T.C. Memo. 2006-34
UNITED STATES TAX COURT
ESTATE OF LORRAINE C. DISBROW, DECEASED,
MARTHA D. JOHNSON, EXECUTRIX, Petitioner v. COMMISSIONER OF
INTERNAL REVENUE, Respondent
Docket No. 6739-04. Filed February 28, 2006.
Terrence E. Smolev, for petitioner.
Marie E. Small, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: Petitioner petitioned the Court to redetermine
a $426,377.57 deficiency that respondent determined in the
Federal estate tax pertaining to the Estate of Lorraine C.
Disbrow, Deceased (decedent’s estate). Following concessions, we
decide whether the fair market value of the residence (residence)
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of Lorraine C. Disbrow, Deceased (decedent), is includable in her
gross estate under section 2036(a)(1).1 Decedent gave the
residence to a newly formed, assetless general partnership whose
partners were decedent, her children, and her children-in-law
(i.e., her daughters-in-law and sons-in-law, collectively).
Shortly thereafter, decedent gave all of her interest in the
partnership to the other partners. Decedent continued to live at
the residence until she died, paying the partnership less than
fair rental value (FRV). Respondent determined that the fair
market value of the residence is includable in decedent’s gross
estate because decedent until her death retained the “possession”
and “enjoyment” of the residence within the meaning of section
2036(a)(1). We sustain that determination. We decide this case
as the parties framed it, and we express no opinion on the
validity of the partnership, which, as we find below, conducted
no business and was not operated with an intent to make a profit.
Nor do we consider respondent’s alternative determination that
decedent’s estate is not entitled to annual exclusions from gift
tax pursuant to section 2503(b) because decedent’s gifts were of
a future interest.
1
Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code. Rule
references are to the Tax Court Rules of Practice and Procedure.
-3-
FINDINGS OF FACT2
1. Preface
Some facts were stipulated. We incorporate herein by this
reference the parties’ stipulation of facts and the exhibits
submitted therewith. We find the stipulated facts accordingly.
Martha Johnson is the executrix of decedent’s estate. Martha
Johnson resided in Hampstead, New Hampshire, when the petition in
this case was filed.
2. Decedent and Her Family
Decedent was born on January 14, 1922, and she died at
7:22 a.m. on February 9, 2000, at the age of 78. She was a U.S.
citizen and a resident of the State of New York. She died
2
During trial, petitioner elicited testimony from two
partners of the partnership and the attorney who recommended and
implemented the transaction in issue. We have evaluated the
testimony of each of these witnesses by observing his or her
candor, sincerity, and demeanor and by assigning weight to the
elicited testimony for the primary purpose of finding disputed
facts. See Neonatology Associates, P.A. v. Commissioner, 115
T.C. 43, 84 (2000), affd. 299 F.3d 221 (3d Cir. 2002). Our
perception of these witnesses while viewing them testifying at
trial, coupled with our review of the record and our finding that
each of these witnesses has a pecuniary interest in the outcome
of this case, leads us to discount much of their uncorroborated
testimony as unreliable. We are not required to, and we do not,
rely on that discounted testimony to support petitioner’s
positions herein. See, e.g., Brookfield Wire Co. v.
Commissioner, 667 F.2d 551, 552 (1st Cir. 1981), affg. T.C. Memo.
1980-321; Haffner’s Serv. Stations, Inc. v. Commissioner, T.C.
Memo. 2002-38, affd. 326 F.3d 1 (1st Cir. 2003). See also Kenney
v. Commissioner, T.C. Memo. 1995-431, where the Court declined to
rely upon most of the testimony of the taxpayer and a long list
of relatives and close friends who testified in support of her
claim for innocent spouse relief.
-4-
testate, having executed a last will and testament on August 24,
1978. Pursuant to that document, decedent bequeathed her estate
to her children in equal shares. Decedent’s estate, as reported
on the Federal estate tax return, consisted primarily of cash,
stocks, bonds, and annuities, and the reported bequest to each
child was $118,000.
Decedent’s husband, John Disbrow, had died on February 23,
1993. He and decedent had five children: Martha Johnson, Nancy
Kerrigan, Linda Labet, Sarah Disbrow, and David Disbrow. When
decedent died, she also had four children-in-law: Robert Johnson
(married to Martha Johnson), Patrick Kerrigan (married to Nancy
Kerrigan), Michael Labet (married to Linda Labet), and David
Wishart (married to Sarah Disbrow). At the time of the
partnership agreement discussed infra, Martha Johnson and her
husband lived in Hampstead, New York; Nancy Kerrigan and her
husband lived in San Jose, California; Linda Labet and her
husband lived in New Milford, Connecticut; Sarah Disbrow and her
husband lived in Lincoln, Nebraska; and David Disbrow lived
unmarried in Fort Lauderdale, Florida. Decedent’s children and
children-in-law all survived her.
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3. The Residence
The residence is at 224 Little Neck Road, Centerport, New
York,3 and includes a two-story, single-family house (house) and
landscaped grounds. The house is approximately 2,400 square feet
and has two bedrooms and a bathroom on the second floor and
three bedrooms and two bathrooms on the first floor. The house
was built in or around 1955 and has a waterview and a private
beach. The house is set in a private wooded area. On
September 1, 1993, decedent had the residence valued through a
comparative market analysis, which concluded that the residence
was marketable at $350,000.
