T.C. Memo. 2003-295
UNITED STATES TAX COURT
HORACE D’ANGELO, JR., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8049-01. Filed October 23, 2003.
Neal Nusholtz, for petitioner.
Gregory C. Okwuosah, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: Petitioner petitioned the Court to redetermine
deficiencies of $35,742 and $26,756 in his 1995 and 1996 Federal
income taxes, respectively. Following concessions,1 we decide:
1
In addition to the explicit concessions, we consider
petitioner to have conceded respondent’s determination that he is
entitled to deduct certain prepaid expenses in 1996, not in 1995.
(continued...)
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1. Whether the notice of deficiency is “arbitrary”. We
hold it is not.
2. Whether petitioner may deduct a forgiven debt in the
amount claimed on his 1995 tax return. We hold he may.
3. Whether petitioner was personally engaged in the trade
or business of developing industrial real estate. We hold he
was.
4. Whether petitioner may under section 162 deduct certain
legal expenses paid by him.2 We hold he may.
5. Whether petitioner may under section 162 or 212 deduct
certain office expenses paid by him. We hold he may not.
FINDINGS OF FACT
Some facts were stipulated. The stipulated facts and the
accompanying exhibits are incorporated herein by this reference.
We find the stipulated facts accordingly. Petitioner resided in
Rochester Hills, Michigan, when the petition was filed.
1
(...continued)
Petitioner failed to advance any arguments as to this issue in
his brief. Accordingly, we deem the issue abandoned. Wilcox v.
Commissioner, 848 F.2d 1007, 1008 n.2 (9th Cir. 1988), affg. T.C.
Memo. 1987-225; Lunsford v. Commissioner, 117 T.C. 183, 187
(2001); Nicklaus v. Commissioner, 117 T.C. 117, 120 n.4 (2001).
2
Unless otherwise stated, section references are to the
applicable versions of the Internal Revenue Code, Rule references
are to the Tax Court Rules of Practice and Procedure, and dollar
amounts are rounded to the nearest dollar.
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Petitioner’s Business Pursuits
Petitioner has been a business associate of Keith Pomeroy
(Pomeroy) since the early 1980s. In 1983, he and Pomeroy entered
into a Development Agreement (1983 Development Agreement). It
provided, in relevant part:
1. Purpose. The principal purpose of the Parties
acting together is to acquire, hold, develop, operate,
and sell various real estate and building projects,
primarily, although not exclusively, nursing homes and
housing for the elderly. The Parties shall contribute
equally funds as are required to acquire, hold,
develop, operate and/or sell projects that are subject
to this Agreement, and each shall own an undivided one-
half interest in such projects. Only those projects
will be acquired and developed on which there is
unanimous agreement. Either Party may decline to
participate in any project for any reason whatsoever.
In such case, the other Party may not proceed with such
project individually.
Pursuant to the 1983 Development Agreement, petitioner and
Pomeroy through the years have organized numerous entities
primarily to acquire, develop, manage, and operate commercial
real estate. Petitioner directly owned an interest in
approximately 21 real-estate-related entities during the subject
years and was involved with numerous other entities primarily by
virtue of contractual relationships through the entities which he
owned. The relevant entities are Arbor Corporation (Arbor),
Peachwood Nursing Center (PNC), H.K. Peach, Inc. (H.K. Peach),
REH1 Corporation (REH1), TROY-SAK Associates (TROY-SAK), Lakeland
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Neuro Care Limited Partnership (Lakeland), and Crittenton
Development Center (Crittenton).
Arbor was an S corporation that handled the day-to-day
record-keeping and management of the entities owned in whole or
in part by petitioner and Pomeroy. Its stock was owned equally
by petitioner and Pomeroy until 1996 when Pomeroy transferred all
of his stock in Arbor to petitioner in connection with the
lawsuits discussed infra. Arbor employed and paid the management
staff for the nursing homes that it managed. These management
fees were then charged to the nursing home to the benefit of
which the services in question inured. Petitioner was Arbor’s
president and managed its daily affairs.
