Estate Of Franklin v. Commissioner

544 F.2d 1045 (9th Cir. 1976)

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Nature of the Case

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Facts

Interest and depreciation deductions were taken by Twenty-Fourth Property Associates, a California limited partnership, of which Franklin (P) and seven other doctors were limited partners. The deductions flowed from the purported purchase by Associates of the Thunderbird Inn, an Arizona motel from the Romneys on November 15, 1968. Under the Sales Agreement, the Romneys agreed to sell for $1,224,000 to be paid over a ten-year period with interest on the unpaid balance at 7.5% per annum. Prepaid interest of $75,000 was payable immediately, and installments of $9,045.36 would be paid monthly with a balloon payment of $975,000. The purchase obligation was nonrecourse, and Romneys’ only remedy for a default would be forfeiture of the partnership’s interest. The agreement was recorded at the county, and a warranty deed was placed in escrow with a quitclaim deed from Associates to Romney with the documents to be delivered on payment in full or upon default. The sale was also combined with a leaseback by Associates to Romney and Associates never took physical possession. The payments were designed to be virtually equal except for the $75,000 prepaid interest and the balloon payment. The lease was a net lease, and Romney was also responsible for the first and second mortgages on the property until the final installment was made on the purchase. Romney could place additional mortgages on the property without the permission of Associates and they, in fact, did so, and they could also make capital improvements and modify the base agreement. The Tax Court held that the transaction constituted an option exercisable in 1979 and disallowed the deductions. The Commissioner contended that the acquisition was a sham or an option. The Tax Court held that Associates had the power at the end of ten years to walk away and only lose $75,000 and the deed was never recorded and the benefits and burdens of ownership appeared to remain with Romney. The sale was combined with a leaseback so no cash would pass and Romney was responsible for the mortgages and could make capital improvements. This appeal resulted.