John Disbrow purchased the residence on March 1, 1956, and
he and decedent lived there until he died. Decedent acquired
sole ownership of the residence upon his death, and the residence
was her principal residence until she died. When John Disbrow
died, decedent’s health was failing, and her health continued to
be poor until she died. Among other things, decedent during the
time after her husband’s death suffered a kidney failure and was
under kidney dialysis; she was affected by a severe case of
peritonitis; she fractured her pelvis; she fractured her hip; she
broke both of her legs (getting out of bed); and she had multiple
heart attacks, the last of which resulted in her death. During
3
Centerport, New York, is on Long Island, New York, near
Huntington Bay of the Long Island Sound. See Rand McNally Road
Atlas 73 (Millennium ed. 2000).
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that time, decedent also was feeble from age and mentally
unstable. After John Disbrow died, decedent did not always stay
at the residence because, for a significant period of time, she
was hospitalized, in rehabilitation, or living with David Disbrow
as his home in Florida. When decedent was at the residence, she
generally confined herself to the first floor because she could
not get up the stairs by herself. Decedent generally lived at
the residence without anyone to assist her except to the extent
that a family member was there also. One or more of decedent’s
children frequently visited or stayed with decedent to assist
her.
4. Funny Hats Partnership (Funny Hats)
In addition to her health complications, immediately
following John Disbrow’s death decedent questioned whether she
wanted to keep living at the residence with all of her memories,
and she was unsure of the financial aspects of her life and how
she would handle the ownership responsibilities associated with
the residence (primarily, its maintenance). (John Disbrow had
always handled the financial aspects and ownership
responsibilities.) Decedent hired a legal team to advise her on
her finances. One of her advisers was Anthony Curto (Curto), the
attorney whom she had recently retained to probate John Disbrow’s
estate. Curto advised decedent on the application to her of the
probate and estate tax laws, and he advised her that she should
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respond to those laws by transferring the residence to a family
general partnership. According to Curto, decedent could then
give all of her interest in the partnership to her family,
continue to live at the residence as a tenant of the partnership,
and remove the residence from the reach of the Federal estate
tax.
Decedent followed Curto’s advice. On December 10, 1993, at
almost 72 years of age, decedent (together with her children and
children-in-law) executed a general partnership agreement
(partnership agreement) forming Funny Hats.4 Curto and his firm
prepared all of the documentation for that purpose. As stated in
the partnership agreement, the partners of Funny Hats and their
partnership interests were as follows:
Partner Partnership Interest
Martha Johnson 7.1875%
Robert Johnson 7.1875
Nancy Kerrigan 7.1875
Patrick Kerrigan 7.1875
Linda Labet 7.1875
Michael Labet 7.1875
David Wishart 7.1875
Sarah Disbrow 7.1875
David Disbrow1 14.3750
Decedent 28.1250
100.0000
1
David Disbrow was decedent’s only unmarried
child at the time Funny Hats was formed, and he
received an interest in Funny Hats equal to the
interest of each married couple.
4
The record does not explain the reason for the name “Funny
Hats”.
-8-
None of the partners of Funny Hats contributed any asset to Funny
Hats upon its formation. Later on December 10, 1993, decedent
transferred her entire interest in the residence to Funny Hats
for no consideration.5 Immediately before that transfer,
decedent, in her capacity as executrix of John Disbrow’s estate,
had transferred the residence to herself from John Disbrow’s
estate. As of the time of decedent’s transfer of the residence
to Funny Hats, the partners of Funny Hats had assured decedent
that she could continue to live at the residence as long as she
furnished the funds necessary to maintain it.
By way of an agreement dated January 1, 1994, decedent gave
her 28.125-percent interest in Funny Hats to her children and
children-in-law (collectively, donees). In accordance with that
agreement, the change to each partner’s interest in Funny Hats
was as follows:
Initial Subsequent
Partner Partnership Interest Partnership Interest
Martha Johnson 7.1875% 10%
Robert Johnson 7.1875 10
Nancy Kerrigan 7.1875 10
Patrick Kerrigan 7.1875 10
Linda Labet 7.1875 10
Michael Labet 7.1875 10
David Wishart 7.1875 10
Sarah Disbrow 7.1875 10
David Disbrow 14.3750 20
Decedent 28.1250 0
100.0000 100
5
As reported on the Federal estate tax return, decedent’s
adjusted basis in the residence was $350,000.
-9-
The partnership agreement of Funny Hats states that Funny
Hats was “created to establish and conduct the business of real
estate ownership and management” and that its place of business
was the address of the residence. Funny Hats conducted no
business and was not operated with an intent to make a profit.
Decedent wanted to divest herself of the responsibility of
maintaining the residence, but the donees wanted her to keep the
residence. The donees persuaded decedent to retain the residence
by telling decedent that they would maintain the residence as
long as decedent furnished the funds necessary to do so. The
donees enjoyed the residence as a place to vacation, to get
together as a family, or simply to relax.
The only assets of Funny Hats were the residence and a
checking account. With four exceptions, the checking account of
Funny Hats was funded by $69,250 of transfers from decedent, a
$6,774 loan from her in 1999, and $1,712 of interest. (We have
attached as an appendix our reconciliation of each year’s
beginning and ending cash balances of the Funny Hats checking
account.) The exceptions are: (1) Funny Hats deposited $348,600
at the end of 2000 from a sale of the residence to David Disbrow,
(2) each of the partners of Funny Hats, other than David Disbrow,
contributed to it $1,000 and $800 in 1995 and 1997, respectively,
(3) David Disbrow contributed to Funny Hats an additional $1,000
and $800 in 1995 and 1997, respectively, and he contributed
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$6,714 to Funny Hats in 2000, and (4) Funny Hats in 1995 and 2000
received from unspecified sources the proceeds of loans of $450
and $7,933, respectively.