H.K. Peach was an S corporation owned equally by petitioner
and Pomeroy. PNC was a partnership formed for the purpose of
leasing certain land and nursing homes constructed thereon. PNC,
an accrual basis taxpayer, was owned equally by H.K. Peach and
Crittenton. REH1 was an S corporation which owned and operated
the industrial real estate properties. REH1 was owned 25 percent
by petitioner, 25 percent by Pomeroy, and 50 percent by other
unrelated individuals. TROY-SAK was a real estate partnership
owned 25 percent by petitioner and 75 percent by Pomeroy and two
other individuals whose names are not material to this case.
Lakeland was a partnership owned 90 percent by REH1 and 10
percent by an unrelated entity named CMS Lakeland, Inc. Lakeland
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was formed for the purposes of owning, developing, leasing, and
operating a certain subacute rehabilitation unit. Crittenton was
a real estate development entity owned by persons unrelated to
petitioner and Pomeroy.
Debt Settlement
Peachwood Center Associates (PCA)3 owned certain property
which it leased to PNC. Beginning in 1989, PNC sublet the
property to Lakeland. Shortly thereafter, Lakeland disputed the
amount of rent payable under the sublease agreement and declined
to pay the amount of that rate. The situation resulted in an
arbitration proceeding between Lakeland, on the one hand, and PCA
and PNC, on the other hand. The parties to the arbitration
proceeding resolved that and at least one other proceeding (the
Oakland 2 lawsuit described infra in which PCA and Crittenton
sued petitioner, Pomeroy, Arbor, and PNC) through an agreement
that included a debt settlement agreement (debt settlement
agreement) and a related redemption agreement (redemption
agreement).
Pursuant to the debt settlement agreement, dated
November 22, 1995, Lakeland agreed to pay PNC $600,000 in
settlement of $992,796 of disputed rent that PNC consider owed
3
Peachwood Center Associates was a partnership in which
petitioner and Pomeroy each owned a 25-percent interest in 1995
and a 50-percent interest in 1996.
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(and had accrued as income) on the sublease. Lakeland agreed to
pay $200,000 of the $600,000 immediately and make subsequent
annual payments of at least $100,000 until the entire $600,000
(exclusive of interest at the prime rate) was fully discharged.
The debt settlement agreement provided:
Notwithstanding anything contained herein to the
contrary, the terms of this Agreement shall be
contingent upon the consummation of the contemplated
redemption of Crittenton Development Corporation’s
interest in Peachwood Center Associates and Peachwood
Nursing Center. Keith J. Pomeroy and Horace D’Angelo
Jr. hereby agree to pursue in good faith the
consummation of said redemption on an expeditious
basis.
Pursuant to the redemption agreement, dated November 30,
1995, PNC redeemed Crittenton’s 50-percent interest for cash. As
of that date, PNC terminated for income tax purposes pursuant to
section 708(b)(1)(B).
Because of the mandatory redemption of Crittenton and the
resulting termination of PNC, PNC and H.K. Peach considered the
eliminated debt of $392,796 (the original debt of $992,796 less
the settlement amount of $600,000) as a worthless debt that
belonged entirely to H.K. Peach. Accordingly, on their
respective 1995 tax returns, PNC did not claim a deduction for
the eliminated debt, but H.K. Peach did. Petitioner and Pomeroy,
each in his capacity as a 50-percent shareholder of H.K. Peach,
claimed for 1995 a bad debt deduction of $196,398 (1/2 of
$392,796). Respondent in the notice of deficiency issued to
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petitioner denied his claim to his 50-percent share of the bad
debt deduction.
Legal Expenses
The differences between and among petitioner, Pomeroy, and
other investors led to a number of lawsuits (lawsuits).
Petitioner personally paid much of the legal fees connected to
the lawsuits, and he now claims that he may deduct these fees as
the ordinary and necessary expenses of his business, purportedly,
the development of industrial real estate. The lawsuits involved
defending petitioner’s business practices, compelling
petitioner’s business associates to account for profits, and
related issues. The lawsuits were handled mainly by the law
firms of Plunkett & Cooney; Williams, Schaefer, Ruby & Williams;
and Jacob & Weingarten.
