Attorney-at-Law

AN OLDIE BUT GOODIE

In Uncategorized on 06/16/2014 at 17:13

A heartwarmer for an elderly chap like me comes from Liz Wallace at KPMG (thanks, Liz) and the Sixth Circuit. Sixth Circuit revisits their sixtysix year old decision in Cleveland Allerton Hotel, Inc. v. Comm’r, 166 F.2d 805 (6th Cir. 1948), and finds it’s just as good today as it ever was.

I won’t ask if you remember Cleveland Allerton, because I sure don’t. It involved a hotel operator enmeshed in a disastrous lease. CA could buy the hotel for way less than it would be paying over the remaining lease term, and negotiated a buyout. Of course, the owner-lessor charged CA well above the odds, to compensate for the lost income stream.

IRS claimed that the entire buyout price was acquisition cost of the hotel, and must be capitalized. But, back in the day, Sixth Circuit agreed with CA, saying that the purchase price was FMV (which CA backed up with an appraisal), and the overage was a currently deductible business expense, to be rid of the nettlesome lease.

Well, IRS is back, and this time its target is ABC Beverage Corporation, No. 13-1701, decided 6/13/14, while I was flying back from the Magnolia City. Note that the full caption is ABC Beverage Corporation v. United States of America, because ABC stumped up the tax and sued for a refund; USDC Western District of Michigan gave ABC a “thumbs up”, and IRS appealed.

IRS loses. CA may be old, but it’s good, and intervening learning from the Supremes, and an amendment to Section 167(c) don’t change Sixth Circuit’s mind.

IRS claims four (count ‘em, four) Supreme decisions wipe out CA.

The first, Millinery Center Building Corp. v. Commissioner, 350 U.S. 456 (1956), doesn’t apply because the Milliners didn’t prove that the lease they bought was burdensome. So essentially they paid FMV, as there was no burdensome lease to get out of.

The second, Woodward v. Commissioner, 397 U.S. 572 (1970), involved legal, brokerage, accounting and appraising fees for a dissident stockholder buyout. But there the issue was whether these costs were part and parcel of the acquisition of the dissenters’ shares, and the Supremes said they were. The test is not the taxpayer’s primary purpose, but rather the claim originated in the acquisition of the asset.

Next is Commissioner v. Idaho Power Co., 418 U.S. 1 (1974). The Idahoans wanted to depreciate construction equipment they bought to build a new facility. The Supremes said that buying and operating that equipment in building the facility was again part and parcel of the construction cost , but to the extent the Idahoans used the construction equipment for operations, they could depreciate that part.

And, finally, our old friend INDOPCO, Inc. v. Commissioner, 503 U.S. 79,(1992), a Tax Court favorite vying with Neonatology Associates as the most-cited case in Tax Court’s canned opinions. After usual deference to facts and circumstances, the Supremes held that the expenditures INDOPCO made to be acquired by a friendly fellow company, (a) benefitted INDOPCO beyond the year paid or incurred, and (b) “bear the indicia” of a capital rather than an ordinary expenditure. And deductions must be construed narrowly.

That’s not the case here, says Sixth Circuit. Getting rid of the lease is deductible, and IRS concedes that, but fights about the acquisition of the hotel.

So the origin of the claim, a la Woodward, is ABC’s desire to get out of the lease, not to buy the hotel. And while INDOPCO teaches us that deductions are to be narrowly-construed, IRS already conceded that the lease buyout would be currently deductible. And Idaho Power allows a capital item to be capitalized and depreciated in different tranches, depending upon facts and circumstances.

IRS then claims Section 167(c)(2) bars adding leasehold basis to property acquired subject to lease for depreciation purposes. But Sixth Circuit says the exact language is ambiguous: does it mean only “while the property remains subject to a lease after acquired” or does it mean “if the property was subject to a lease at the moment of acquisition, whatever happens later”?

Legislative history says the provision was enacted to prevent taxpayers from using the Section 197 quick-kick depreciation while including in basis the leasehold interest in the property. Not the case here. And “subject to” is a phrase with much judicial glossing, all of which says “ongoing”, as in “subject to a mortgage”.

So Judge Cole concludes: “Because § 167(c)(2) does not prohibit ABC from deducting the lease expense at issue, and because no decision of the Supreme Court requires us to modify our prior decision, Cleveland Allerton remains in full effect, controls the outcome of this case, and permits ABC to deduct the lease expense.” Decision, at p. 12.

Us old guys keep going on and on and on….

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