Decedent, when she was not a partner in Funny Hats, wrote on
her personal bank account eight checks that were payable to Funny
Hats and that she then endorsed and deposited into the checking
account of Funny Hats. Six of those checks were for rent.
5. The Lease Agreements
Curto and his firm also prepared annual lease agreements
(collectively, lease agreements) under which Funny Hats rented
the residence to decedent for each year from January 1, 1994,
through December 31, 2000. Curto and his firm represented both
decedent and Funny Hats in preparing these agreements and other
documents. Curto had recommended to the parties to the lease
agreements that the agreements be in writing, and the parties
followed that advice. The lease agreements were all signed by
Linda Labet, in her capacity as a partner of the landlord Funny
Hats, and by decedent in her individual capacity as tenant. None
of the lease agreements states the date on which it was signed by
either of those individuals, and none of the lease agreements
bears the signature of a witness to those individuals’
signatures.
Curto’s firm prepared each of the lease agreements on the
the same form document that applies to house leases in general.
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The form contains 30 paragraphs of pretyped provisions and
requires that a user supply only the following information:
(1) Name of landlord and the landlord’s address for notices;
(2) name of tenant; (3) identification of the premises;
(4) “Lease date”; (5), term of lease, including beginning and
ending dates; (6) amount of yearly rent; (7) amount of monthly
rent; and (8) amount of security. The form also has two spaces
for the respective signatures of the landlord and the tenant, and
a single space for the signature of a witness. Each of the lease
agreements as filled out by Curto and his firm is identical,
except for the last two numbers of the applicable year (in the
case of 2000, the “19" on the form is crossed out and “2000" is
typed above) and the amounts of monthly and yearly rents.
Pursuant to Curto’s advice, certain of the pretyped provisions of
the lease agreements were crossed out; i.e., provisions stating
that “These charges [cost of required maintenance service
contracts] will be added rent”, “Tenant may not alter, decorate,
change or add to the Premises”, and “Tenant may not sublet all or
part of the Premises, or assign this Lease or permit any other
person to use the Premises”. Curto also advised the parties to
the lease agreements as to the amount of rent that decedent
should pay under each of the lease agreements, and the parties
followed that advice as well.
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The lease agreement for 1994 states that the lease is
between Funny Hats, as landlord, and decedent, as tenant, that
the lease is a 1-year lease of the “Premises” for $8,400, and
that the “Premises” are “224 Little Neck Road, Centerport,
New York 11721”. The 1994 lease agreement also states that
decedent may pay this rent monthly in $700 installments and that
“The Premises must be used to live in only and for no other
reason. Only a party signing this Lease, spouse and children of
that party may use the Premises.” The 1994 lease agreement
requires as to the payment of rent that
The rent payment for each month must be paid on
the first day of that month at the Landlord’s address
above. Landlord need not give notice to pay the rent.
Rent must be paid in full and no amount subtracted from
it. The first month’s rent is to be paid when Tenant
signs this Lease. Tenant may be required to pay other
charges to Landlord under the terms of this Lease.
They are to be called “added rent”. This added rent is
payable as rent, together with the next monthly rent
due. If Tenant fails to pay the added rent on time,
Landlord shall have the same rights against Tenant as
if it were a failure to pay rent.
The whole amount of rent is due and payable when
this Lease is effective. Payment of rent in
installments is for Tenant’s convenience only. If
Tenant defaults, Landlord may give notice to Tenant
that Tenant may no longer pay rent in installments.
The entire rent for the remaining part of the Term will
then be due and payable.
The 1994 lease agreement states that the failure to pay rent or
added rent on time is a “default”.
The 1994 lease agreement allows decedent to alter, decorate,
change, or add to the residence, to sublet all or part of the
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residence, to assign the lease, and to permit other persons to
use the residence. The 1994 lease agreement states that the
“Tenant may peaceably and quietly have, hold and enjoy the
Premises for the Term of this Lease”, and that the “Tenant has
read this Lease. All promises made by the Landlord are in this
Lease. There are no others. This Lease may be changed only by
an agreement in writing signed by and delivered to each party”.
The 1994 lease agreement requires that decedent maintain,
continue, and pay for maintenance service contracts and indicates
that these payments are not considered added rent. The 1994
lease agreement states that decedent must give to Funny Hats, as
landlord, keys to each lock in the residence.
Each of the lease agreements for the years after 1994
contains the same terms as the 1994 lease agreement, except that
the post-1994 lease agreements require the payment of the
following annual rent and monthly installments:
Year Annual Rent Monthly Installments
1995 $8,700 $725
1996 9,000 750
1997 9,300 775
1998 9,600 800
1999 9,900 825
2000 10,200 850
None of the lease agreements restricts decedent’s use of the
residence. None of the lease agreements requires that decedent
pay a security deposit as to the residence, although each
agreement contains a provision as to security deposits.
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6. Annual and Monthly FRV of the Residence
The annual and monthly FRVs of the residence were as
follows:
Year Annual FRV Monthly FRV
1994 $17,280 $1,440
1995 16,560 1,380
1996 17,160 1,430
1997 17,880 1,490
1998 19,020 1,585
1999 21,060 1,755
2000 26,400 2,200
7. Decedent’s Payments as to the Residence
During decedent’s leasehold, Funny Hats maintained the
residence and made capital improvements. The dollar amounts of
the capital expenses attributable to the residence were reported
on the Federal estate tax return of decedent’s estate as $3,161
in 1995, $800 in 1996, and $4,225 in 1999, for a total of $8,186.
The reported maintenance expenses for each year from 1994 through
2000 are set forth infra and aggregate $21,657.