For 1995, petitioner incurred legal expenses in the
following proceedings which are at issue in this case: (1)
Oakland County Case No. 91-413151-CK (Oakland 1), (2) Oakland
County Case No. 89-367018-CB (Oakland 2), and (3) Oakland County
Case No. 93-455713 CK (Oakland 3). Oakland 1 was a lawsuit by
Arbor against Pomeroy and others, to which petitioner was later
added as a cross-plaintiff. The proceeding essentially involved
claims of diversion of management fees and breach of fiduciary
duty. Oakland 2 was a lawsuit by PCA and Crittenton against
petitioner, Pomeroy, Arbor, and PNC. The proceeding generally
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involved claims of breach of fiduciary duty, failure to pay rent,
and failure to make appropriate partnership contributions.
Oakland 3 was a lawsuit in which Pomeroy had accused petitioner
of, among other things, taking over H.K. Peach and otherwise
breaching his fiduciary duty. With respect to all these
proceedings, petitioner claimed in 1995 as a deduction legal fees
of $90,392 (relating to Oakland 1 and Oakland 2) and $770
(relating to Oakland 3).
For 1996, petitioner incurred legal expenses in the
following proceedings which are at issue in this case: (1)
Oakland 1, (2) Oakland 2, (3) Oakland County Case No. 91-413076-
CK (Oakland 4), and (4) Oakland County Case No. 93-455889
(Oakland 5). Oakland 4 was a lawsuit where petitioner sued
individually and on behalf of REH1 as coplaintiffs. The case
included an allegation against Pomeroy and others for a failure
to account for profits. Oakland 5 was a lawsuit by Pomeroy and
his business partner, whose name is not material to this
proceeding, to compel petitioner to turn over his partnership
interest in TROY-SAK pursuant to an agreement. In 1996,
petitioner claimed as a deduction legal fees of $57,799 (relating
to Oakland 1, Oakland 2, Oakland 3, Oakland 4, and Oakland 5).
Respondent maintains that petitioner may not deduct these
amounts because he is not engaged in “any trade or business”
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within the meaning of section 162(a) and/or because these amounts
constitute capital expenditures.
Office Expenses
For 1995, petitioner deducted $14,065 of expenses, which he
personally bore after moving the office and the staff of Arbor
into a house he owned. The move was precipitated by
disagreements that had arisen between petitioner and Pomeroy.
Petitioner and some of the Arbor employees worked in the office.
Those employees were a bookkeeper, an administrative assistant,
an individual responsible for Medical/Medicaid costing reports, a
comptroller, a secretary, and another individual responsible for
maintenance, landscaping, computers, and marketing.
The expenses deducted by petitioner included costs of
furniture, asphalt repair, water softener, and other items.
Respondent asserts that these expenses belong to Arbor and thus
cannot be deducted by petitioner personally. Additionally,
respondent maintains that the following items should be
capitalized and, if deductible, depreciated:
Expense Amount
Table $171
Water softener 188
Asphalt repair 1,850
Furniture 338
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OPINION
I. Burden of Proof
In general, respondent’s determinations are presumed
correct, and taxpayers bear the burden of proving them wrong.
Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933).
As one exception to this rule, section 7491(a) places upon the
Commissioner the burden of proof with respect to any factual
issue relating to liability for tax if the taxpayer maintained
adequate records, satisfied applicable substantiation
requirements, cooperated with respondent, and introduced during
the court proceeding credible evidence on the factual issue. A
taxpayer such as petitioner must prove that he has satisfied the
recordkeeping, substantiation, and cooperation requirements
before section 7491(a) places the burden of proof upon the
Commissioner. Prince v. Commissioner, T.C. Memo. 2003-247.
In that the record is sufficient for us to decide this case
on its merits based on a preponderance of the evidence, we need
not and do not decide which party bears the burden of proof in
this case as to the substantive issues. We note, however, that
we disagree with petitioner’s assertion that the notice of
deficiency is arbitrary because it, unlike a notice of deficiency
issued to Pomeroy, did not include or refer to an exhibit that
explained the income-adjustment allocations relating to H.K.
Peach. The notice of deficiency at hand correctly identified
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petitioner, stated the disallowed amounts and the years to which
they pertain, and adequately explained the calculations employed
in arriving at them.
