Despondent determined the following deficiencies in petitioners’ income tax:
Year Deficiency
1963 _$13,153.44
1964 _ 22,696.75
1965 _ 30,512.00
1966 _ 90,186.00
Certain concessions Raving been made, tbe only issue remaining for our consideration is whether petitioners are entitled to deductions for depreciation on account of certain real and personal property under the circumstances set forth herein. A decision with respect to this issue governs the allowability of rental and. interest expenses and the investment credits claimed by petitioners.
EINDINGS OE EACT
Some of the facts have been stipulated. The stipulation and exhibits attached thereto are incorporated herein by this reference.
David F. Bolger (hereinafter referred to as the petitioner) and Barbara A. Bolger are husband and wife whose legal residence was Eidgewood, N.J., at the time the petitions herein were filed. Joint returns for the years in question were filed with the district director of internal revenue for the Manhattan District, New York. Petitioner Barbara A. Bolger is a party herein solely because she filed joint returns with her husband for the years in question.
During the years in question, petitioner was actively engaged in real estate investment and finance. As a result of his experience, he became familiar with the intricacies of various real estate transactions, one form of which is the subject herein.
Petitioner’s modus operandi was generally the same for all 10 transactions challenged by respondent. Typically, petitioner would form a financing corporation with an initial capitalization of $1,000. The shareholders consisted of those individuals who would ultimately receive title to the property, as explained infra.
Petitioner would then arrange to have the corporation purchase a building which some other manufacturing or commercial concern (hereinafter referred to as the user) desired to lease; on occasion, the seller was the user itself. Then, within several days, and, more often, on the same day, all of the following transactions would take place: (1) The seller would convey the property to the financing corporation; (2) the financing corporation would enter into a lease with the user; and (3) the financing corporation would then sell its own negotiable interest-bearing corporate notes in an amount equal to the purchase price to an institutional lender (or lenders, as the case might be) pursuant to a note purchase agreement (as the document was usually called), which would provide that the notes be secured by a first mortgage (which, sometimes took the form of a deed of trust), and by an assignment of the lease.
The mortgage notes provided for payment to be made over a period equal to or less than the primary term of the lease and the financing corporation was also obligated to pay for all of the lender’s out-of-pocket expenses, including legal fees.
The mortgage was a lengthy, detailed document covering almost every conceivable contingency. It spelled out in great detail the terms of payment and right of prepayment, the rights of the parties in case of default, and the responsibilities and limitations of the financing corporation under the agreement. More specifically, the corporation promised to maintain its existence and to refrain from any business activity whatsoever except that which arose out of the ownership and leasing of the property. Payments by the lessee were to be made directly to the mortgagee (or trustee) in satisfaction of payments on the secured notes. Moneys received under the lease were to be first applied to payment on the mortgage notes with the remainder to be paid over to the financing corporation. Provision was made as to the circumstances under which the corporation could sell or transfer the property, the transferee being required to assume all obligations under the mortgage and lease except that the transferee assumed no personal financial obligation for the payment of principal and interest or any other monetary judgment, liability on such assumption being limited to the property transferred. The transferee was also required to compel the financing corporation to maintain its existence, prevent it from engaging in any business other than that arising out of the property and lease thereon, cause such corporation to maintain books available for inspection by the mortgagee, and prevent any merger or consolidation by such corporation with any other corporation.
The lease was for a primary term at least equal to, and, on occasion, in excess of, the period of the mortgage note. Provision was also made for payment by the lessee of all taxes, insurance, repairs, etc., and all costs of acquisition save the purchase price incurred by the lessor— i.e., it was a net lease. The lessee’s right and interest in the property, easements, or appurtenances were subordinated to the mortgage. Payments under the lease were to continue even if the building was destroyed; the lessee had the right to purchase the property in such event for a price set in accordance with a schedule attached to the lease which approximated the amount required from the lessor to prepay the note. Refusal to accept the offer of purchase would result in the termination of the lease. The lessee further agreed to indemnify the lessor from any liability resulting from any occurrence on the premises or because of the work being done on the premises by the lessee. The lessee was permitted to sublease the premises or any portion thereof, and he was permitted to assign his interest in the lease, pro vid-ing the sublessee or assignee promised to comply with the terms of the mortgage and the lease and further providing the lessee remain personally liable for the performance of all its obligations under the lease.