Decedent paid (directly or indirectly) most of the expenses
connected with the residence. The partners of Funny Hats did not
want to incur out-of-pocket costs as to the residence, and they
asked decedent to pay “rent” greater than that stated in the
lease agreements to the extent that the stated rent was
insufficient to pay expenses connected with the residence.
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Decedent wrote the following personal checks to Funny Hats for
rent:6
Date of Check Amount of Check Notation on Face of Check
Mar. 31, 1994 $3,000 Rent Jan Feb Mar Apr
May 6, 1994 1,500 May June
July 25, 1994 2,250 Rent July Aug Sept
Oct. 12, 1994 2,100 Rent
8,850
Dec. 27, 1994 2,400 Rent Jan Feb Mar
11,250
May 20, 1995 2,400 Rent Apr May Jun
Aug. 14, 1995 2,400 ---
Oct. 5, 1995 2,400 Rent Oct Nov Dec
7,200
Jan. 25, 1996 2,400 Rent Jan Feb Mar
Apr. 9, 1996 2,400 ---
June 10, 1996 2,400 Rent July Aug Sept
7,200
Jan. 25, 1997 2,400 ---
Apr. 8, 1997 2,400 Rent Apr May June
Oct. 8, 1997 2,400 Rent July Aug Sept
7,200
Feb. 7, 1998 3,000 Rent Jan Feb Mar
May 28, 1998 3,000 Rent Apr May Jun
6,000
Apr. 24, 1999 3,000 Rent Apr May Jun
Aug. 20, 1999 3,000 3Q Rent
Nov. 27, 1999 4,000 Rent Oct Nov Dec
10,000
Decedent also wrote the following three personal checks to Funny
Hats:
6
In addition to the checks listed below for 1996, decedent
made one other $2,400 payment of rent to Funny Hats sometime
during that year.
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Date of Check Amount of Check Notation on Face of Check
May 7, 1997 $4,000 ---
Dec. 5, 1997 3,000 ---
Jan. 11, 1999 7,000 Transfer
14,000
Decedent did not designate on the face of any of these three
checks that she was writing the check for “rent”, and the parties
have not stipulated that the check represented “rent”. Nor do we
find that decedent gave any of these three checks to Funny Hats
as rent.
Decedent’s bank also paid from decedent’s personal account a
$4,000 check that was dated February 7, 2000, and was payable to
Funny Hats. The face of the check bears the signed name of
decedent on the signature line and contains no notation as to its
purpose. Decedent did not write or sign this check. The check
was written and signed by Linda Labet, and she gave it to another
individual (not decedent) to endorse and to deposit into the
checking account of Funny Hats. As shown on the back of this
$4,000 check, the check was deposited into the checking account
of Funny Hats on February 11, 2000.
In addition to the payments discussed above, during her
leasehold decedent directly paid the following expenses
associated with the residence: Telephone, heating, water, and
cable. Decedent also paid these same types of expenses before
she transferred the residence to Funny Hats.
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8. Decedent’s Use of the Residence
Funny Hats did not treat decedent in her capacity as a
tenant the same way that Funny Hats would have treated a tenant
who was a stranger. Decedent did not regularly pay her rent as
required by the lease agreements, she did not always pay the
amount of rent that was stated in the lease agreements, and she
often paid her rent later than the time required by the lease
agreements. Funny Hats never mailed decedent a notice demanding
that she pay her rent, nor did Funny Hats ever send to decedent a
notice of eviction. The donees knew that decedent would respect
the integrity of the residence, and they wanted her to live there
as long as she could.
The donees also wanted decedent to continue to use the
residence after its transfer to Funny Hats, as she had before its
transfer. Decedent always had the exclusive use and enjoyment of
the entire residence, and she always had the right to use the
entire residence. There were no lease agreements with anyone
other than decedent with respect to the residence, and no
individual had a right superior to that of decedent to use the
residence from January 1, 1994, through decedent’s death.
Decedent permitted the donees and their families and friends to
visit and stay at the residence rent free during various times
from January 1, 1994, through decedent’s death.
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9. Relevant Financial Information
Funny Hats filed a Form 1065, U.S. Partnership Return of
Income, for each year from 1994 through 2000. These returns
state that the principal business activity of Funny Hats is
“rental” and that its principal product or service is “real
estate”. According to the returns, Funny Hats received rent and
incurred related expenses, depreciation, and net losses as
follows:7
1994 1995 1996 1997 1998 1999 2000
Gross rents $11,250 $7,200 $9,600 $10,200 $6,000 $17,000 $4,000
Cash expenses:
Insurance -0- -0- 2,279 100 1,203 1,208 1,208
Legal fees 280 521 649 663 691 747 942
Taxes -0- 8,940 9,072 9,251 9,501 4,819 10,309
Miscellaneous -0- 19 -0- 33 -0- -0- -0-
Travel -0- -0- -0- -0- -0- -0- 6,397
Business meals -0- -0- -0- -0- -0- -0- 769
Repairs & maint.8,663 401 238 2,265 4,216 5,343 531
Exterminating -0- 76 81 -0- 81 119 -0-
Bank charges -0- -0- -0- 13 10 96 100
8,943 9,957 12,319 12,235 15,702 12,332 20,256
Depreciation1 8,364 8,773 8,921 9,003 8,947 9,022 7,975
17,307 18,730 21,240 21,328 24,649 21,354 28,231
Net loss 6,057 11,530 11,640 11,128 18,649 4,354 24,231
1
Funny Hats claimed depreciation on the entire house and not just on the
portion of the residence that was purportedly rented to decedent.
Funny Hats also reported for 1997 through 2000 that it had
received interest income of $529, $177, $73, and $580,
respectively. Funny Hats also reported for 2000 that it had
realized a $51,418 “net section 1231 gain”.