II. Debt Settlement
The parties agree that the $392,796 bad debt deduction
resulted from the forgiveness in the debt settlement agreement of
that amount of accrued rent and, more specifically, a settlement
of the proceedings discussed above. The parties do not dispute
that PNC was entitled to deduct the eliminated debt as a bad debt
but challenge only the amount of that deduction allocable to
petitioner.
Petitioner argues on brief that the debt was settled after
Crittenton’s termination and that he, as a 50-percent shareholder
of H.K. Peach, is entitled to deduct half ($196,398) of the debt.
Petitioner focuses primarily on respondent’s reference to the all
events test and argues that this test was not met before
Crittenton’s redemption in that the redemption was a vital term
of settlement. Alternatively, petitioner argues, respondent’s
earlier resolution of this issue, coupled with respondent’s
representations to the Court, means that respondent is now
estopped from challenging the amount of his deduction in this
proceeding.
Respondent argues on brief that the debt was settled before
Crittenton’s termination. Thus, respondent concludes, only half
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($196,398) of the bad debt flowed through to H.K. Peach (the
other half flowing through to Crittenton), and petitioner may
deduct only half of that half (in other words, $98,199).
Respondent reads PNC’s pretermination financial statements to
indicate that petitioner, in his capacity as president of Arbor,
believed that the debt was settled before Crittenton’s (and hence
PNC’s) termination. In particular, respondent observes, PNC
recorded in those statements a $600,000 note receivable that it
received from Lakeland in connection with the debt settlement
agreement. Respondent makes no mention of the terms of
redemption in the debt settlement agreement but considers the
reporting of the $600,000 note receivable to be dispositive of
this issue.
On the basis of the facts and circumstances of this case, we
hold for petitioner. We conclude from our reading of the debt
settlement agreement that the $392,796 was not forgiven until
after the redemption of Crittenton. The parties to that
agreement went to great lengths to memorialize their
understanding that this redemption was a condition precedent to
the settlement of the debt. Respondent has not alleged that the
debt settlement agreement was a sham or that the terms thereof
should be disregarded by the Court. We respect the express terms
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of the debt settlement agreement and hold for petitioner.4 H.K.
Peach, PNC’s successor, may deduct the entire amount of the
eliminated debt, and petitioner, as a 50-percent shareholder of
H.K. Peach, may deduct $196,398, or one-half of the entire
amount.
III. Engaged in a Trade or Business
Petitioner argues that his extensive involvement in real
estate business ventures places him in a trade or business of
developing industrial real estate during the subject years.
Respondent maintains that petitioner’s involvement with the real
estate has always been on behalf of Arbor. Respondent concludes
that petitioner was not personally engaged in a trade or
business. We agree with petitioner.
Petitioner began his real estate career more than 20 years
ago. In 1995 and 1996, he was actively involved in developing
the industrial real estate and nursing home businesses, in
accordance with the terms of the 1983 Development Agreement.
Over the years, petitioner and Pomeroy, alone and sometimes with
others, built a number of industrial rental and nursing home
rental partnership enterprises. Petitioner personally ran a
substantial part of the operations, supervising Arbor’s
management activities and the partnerships’ rental activities.
4
On the basis of our holding, we need not and do not
discuss petitioner’s alternative argument.
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Petitioner was also in charge of applying for and procuring the
licenses necessary to conduct the operations relating to nursing
homes within the State of Michigan.
A general partner may be deemed to be conducting the trade
or business activity of the partnership in which he or she is a
member. Hoffman v. Commissioner, 119 T.C. 140 (2002); see also
Flood v. United States, 133 F.2d 173, 179 (1st Cir. 1943); Cokes
v. Commissioner, 91 T.C. 222, 228 (1988); Drobny v. Commissioner,
86 T.C. 1326, 1342 (1986); Brannen v. Commissioner, 78 T.C. 471,
504 (1982), affd. 722 F.2d 695 (11th Cir. 1984); Ward v.
Commissioner, 20 T.C. 332, 343 (1953), affd. 224 F.2d 547 (9th
Cir. 1955). See generally Rev. Rul. 92-17, 1992-1 C.B. 142.
