct as a refuge from surtaxes should not obscure the basic issue. That issue is whether the grantor after the trust has been established may still be treated, * * * as the owner of the corpus. See Blair v. Commissioner,300 U.S. 5 , 12. In absence of more precise standards or guides supplied by statute or appropriate regulations,1 the answer to that question must depend on an analysis of the terms of the trust and all the circumstances attendant on its creation and operation. And where the grantor is the trustee and the beneficiaries are members of his family group, special scrutiny of the arrangement is necessary * * * [Footnote omitted.]
Clifford, it is true, dealt with, the question of whether the grantor of a trust might be taxed upon the trust’s income under the predecessor of section 61, I.R.C. 1954, but the principles enunciated therein are equally applicable, and have previously been applied, in determining whether a “donor” has retained such dominion and control over his “gift” to a family member as to prevent him from deducting “rents” and “royalties” paid to such family member for his use of the “donated” property. White v. Fitzpatrick,
Taking the approach indicated by Clifford, then, we have no dou'bt that petitioners must be considered the owners of the medical building both before and after their transfers in trust. Pxior to the construction of this building, Sidney had been in practice with another physician, but that partnership was dissolved and Sidney decided to go out on his own and to build his own medical facilities. He acquired a plot of land and personally supervised the design and construction of a medical building thereon which would meet the needs of his practice. There was no question, either before or after the transfer of the building to the children’s trusts, that it would be used by him in his practice; indeed, this was obviously the very purpose of his buying the land and constructing the building. He ¡did in fact occupy the medical building after its completion and after the transfers in trust,
The transfer of the building to eight trusts for the benefit of their four children did not, then, cause any change in petitioners’ planned use of the building and an examination of the terms of the trust agreements shows how little petitioners actually did give up.. Sidney was named sole trustee of each of the trusts, and Barbara was to serve as successor trustee in the event of his death, resignation, or incapacity. Petitioners retained a reversion in the building which, for all practical purposes, could take effect in somewhat less than 11 years after the trusts were created, since Sidney as sole trustee could declare any or all of the eight trusts at an end after December 31, 1967. As sole trustee, Sidney also had discretionary powers over trust income (if he ascertained that “the economic status of the parents of a minor beneficiary * * * [was such] that said parents * * * [were] currently unable to defray the ordinary and customary expenses of support, maintenance, welfare or education of such beneficiary”), and the invasion of the trust corpus (in the event of any “emergency” in the affairs of the beneficiaries by reason of “sickness, accident or other unusual circumstances”). More significant, however, were the powers Sidney retained over the administration of the trust corpus, including of course the medical building in respect of which petitioners claim to bo entitled to deductions for rent. He had, inter alia, the power to sell or exchange all trust property, to rent or lease it “for terms ending during or after the termination of this trust,” to make repairs and improvements to real property and to determine the extent to which such repairs and improvements should be apportioned between principal and income, and to encumber trust property by mortgage or otherwise. And he could freely exercise such powers “notwithstanding that he may also be acting individually, or as trustee of other trusts” so long as he acted in a “fiduciary capacity.”
The informal manner in which Sidney acted after the conveyance of the medical building to his children’s trusts lends further support to the conclusion that he (and his wife) remained the true owners of such property. For, although Sidney occupied the medical 'building during each of the years 1961, 1962, and 1963, there was no written lease ¡between Sidney, 'as trustee, and Sidney individually, during any of these years which granted him the right of possession. Perhaps the absence of a written lease would not be important in determining the availability of a deduction for rent under section 162(a) (3) where the parties have dealt with one another at arm’s length. However, in light of the obvious possibilities of abuse, where a taxpayer enters into such transaction with members of his family group, or with himself acting in another capacity, without specifically setting forth the consequences of the transaction, the rights and obligations of the parties, in some formal, binding way, there may be serious question as to whether payments made in such circumstances qualify as bona fide rent under the statute. Certainly, the method by which Sidney allegedly rented the medical 'building to himself during the years in issue cannot withstand the “special scrutiny” which must be accorded all such transactions. For example, rent is ordinarily paid monthly or at some other stated interval, yet Sidney’s payments were of such random character, both as to amount and time, as to indicate that they were made solely at his convenience without regard to any fixed legal obligation. Moreover, the payments of “rent” made by Sidney from time to time during 1961,1962, and 1963, aggregating $9,000 per year, were in excess of $7,200 which the parties have stipulated was the fair rental value of the property during those years. Cf. Kirschenmann v. Westover,
Tn light of all the facts and circumstances surrounding1 the creation and operation of the trusts, including the fact that the tax-savings purpose obviously played a significant part in the “gift”-leaseback arangement, cf. Van Zandt v. Commissioner,
The cases of Skemp v. Commissioner,
Finally, petitioners insist that the conveyance of their reversionary interests in the trust property to their children in 1963 completely divested them of any interest in the property, and that, at least after such time, they should be allowed a deduction for rent. It should be noted initially that although the quitclaim deeds by which petitioners conveyed their reversionary interests were “dated” as of January 1, 1963, they were not notarized until December 18, 1963, and were not recorded until December 20, 1963, and petitioners do not claim that their conveyance should be taken into account in determining the allowability of their rental deduction before December 20,1963. Thus, at best petitioners would be allowed to deduct 11/365 of the fair rental value (not the actual “rent” paid) of the property in 1963 if their position should be sustained. But we do not think it should be. In view of all the facts and circumstances, including the extensive administrative powers still retained by Sidney as trustee after December 20,1963, the fact that he occupied the property without any written lease throughout 1963, and the fact that the rents actually paid were unreasonable in amount, we feel justified in concluding that petitioners’ dominion and control over the trust property was not significantly diminished by the conveyance of their reversionary interests therein within the family group, and that they are not entitled to any deduction for rent under section 162(a) for the year 1963, or any portion thereof.
Decision will be entered v/rvder Bule 50.
Notes
He occupied the property for some months prior to transferring it to the trusts. The record) shows that the building was completed in December 1960, and petitioners would have us believe that it was promptly transferred to the trusts on Jan. 1, 1961. Although it is true that the deeds to the trusts are “dated” Jasa. 1,19.61, it is clear that they were prepared by petitioners’ attorney, Myron Blumberg, who notarized the deeds on. July 17, 1961, which were In fact recorded on July 18., 19,61. On this state of the record, bearing in mind that the burden of proof was on petitioners, it is a reasonable inference that the deeds were not executed prior to July 17, 1761, and we have drawn that inference in our findings of fa'et. Moreover, since the deeds and the trust agreements were part of the same package prepared by Mr. Blumberg, we have drawn the further inference, in the absence of any convincing evidence to the contrary, that the trust agreements similarly were not executed prior to July 17, 1961.