7
Funny Hats also filed a 1993 Form 1065 that did not report
any income or expense. The 1993 Form 1065 reported that the
residence was an asset of Funny Hats and that the principal
business activity of Funny Hats was “inactive”.
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For each of the years 1994 through 1996 and for 1998, the
amount of gross rent reported for the year corresponds to the
amount of rent that decedent paid Funny Hats during that year.
The $10,200 reported for 1997 apparently corresponds to the
$7,200 of rent paid during that year plus the $3,000 payment that
decedent made to Funny Hats on December 5, 1997.8 The $17,000
reported for 1999 apparently corresponds to the $10,000 of rent
paid during that year plus the $7,000 payment that decedent made
to Funny Hats on January 11, 1999. The $4,000 reported for 2000
apparently corresponds to the $4,000 check dated February 7,
2000, that was paid to Funny Hats from the checking account of
decedent.
10. David Disbrow
David Disbrow has worked as a commercial airline pilot since
1981, flying mostly international routes in and out of New York,
New York. He lived at the residence from his birth in or around
1960 until approximately 1982. He returned to the residence in
1985 and lived there through 1988. He visited at the residence
periodically from 1988 through 1997.
8
The record does not explain the purpose of the $4,000
check that decedent wrote to Funny Hats on May 7, 1997, for other
than rent. It appears from our reconciliation in the appendix
that this $4,000, while deposited into the checking account of
Funny Hats, was withdrawn for use by someone other than Funny
Hats.
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David Disbrow resided principally in Florida during some or
all of the time discussed herein. In late 1997, after he was
reassigned to fly in and out of New York, New York, he began to
stay approximately 3 days a week at the residence with the
consent of decedent. Also with her consent, he allowed his
girlfriend to stay periodically at the residence beginning in or
about January 1998. The girlfriend worked out of New York, New
York, as a flight attendant, and she had recently been reassigned
there. She was without any other place to stay, and she became
David Disbrow’s wife in late 1998 or early 1999. When David
Disbrow and his girlfriend stayed at the residence, they slept on
the second floor of the house. They did not pay any rent for
their use of the residence, and they did not pay any expense
connected with the residence.
11. Sale of the Residence
When decedent died on February 9, 2000, the fair market
value of the residence was $400,000. On November 30, 2000, Funny
Hats sold the residence to David Disbrow for $350,000. Funny
Hats sold the residence to David Disbrow upon his request and did
not attempt to obtain a second bid for the residence or otherwise
sell it in the market.
12. 2001 Through 2003 Forms 1065
In addition to the Forms 1065 mentioned above, Funny Hats
filed 2001 through 2003 Forms 1065. Each of the post-2000
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returns reports that Funny Hats’ principal business activity was
“rental” and that its principal product or service was “real
estate”. None of those returns reports any rent for those years.
The 2001 return reports that Funny Hats realized $277 of interest
income during 2001 and was entitled to claim $1,153 in
“miscellaneous” deductions. The 2002 return reports that Funny
Hats realized $47 of interest income during 2002 and was entitled
to claim $843 in “miscellaneous” deductions. The 2003 return
reports that this return was a final return and that Funny Hats
had realized $29 of interest income during 2003.
13. Estate Tax Return and Notice of Deficiency
On or about May 3, 2001, Martha Johnson filed a Federal
estate tax return for decedent’s estate. The return reports in
part that decedent’s estate owes Funny Hats $8,500 for the
“Balance of annual rent due pursuant to lease agreement” and that
decedent’s estate incurred a $6,000 expense for the “Clean out
and removal of property re: Decedent’s home”. By notice of
deficiency dated February 10, 2004, respondent determined the
estate tax deficiency in issue. The parties now agree that
decedent’s estate is not entitled to deduct any of the $8,500 as
rent payable to Funny Hats and that decedent’s estate is entitled
to deduct only $342.04 as a cleaning expense.
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OPINION
Respondent determined that the fair market value of the
residence is includable in decedent’s gross estate under section
2036(a)(1) because decedent until her death retained the
“possession” and “enjoyment” of the residence within the meaning
of that section. Petitioner argues that section 2036(a)(1) does
not apply to this case because decedent paid FRV for her use of
the residence. Petitioner asserts that decedent did not have to
pay FRV for the entire residence because she shared the residence
with the donees and their families and friends, including David
Disbrow’s girlfriend. Petitioner recognizes that the 2000 lease
agreement required rent installment payments of $850 per month
but asserts that this amount was written erroneously into the
agreement. Petitioner asserts that the parties to the 2000 lease
agreement modified the agreement orally to require that decedent
pay monthly rent of $1,333.33, which, petitioner claims, was no
less than the FRV for decedent’s “shared restricted use” of the
residence.
The Federal estate tax is imposed on the transfer of the
taxable estate of every decedent who is a citizen or resident of
the United States. See sec. 2001. Decedent’s taxable estate
equals her gross estate less applicable deductions. See sec.
2051. Decedent’s gross estate includes the fair market value of
all property to the extent provided in sections 2031 through
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2046. See sec. 2031. For purposes of this computation, the
parties dispute whether section 2036(a) applies to the residence.
In relevant part, section 2036(a) provides:
SEC. 2036. TRANSFERS WITH RETAINED LIFE ESTATE.