Upon the completion of the foregoing, the financing corporation would convey the property to its shareholders for “One dollar and other valuable consideration,” subject to the lease and the mortgage and without any cash payment or promise thereof by the transferee. Concurrently, the transferee would execute an assumption agreement in favor of the financing corporation, promising to assume all of the financing corporation’s obligations under the lease and the mortgage but limited as aforesaid.
The particulars of the various transactions, insofar as they are material to the within case, are summarized in the following chart and the qualifications thereafter set forth:
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In the Colton, Calif., transaction, the transfer of the property from Stonbernardino Properties, Inc., to petitioner was delayed for 5 months. Also, upon receipt of the deed, petitioner conveyed the underlying land to a third party for $83,923.91 and simultaneously leased the property back for a term equal to that of the primary lease on the building. Petitioner paid a rental equal to 32 percent of the rent received from the lessee of the building less 32 percent of any expenses incurred by Stonbernardino or petitioner in conformity with the mortgage and lease.
In the Kinney Shoe transaction, one of seven parcels acquired by Janess Properties, Inc., was not actually conveyed to it until July 29, 1964, a month and a half after the original transaction was executed. All transfers of the parcel to petitioner and his associates then proceeded as in the model transaction.
In the San Antonio transaction, the initial amount of financing proved inadequate to cover the cost of the facilities built on the property. Therefore, on June 15, 1965, about 6 months after the initial transactions, an additional $100,000 was financed in a manner similar to the initial cost. The mortgage and lease agreements were amended to absorb this cost and Andrean Properties, Inc., was a party to the modification docmnents.
In the Etiwanda, Calif., and Eockford, Ill., transactions, a separate document was executed purporting to designante the financing corporation as the nominee of petitioner and his associates.
In each instance, the fair market value of the underlying property was at least equal to the face amount of the mortgage, or the unpaid balance thereof, at the date the financing transactions were completed and at the date of the transfers to petitioner and, in some instances, to his associates.
Petitioner reported in the tax returns for the years in question his proportionate share of the income and deductions attributable to the properties after his acquisitions.
OPINION
The dispute in this case — whether petitioner is entitled to depreciation deductions under section 1671 with respect to certain properties— arises from a single factual pattern repeated several times, planned and executed by the petitioner, on each occasion using a different property and different persons in the supporting roles of lessee and mortgagee. In each instance, the petitioner acquired legal title to the property, subject to a long-term lease of the property and a mortgage encumbering the property in respect of which he assumed no personal liability. At the time of petitioner’s acquisition, the value of each property at least equaled the unpaid principal amount of the mortgage, and petitioner neither made nor obligated himself to make any cash investment in the property out of his own pocket.
The essential facts of the several transactions are set forth in our findings and include a recital of certain variations in respect of the several properties involved. Neither party argues that these variations should produce different results for a particular piece of property.2 The two issues upon which resolution of the basic question depends are: (1) Should the corporations from which the petitioner acquired his ownership interest in the properties be recognized as separate viable entities; and (2) if they should be so recognized, are they or the petitioner entitled, to an allowance for depreciation and for other related items.