Moreover, the trade or business of the partnership may be imputed
to a general partner irrespective of the fact that the partner
did not actively or materially participate in the partnership.
Bauschard v. Commissioner, 31 T.C. 910, 916-917 (1959), affd. 279
F.2d 115 (6th Cir. 1960). Additionally, an individual taxpayer
may be engaged in more than one trade or business. Oliver v.
Commissioner, 138 F.2d 910 (4th Cir. 1943), affg. a Memorandum
Opinion of this Court.
Respondent concedes that petitioner was materially involved
in developing the real estate and nursing home businesses.
Nevertheless, respondent argues that at all times when petitioner
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was so involved, he was acting on behalf of Arbor. The record as
a whole indicates otherwise.
We agree that merely providing services to a corporation to
increase its value does not rise to the level of a trade or
business other than a trade or business of performing services as
an employee. However, while petitioner did devote substantial
time and effort to running the business of Arbor, his activities
were not so limited. Petitioner was actively involved in
procuring licenses for operation of nursing homes, selecting
location of buildings and their design, and similar engagements.
Moreover, the 1983 Development Agreement attests to the intention
of petitioner and Pomeroy to engage in a trade or business of
developing “various real estate and building projects, primarily,
although not exclusively, nursing homes and housing for the
elderly.” The record demonstrates that petitioner fulfilled that
intention during the years in question.
A trade or business is a continuous and regular vocation
engaged in for profit. See generally Commissioner v.
Groetzinger, 480 U.S. 23 (1987). According to the record, during
the years at issue, petitioner actively carried out the business
activities referenced in 1983 Development Agreement. We find
that these activities rose to the level of his own trade or
business pursuant to the terms of the 1983 Development Agreement.
See Hoffman v. Commissioner, supra. We hold that during 1995 and
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1996, petitioner was engaged in a trade or business of developing
industrial real estate.
IV. Legal Fees
At issue here are professional fees of $770 and $90,392 for
1995, and $57,799 for 1996. These amounts were incurred by
petitioner in the course of his participation in several lawsuits
in the Oakland County District Court in his capacity as an
officer, partner, and/or shareholder of the entities he owned in
whole or in part.
Petitioner maintains that these amounts are deductible by
him under section 162 as the ordinary and necessary business of
his trade or business of developing industrial real estate.
Alternatively, petitioner asserts, these amounts are deductible
under section 212 as expenses attributable to property held for
the production of income. Respondent argues that all of these
amounts are nondeductible capital expenditures, except for the
portion of legal expenses allocable to Oakland 2.5 We agree with
petitioner.
Section 162(a) allows a deduction for all ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business. To qualify as an allowable
deduction under section 162(a), an item must (1) be paid or
5
The parties stipulated allocating 50 percent of the
$90,392 at issue to Oakland 2.
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incurred during the taxable year, (2) be for carrying on any
trade or business, (3) be an expense, (4) be a necessary expense,
and (5) be an ordinary expense. Commissioner v. Lincoln Sav. &
Loan Association, 403 U.S. 345, 352 (1971). The principal
difference between classifying a payment as a deductible expense
or a capital expenditure concerns the timing of the taxpayer’s
recovery of the cost. See INDOPCO, Inc. v. Commissioner, 503
U.S. 79, 83-84 (1992); Interstate Transit Lines v. Commissioner,
319 U.S. 590 (1943); Lychuk v. Commissioner, 116 T.C. 374 (2001);
Metrocorp, Inc. v. Commissioner, 116 T.C. 211 (2001).
Just because a particular expense fits within the literal
language of section 162, it does not automatically become
deductible. This is because other sections, such as section 261,
except certain payments from the current deductibility
provisions. INDOPCO, Inc. v. Commissioner, supra at 84. Section
261 states that “no deduction shall in any case be allowed in
respect of the items specified in this part”, e.g., Part IX,
Items Not Deductible. Section 263(a)(1), which is contained in
Part IX, generally provides that a deduction is not allowed for
"Any amount paid out for new buildings or for permanent
improvements or betterments made to increase the value of any
property or estate."