(a) General Rule. The value of the gross estate
shall include the value of all property to the extent
of any interest therein of which the decedent has at
any time made a transfer (except in case of a bona fide
sale for an adequate and full consideration in money or
money’s worth), by trust or otherwise, under which he
has retained for his life or for any period not
ascertainable without reference to his death or for any
period which does not in fact end before his death--
(1) the possession or enjoyment of, or
the right to income from, the property * * *
Congress enacted section 2036 intending to bring within a
decedent’s gross estate “‘transfers that are essentially
testamentary–-i.e., transfers which leave the transferor a
significant interest in or control over the property transferred
during his lifetime.’” Estate of Abraham v. Commissioner,
408 F.3d 26, 37 (1st Cir. 2005) (quoting United States v. Estate
of Grace, 395 U.S. 316, 320 (1969)), affg. T.C. Memo. 2004-39;
see also Mahoney v. United States, 831 F.2d 641 (6th Cir. 1987).
Pursuant to section 2036(a), decedent’s gross estate will include
the fair market value of the residence if decedent retained an
interest in the residence for her life or for any other period
that does not end before her death.
In order not to have retained an interest described in
section 2036(a), decedent must have “absolutely, unequivocally,
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irrevocably, and without possible reservations,” parted with all
of her title, possession, and enjoyment of the residence.
Commissioner v. Estate of Church, 335 U.S. 632, 645 (1949).
Decedent will have retained such an interest in the residence if
she transferred the residence to Funny Hats with an understanding
or agreement, express or implied, that the possession or
enjoyment of the residence would be for her pecuniary benefit.
See Guynn v. United States, 437 F.2d 1148, 1150 (4th Cir. 1971);
Estate of Rapelje v. Commissioner, 73 T.C. 82, 86 (1979); sec.
20.2036-1(b)(2), Estate Tax Regs.; see also United States v.
Byrum, 408 U.S. 125, 146 n.28 (1972) (in the context of section
2036(a)(1), the word “enjoyment” denotes the receipt of a
substantial present economic benefit); Estate of Maxwell v.
Commissioner, 3 F.3d 591, 593 (2d Cir. 1993) (in the context of
section 2036, the terms “possession” and “enjoyment” as applied
to real property denote “‘the lifetime use of the property’”
(quoting United States v. Byrum, supra at 147)), affg. 98 T.C.
594 (1992). Such is so even if the retained interest is not
legally enforceable. See Estate of Abraham v. Commissioner,
supra at 39; Estate of Maxwell v. Commissioner, supra at 593;
Estate of Reichardt v. Commissioner, 114 T.C. 144, 151 (2000);
Estate of Rapelje v. Commissioner, supra at 86.
Whether decedent had an understanding or agreement to retain
possession or enjoyment of the residence following its transfer
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to Funny Hats is determined from all of the facts and
circumstances surrounding both the transfer itself and the
subsequent use of the residence. See Estate of Abraham v.
Commissioner, supra at 39. We carefully scrutinize the facts and
circumstances of a case such as this that involves an intrafamily
transaction. See Estate of Hartshorne v. Commissioner, 402 F.2d
592, 594 n.2 (2d Cir. 1968), affg. 48 T.C. 882 (1967); Estate of
Huntington v. Commissioner, 100 T.C. 313, 316 (1993); Estate of
Labombarde v. Commissioner, 58 T.C. 745 (1972), affd. per curiam
without published opinion 502 F.2d 1158 (1st Cir. 1973); cf.
Estate of Abraham v. Commissioner, supra at 39; Estate of Maxwell
v. Commissioner, 98 T.C. at 602.
Section 7491 was added to the Code by the Internal Revenue
Service Restructuring and Reform Act of 1998, Pub. L. 105-206,
sec. 3001(c), 112 Stat. 727, effective for court proceedings
arising from examinations commencing after July 22, 1998.
Section 7491(a)(1) provides that the burden of proof is on the
Commissioner in specified circumstances. While petitioner makes
no argument that section 7491(a)(1) applies here, we need not and
do not decide whether petitioner has met all of the prerequisites
for that section to apply. See, e.g., sec. 7491(a)(2) (section
7491(a)(1) applies only when certain limitations are met). We
decide this case without regard to which party bears the burden
of proof. Specifically, on the basis of the record at hand, we
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find that decedent made a transfer of the residence to Funny Hats
whereby she retained lifetime possession and enjoyment of the
residence pursuant to her express and implied understandings and
agreements with the donees. It seems to us plainly inferable
that decedent’s children meant for her to stay at the residence
until she died, unless, of course, they had to put her in an
assisted living facility or a nursing home.
The express understandings and agreements of retention are
memorialized in the lease agreements. These agreements gave
decedent the right to the same quiet enjoyment of the entire
residence that she had enjoyed before transferring the residence
to Funny Hats. The lease agreements stated specifically and
without reservation that the leased property was the address of
the residence, and they contained no relevant limitation on
decedent’s exclusive use of the leased property. The lease
agreements also stated, specifically and without reservation,
that decedent might “peaceably and quietly have, hold and enjoy”
the residence for the term of the lease and allowed decedent to
further her possession and enjoyment of the residence by
altering, decorating, changing, or adding to it. The lease
agreements even gave decedent the right to sublet all or part of
the residence, to assign the lease, or to permit any other person
to use the residence. While the presence of a lease may
sometimes lead to a finding of a lack of retention for purposes
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of section 2036(a)(1), see, e.g., Estate of Barlow v.
Commissioner, 55 T.C. 666 (1971) (possession and enjoyment of
real property pursuant to a lease was not a retention of the
possession or enjoyment of the property for purposes of section
2036(a) where the tenant paid FRV), such is not true where, as
here, the tenant pays less than FRV as to the lease of the
property. Decedent’s rights under the lease agreements to the
exclusive possession and enjoyment of the residence triggers the
application of section 2036(a)(1) to the residence in that
decedent did not pay FRV for that possession and enjoyment.
As to the implied understanding and agreement between
decedent and Funny Hats as to her continued possession and
enjoyment of the residence following its transfer to Funny Hats,
we find such an understanding or agreement when we view the
conduct of the parties to the lease agreements, as well as the
lease agreements themselves. See Estate of Reichardt v.
Commissioner, supra at 151; Estate of Rapelje v. Commissioner,
supra at 86. We further find that the annual lease agreements
were a subterfuge to disguise the testamentary nature of the
transfer.
First, Funny Hats was not a business operated for profit but
was a testamentary device whose goal was to remove the residence
from decedent’s gross estate. During decedent’s life, Funny Hats
operated solely as a conduit for the payment of expenses related
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to the residence and operated for the most part only to the
extent that decedent furnished it with funds. Funny Hats used
the funds that it received from decedent to pay indirectly the
same types of expenses that she had paid directly before she
transferred the residence to Funny Hats. Shortly after decedent
died, Funny Hats sold the residence and conducted no activity
except for limited tasks related to the liquidation of Funny
Hats.
Second, decedent’s relationship to the residence following
its transfer to Funny Hats was not treated by either decedent or
Funny Hats as that of a tenant to leased property. Decedent was
frequently delinquent in paying, or failed to pay, rent due under
the terms of the lease agreements. Decedent also did not pay
rent every year upon signing the lease, as also was required by
the terms of the lease agreements. Yet in no instance did Funny
Hats send decedent a late notice, accelerate her installment
payments, make a written demand for payment, seek her eviction,
or ask her to post a security deposit. Nor did Funny Hats set
decedent’s rent at FRV; the rent was set at a lesser amount that
was considered necessary to maintain the residence. It also
appears that decedent directly paid the taxes on the residence in
1994 and that she directly paid the insurance on the residence in
both 1994 and 1995.
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Third, decedent transferred the residence to Funny Hats when
she was almost 72 years old and in poor health. Following the
transfer, decedent continued to live at the residence until she
died, and Funny Hats never rented, or sought to rent, the
residence after decedent died. Instead, Funny Hats sold the
residence to David Disbrow for $350,000 shortly after decedent’s
death, without attempting to sell the residence in the market for
a higher price. The $350,000 sale price was $50,000 less than
the fair market value of the residence at the time of decedent’s
death, and we find nothing in the record that would account for
the purported 12.5-percent decline in the fair market value of
the residence from the time of decedent’s death until the time of
the sale. We also note that the $350,000 sale price equaled the
market value of the residence as of September 1, 1993, as
ascertained through the comparative market analysis obtained by
decedent on that date.
Fourth, as admitted at trial by a partner of Funny Hats, the
donees wanted decedent to continue to use and possess the
residence as she had before its transfer and wanted decedent to
live at the residence for as long as she could. The substance of
this admission is not remarkable given that decedent was elderly
and infirm at the time of the transfer, that she had lived in the
residence for approximately 37 years before the transfer, and
that the donees were the natural objects of decedent’s affection
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and bounty. While petitioner places great weight on the fact
that Funny Hats could have theoretically evicted decedent from
the residence at the end of a year by not renewing her lease for
the next year, we do not. As stated above, lifetime enjoyment
and possession may be retained by implied agreement even though
not legally enforceable. In addition, from a factual point of
view, the partners of Funny Hats were all members of decedent’s
immediate family, and the record gives us no reason to find that
they would have evicted decedent from the residence. Such is
especially so given our finding that many of the children
traveled from afar to visit decedent both before and after the
transfer. We also add that decedent during her leasehold
retained much wealth in her name and that the children were the
equal beneficiaries of that wealth.
Fifth, decedent transferred the residence to Funny Hats on
the advice of counsel to minimize the tax on her estate.
Decedent appears to have understood that transferring the
residence to Funny Hats and executing the lease agreements with
Funny Hats was merely a mechanism for removing the residence from
her gross estate while allowing her to retain beneficial
ownership of the residence. As the beneficial owner of the
residence, but not as a partner of Funny Hats, decedent
constantly wrote checks to Funny Hats and personally cashed those
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checks to generate funds that were used to maintain the
residence.
Petitioner attempts to equate decedent’s payment of rent
with FRV by arguing that decedent shared the residence with
others. As we understand petitioner’s argument, Funny Hats
retained a right under the lease agreements to use (or designate
who could use) the residence in derogation of decedent’s wishes
and without the payment of rent in that (1) the agreements stated
that the “children of the party [decedent] may use the premises”,
(2) the partners of Funny Hats were decedent’s children and
children-in-law, and (3) the partners, as effective owners of the
residence through their interests in Funny Hats, did not have to
pay themselves rent for their (or their designated person’s) use
of the residence. As we further understand petitioner’s
argument, Funny Hats, pursuant to these retained rights, allowed
David Disbrow to possess all of the residence, except for
decedent’s bedroom which decedent possessed under the lease
agreements, and decedent, therefore, was required to pay only the
portion of the FRV of the residence that corresponded to the
portion of the residence that she possessed. As we understand
the conclusion of petitioner’s argument, decedent paid FRV for
her “shared usage” of the residence in 2000 in that she paid
Funny Hats $4,000 in rent for the first quarter of that year.
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We find petitioner’s argument unavailing. We find no
credible evidence in the record to establish that someone other
than decedent was entitled to use the residence without
decedent’s consent. The record contains no agreement (with the
exception of the lease agreements) that governs the use of the
residence, and the lease agreements contain no provision
permitting any individual to use any part of the residence in
derogation of decedent’s wishes. Although we find that
individuals other than decedent visited and stayed at the
residence after the transfer, most of these individuals also
visited and stayed with decedent before the transfer. As was
true in both cases, the individuals who visited and stayed with
decedent were obviously there with decedent’s consent, express or
tacit. In fact, although we find that legal title to the
residence changed on account of the transfer, we find no
substantial change in the way that decedent possessed and enjoyed
the residence.