As we recently noted in Lychuk v. Commissioner, supra at
386, the Supreme Court’s mandate as to capitalization requires
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that an expenditure be capitalized when it (1) creates a separate
and distinct asset, (2) produces a significant future benefit,
or (3) is incurred “in connection with” the acquisition of a
capital asset. See also Commissioner v. Idaho Power Co., 418
U.S. 1, 13 (1974); Woodward v. Commissioner, 397 U.S. 572, 575-
576 (1970). If any of the three conditions is met, an expense
may not be deducted and must be capitalized.
Here, the correct legal framework in determining whether the
disputed legal fees are deductible is the origin of the claim
test. United States v. Gilmore, 372 U.S. 39 (1963). In order
for these fees to be deductible, the origin of the claim in the
underlying action must be proximately related to petitioner’s
trade or business. Kornhauser v. United States, 276 U.S. 145
(1928). The origin of the claim test is factual, and the factors
to be considered include: (1) Allegations in the complaint,
(2) the legal issues involved, (3) the nature and objectives of
the litigation, (4) the defenses asserted, (5) the purposes for
which the amounts claimed as deductible were expended, and
(6) the background of litigation and all facts pertaining to the
controversy. Boagni v. Commissioner, 59 T.C. 708, 713 (1973).
The first disputed fee, $770, relates to Oakland 3. The
complaint by Pomeroy in this case alleged that petitioner, in his
capacity as president of H.K. Peach, had seized control of the
corporation and had operated the corporation “as his private
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fiefdom,” to the exclusion of Pomeroy. The complaint alleged
further that petitioner, in his capacity as a director, officer,
and shareholder of H.K. Peach, “has engaged in a course of action
constituting illegal, fraudulent, willfully unfair and oppressive
acts”, including the establishment of certain bank accounts,
purportedly authorized by the board of directors of H.K. Peach,
the fact of which authorization was denied by Pomeroy. Remedies
sought by Pomeroy included attorney’s fees, “appropriate
damages”, recovery of the misappropriated funds on behalf of H.K.
Peach, and dissolution and liquidation of the assets and business
of H.K. Peach.
Applying the test of Commissioner v. Lincoln Sav. & Loan
Association, supra, we find that this fee (1) was paid or
incurred during 1995, (2) was incurred in connection with
carrying on petitioner’s trade or business, (3) was an expense,
(4) was a necessary expense in that petitioner was required to
defend himself in a lawsuit, and (5) was an ordinary expense in
that litigation expenses commonly arise in the course of
conducting business. Therefore, petitioner may deduct the fee in
question if no other limitations, such as section 263, indicate
that capitalization is required.
The “origin of the claim” test yields the same result. In
Oakland 3, the origin of the claim was Pomeroy’s allegations that
petitioner had breached his fiduciary duty and mismanaged the
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entities. Petitioner’s defense was no more than an attempt to
preserve the status quo; namely, to defend his business practices
against those allegations and to preserve his already established
position within H.K. Peach. Petitioner did not attempt to create
a separate or distinct asset, produce a significant future
benefit, or acquire a capital asset. See Lychuk v. Commissioner,
supra. To the extent that any benefit was created by virtue of
petitioner’s defending this lawsuit, it appears to us more
immediate than future, in that an imminent harm to petitioner
would ensue if he failed to defend himself in this proceeding.
Respondent relies exclusively on Lin v. Commissioner, T.C.
Memo. 1984-581, to support his assertion that these fees must be
capitalized. There, the legal fees related to two proceedings.
The first proceeding concerned a dispute as to the ownership and
management of two corporations. The second proceeding concerned
a dispute to set aside a deed as fraudulent and void. The Court
concluded that the origin of the claim in the first proceeding
was to “protect or defend * * *[the taxpayers’] proportionate
interest in the ownership of the stock of the corporations”, and
in the second proceeding was to restore and establish the
taxpayers’ right to the ownership of the property in question.
We find Lin distinguishable on its facts and hold that the legal
fees related to Oakland 3 are deductible as ordinary and
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necessary business expenses incurred in the course of
petitioner’s trade or business.