We also note inconsistencies between petitioner’s claim of
decedent’s shared usage and the manner in which Funny Hats and
decedent’s estate reported the rental for Federal tax purposes.
On its partnership returns, Funny Hats reported its rental of the
residence to decedent as that of the entire residence in that
Funny Hats deducted 100 percent of its related expenses and
claimed depreciation on the entire house. The estate tax return
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of decedent’s estate reports that decedent’s estate was entitled
to deduct a $6,000 expense for cleaning out “Decedent’s home”.
We also find nothing credible in the record to persuade us
that decedent agreed to pay monthly installments of rent for 2000
in amounts other than the $850 shown in the 2000 lease agreement,
or that decedent was liable in 2000 for more than $850 per month.
Petitioner invites the Court to find that there was an oral
agreement modifying the 2000 lease agreement and to find that
decedent paid $4,000 of rent for the first quarter of 2000 by
means of the February 7, 2000, check. We decline to make either
finding. First, decedent’s estate admitted on the estate tax
return that it considered $8,500 of rent to be owing to Funny
Hats. Decedent died in February 2000, and this $8,500
corresponds to the product of the remaining 10 months in that
year multiplied by the $850-per-month rate shown in the 2000
lease agreement. The $850-per-month rate is also consistent with
each of the rates of rent set forth in the lease agreements for
prior years, although petitioner now asks the Court to find that
decedent’s rent for years after 1996 actually reflected
decedent’s shared use of the residence with David Disbrow and
others.
Second, even if we were to assume arguendo that the parties
to the 2000 lease agreement could modify that agreement orally,
an assumption that we make with much reservation, the record does
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not support a finding that the referenced $4,000 check was
decedent’s payment of rent for 2000. In addition to the fact
that the check was not written by decedent, nor do we find that
it was written by another individual at the direction of
decedent, the check was written 2 days before decedent died and
was not deposited into the account of Funny Hats until 2 days
after decedent died. We are skeptical of the legitimacy of that
check as one payable from decedent’s account.
We hold for respondent.9 We have considered all arguments
by petitioner for a contrary holding and find those arguments not
discussed herein to be without merit. Given respondent’s
concessions,
Decision will be entered
under Rule 155.
9
Petitioner also seeks a contrary holding relying upon
Estate of Barlow v. Commissioner, 55 T.C. 666 (1971); Estate of
Roemer v. Commissioner, T.C. Memo. 1983-509; Diehl v. United
States, 21 AFTR 2d 1607, 68-1 USTC par. 12,742 (W.D. Tenn. 1967);
and Stephenson v. United States, 238 F. Supp. 660 (W.D. Va.
1965). Each of those cases is factually distinguishable from the
case at hand mainly in that: (1) Decedent did not pay (nor did
she agree to pay) FRV for her use of the residence after its
transfer to Funny Hats and (2) decedent and the donees had an
understanding and agreement that she would retain possession and
enjoyment of the residence until she died.
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APPENDIX
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Cash, beginning -0- $2,307 $6,839 $3,320 $9,724 $199 $7,489 $354,292 $4,816 $4,020
Transfers by decedent
Payment of rent $11,250 7,200 9,600 7,200 6,000 10,000 -0- -0- -0- -0-
Other checks -0- -0- -0- 7,000 -0- 7,000 4,000 -0- -0- -0-
Partners’ contributions
David Disbrow -0- 2,000 -0- 1,600 -0- -0- 6,714 -0- -0- -0-
Other 8 partners equally -0- 8,000 -0- 6,400 -0- -0- -0- -0- -0- -0-
Interest income -0- -0- -0- 529 177 73 580 277 47 29
Proceeds from loans
From decedent -0- -0- -0- -0- -0- 6,774 -0- -0- -0- -0-
From unspecified sources -0- 450 -0- -0- -0- -0- 7,933 -0- -0- -0-
Proceeds from sale of residence -0- -0- -0- -0- -0- -0- 348,600 -0- -0- -0-
Payment of expenses (8,943) (9,957) (12,319) (12,325) (15,702) (12,332) (20,256) (1,153) (843) -0-
Purchase of capital assets -0- (3,161) (800) -0- -0- (4,225) -0- -0- -0- -0-
Nondeductible portion of
“business meals” -0- -0- -0- -0- -0- -0- (768) -0- -0- -0-
Distributions to partners
David Disbrow -0- -0- -0- -0- -0- -0- -0- (72,058)1 -0- (810)
Other 8 partners equally -0- -0- -0- -0- -0- -0- -0- (261,384) -0- (3,239)
Repayment of loans -0- -0- -0- -0- -0- -0- -0- (15,158) -0- -0-
Unaccounted withdrawal -0- -0- -0- (4,000) -0- -0- -0- -0- -0- -0-
Cash, ending 2,307 6,839 3,320 9,724 199 7,489 354,292 4,816 4,020 -0-
1
We note that $72,058 equals $6,714 plus $65,344. Six thousand seven hundred and fourteen dollars corresponds to David
Disbrow’s contribution for 2000, and $65,344 approximates the product of David Disbrow’s 20-percent partnership interest in
Funny Hats and the difference between the total distributions for 2001 and $6,714 ($72,058 + $261,384 - $6,714 = $326,728;
$326,728 x .20 = 65,345.60).