The second portion of the disputed legal expenses, $90,392,
was incurred by petitioner with respect to Oakland 1 and Oakland
2. Oakland 1 was brought against Pomeroy and others, and
involved claims of diversion of Arbor funds to Pomeroy’s own
management company, failure to pay to Arbor the management fees
to which it was entitled, and breach of fiduciary duty. The
remedies sought in that proceeding included restitution and
exemplary damages. Claims in Oakland 2 focused on the alleged
breach of fiduciary duty by petitioner and Pomeroy, and their
purported financial manipulation of Crittenton through “corporate
instrumentalities” which included H.K. Peach, Arbor, and PNC.
This proceeding also involved claims of failure to pay rent on
the part of PNC and failure to make partnership contributions by
H.K. Peach.
For reasons similar to those described above as to the $770,
we conclude that the Lincoln Sav. & Loan Association test has
been met as to the $90,392. Our analysis of the origin of the
claim test here is also similar to that of the fees relating to
Oakland 3. We find that in Oakland 1, petitioner’s position
originated from his desire to negate the claims of breach of
fiduciary duty and diversion of fees. In addition, he
counterclaimed against Pomeroy under the same theories.
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Regardless of the success of those claims, petitioner did not
seek to create a separate or distinct asset, produce a
significant future benefit, or acquire a capital asset. Again,
to the extent a benefit inured to petitioner by virtue of
defending and counterclaiming in this lawsuit, it appears to us
more immediate than future, in that an imminent harm to
petitioner would ensue if he failed to defend himself in this
proceeding.
Examination of the fees incurred in Oakland 2 yields the
same result. Those fees were (1) paid or incurred during 1995,
(2) incurred in connection with carrying on petitioner’s trade or
business, (3) an expense, (4) a necessary expense in that
petitioner’s participation in the lawsuit was mandated by virtue
of claims brought against him, and (5) an ordinary expense in
that businessmen such as petitioner, who are actively and closely
involved in a trade or business, are subject to litigation and to
incurring the associated expenses. As for the origin of the
claim in Oakland 2, we do not find the claim to have sought to
create a separate or distinct asset, produce a significant future
benefit, or acquire a capital asset.
Again, respondent argues that the similarity of these claims
to those in Lin v. Commissioner, supra, dictates the conclusion
that the fees at issue in Oakland 1 and Oakland 2 must be
capitalized. We disagree. Just as we observed with respect to
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the Oakland 3 proceeding, neither Oakland 1 nor Oakland 2
involved a dispute as to the validity of ownership interests, or
involved a claim to set aside a fraudulent conveyance, as in Lin
where the Court concluded that the origin of the claim was to
protect, defend, or restore the taxpayers’ interest in the stock
of the corporations or in other property. Instead, the claims in
the proceedings at issue can best be characterized as breach of
contract claims. The legal expenses incurred by petitioner to
defend against such claims constitute an ordinary and necessary
expense of conducting petitioner’s trade or business. The
proceedings in which he incurred those expenses did not relate to
protecting, defending, or restoring petitioner’s interests in the
companies he owned.
Respondent also notes that Oakland 2 involved a claim for
failure to make partnership contributions. Citing section 741
and Commissioner v. Shapiro, 125 F.2d 532 (6th Cir. 1942), affg.
a Memorandum Opinion of the Board of Tax Appeals, which allegedly
treat a partnership interest as a capital asset, respondent
concludes that the legal expenses in Oakland 2 must be
capitalized to the extent that they related to an issue of
partnership contribution in that they created or enhanced a
capital asset. Respondent’s references to section 741 and
Shapiro are misplaced. Both authorities deem a partnership
interest a capital asset solely for disposition purposes. By
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contrast, the issue of disposition does not arise in Oakland 2.
Therefore, we disagree that on that basis, petitioner must
capitalize these expenses. We hold that they are deductible
under section 162(a), just like the other legal fees incurred by
virtue of Oakland 2.
The last segment of the legal expenses at issue pertains to
1996. That amount ($57,799) was incurred during that year by
petitioner in connection with Oakland 1, Oakland 2, Oakland 3,
Oakland 4, and Oakland 5. As we have already discussed the
deductibility of the litigation expenses relating to the first
three proceedings and find the reasoning equally applicable here,
we focus our analysis on the fees relating to Oakland 4 and
Oakland 5.
Petitioner brought the Oakland 4 suit individually and as a
shareholder of REH1. The suit included claims for breach of
fiduciary duty by Pomeroy and others, by virtue of their managing
the affairs of REH1 to the exclusion of petitioner and to the
possible detriment to REH1. Petitioner sought the appointment of
a receiver for REH1 and damages for failure to account for and
distribute corporate profits to petitioner and REH1.
In Oakland 5, petitioner was forced to defend against
Pomeroy and others who were trying to compel the surrender of his
interest in TROY-SAK pursuant to the terms of the TROY-SAK
partnership agreement. In response to petitioner’s earlier
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action for dissolution of TROY-SAK and motion for preliminary
injunction to arrest the development of this proceeding, the
plaintiffs in Oakland 5 sought a court order compelling
petitioner to transfer his partnership interest in TROY-SAK to
them, so as to achieve the termination of the partnership on
their terms.
Under the Lincoln Sav. & Loan Association test, the fees in
Oakland 4 were (1) paid or incurred during 1996, (2) incurred in
connection with carrying on petitioner’s trade or business, (3)
an expense, (4) a necessary expense in that petitioner was
fulfilling his fiduciary duty by bringing the lawsuit, and (5) an
ordinary expense in that breaches of fiduciary duty are not
uncommon in business affairs. Furthermore, the claims in this
proceeding did not have as their origin the creation of a
separate or distinct asset, production of a significant future
benefit, or an acquisition of a capital asset. Petitioner
instead sought to enforce the fulfillment of the fiduciary duty
owed to REH1 by Pomeroy and others. We conclude that the fees
relating to Oakland 4 are deductible under section 162(a).
Further, we find the fees relating to Oakland 5 to have been
(1) paid or incurred during 1996, (2) incurred in connection with
carrying on petitioner’s trade or business of developing real
estate as they relate to his involvement with TROY-SAK, (3) an
expense, (4) a necessary expense in that petitioner was required
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to defend himself in a lawsuit, and (5) an ordinary expense in
that souring of business relationships between the partners is a
routine business reality. See Commissioner v. Lincoln Sav. &
Loan Association, 403 U.S. 345 (1971). Under these standards, we
find petitioner’s expenses incurred in connection with Oakland 5
deductible because he did not seek to create a separate or
distinct asset, produce a significant future benefit, or acquire
a capital asset in that proceeding. Instead, he was defending
his position as a partner with respect to the contractual
obligations specified in the partnership agreement.
In view of the above, we hold that petitioner may deduct the
legal fees in the amounts of $770 and $90,392 for 1995 and
$57,799 for 1996.
V. Office Expenses
For 1995, petitioner deducted $14,065 of office expenses as
expenses paid in carrying on his trade or business. Petitioner
and some of the Arbor employees worked in the office. Evidence
in the record supports the conclusion that Arbor was an
“umbrella” entity organized to develop and manage industrial real
estate and nursing homes owned by petitioner and his co-
venturers. The office in question was used by petitioner to
house Arbor’s intended business activities. The expenses at
issue are those of Arbor, not those of petitioner. Thus, he
cannot deduct the fees at issue under section 162.
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Nor do we find any evidence of payment of rent by Arbor to
petitioner, so as to justify writing off the office expenses by
him personally, in his capacity as a landlord, under section 212.
Sec. 1.212-1(h), Income Tax Regs. (second sentence). As
enunciated by the Supreme Court, the “doctrine of corporate
entity” fills a useful purpose in business life, and whether the
purpose be to gain an advantage under law of the State of
incorporation, so long as that purpose is the equivalent of
business activity, the corporation remains a separate taxable
entity. Moline Props., Inc. v. Commissioner, 319 U.S. 436, 438
(1943).
Short of disregarding the corporate integrity of Arbor for
petitioner’s benefit, we see no basis for allowing petitioner to
personally expense Arbor’s office costs. We hold that the
$14,065 of office expenses may not be deducted by petitioner.
We have considered all arguments of the parties related to
our holdings set forth herein and, to the extent not discussed
herein, find those arguments to be irrelevant or without merit.
Decision will be entered
under Rule 155.