We consider first the viability of the corporations. There is no question that they were organized and utilized in the initial stages for business purposes, namely, to enable the contemplated transactions to produce maximum financing by avoiding State law restrictions on loans to individuals rather than corporate borrowers, to provide a mechanism for limiting personal liability, and to facilitate multiple-lender financing. In furtherance of these purposes, the corporations purchased the properties, entered into the leases, issued their corporate obligations, and executed mortgages and assignments of the leases as security for the payment of those obligations. At that point of time the corporations were undoubtedly separate viable entities whose separate existence could not be ignored for tax purposes. Moline Properties v. Commissioner, 319 U.S. 436 (1943). The activities of the corporations involved in Jackson v. Commissioner, 233 F. 2d 289 (C.A. 2, 1956), O’Neill v. Commissioner, 170 F. 2d 596 (C.A. 2, 1948), and Dallas Downtown Development Co., 12 T.C. 114 (1949), relied upon by petitioner, were far less by comparison; those cases are therefore distinguishable. Nor do we think the record herein can support petitioner’s assertion that, in engaging in the aforementioned transactions, the corporations were merely acting as agents or nominees.3 National Carbide Corp. v. Commissioner, 336 U.S. 422 (1949); Taylor v. Commissioner, 445 F. 2d 455 (C.A. 1, 1971), affirming a Memorandum Opinion of this Court; Fort Hamilton Manor, Inc., 51 T.C. 707, 719-720 (1969), affd. 445 F. 2d 879 (C.A. 2, 1971). Compare Paymer v. Commissioner, 150 F. 2d 334 (C.A. 2, 1945), reversing in part a Memorandum Opinion of this Court on facts distinguishable from those involved herein. Indeed, the existence of an agency relationship would have been self-defeating in that it would have seriously endangered, if not prevented, the achievement of those objectives which, in large part, gave rise to the use of the corporations, namely, the avoidance of restrictions under State laws.
We still must determine, however, whether the corporations should be recognized as separate viable entities after the transfers of the properties in question. At that point, they were stripped of their assets and, by virtue of their undertakings, could not engage in any other business activity. On the other hand, the corporations continued to be liable on their obligations to the lenders and were required, under the terms of those obligations, to remain in existence, to abide by certain other undertakings, and to preserve their full powers under the applicable State laws to own property and transact business. Moreover, the transferees of the properties agreed to cause the corporations to comply with their undertakings, albeit that any claim for breach of such agreement was limited to the property and could not constitute a basis for the assertion of personal liability. Finally, we note that, in the case of the San Antonio property, the corporation participated in refinancing arrangements subsequent to the transfer to petitioner.
Under the foregoing facts and based upon the record before us, the circumstances herein do not constitute an exception to the following test enunciated in Moline Properties, Inc. v. Commissioner, 319 U.S. at 438-439, and we hold that the corporations continued to be separate viable entities for tax purposes:4
The doctrine of corporate entity fills a useful purpose in business life. Whether tbe purpose be to gain an advantage under tbe law of tbe state of incorporation or to avoid or to comply with tbe demands of creditors or to serve tbe creator’s personal or undisclosed convenience, so long as that purpose is tbe equivalent of business activity or is followed by tbe carrying on of business by tbe corporation, tbe corporation remains a separate taxable entity. * * * [Citations omitted.]
On the same basis, we conclude that the corporations cannot be considered as agents of the transferees during the period following the transfers.
Having held that the corporations should be treated as separate viable entities at all times pertinent herein, we are required to decide the second issue raised by the parties — whether petitioner as a transferee of the properties in question is entitled to the deduction for depreciation. Eesolution of this issue depends upon who has the de-preciable interest in the properties, the corporations or the petitioner,5 and, in the event that it is the petitioner, the measure of his basis. The key to our decision ultimately lies in a determination of the extent to which the doctrine of Crane v. Commissioner, 331 U.S. 1 (1947), applies.
We turn first to a consideration of the nature of the interest which the petitioner acquired. Petitioner contends that he and his associates acquired both legal title and full beneficial ownership of the properties from the corporations. Eespondent counters with the assertion that, because of tbe long-term leases and the commitments of the rentals to the payment of the mortgages by virtue of the assignments of the leases which were consummated prior to the execution of the deeds, the conveyances by each corporation transferred only a rever-sionary interest in the buildings6 and that consequently petitioner did not acquire a present interest in the properties which may be depreciated for income tax purposes. We agree with petitioner.
Implicit in respondent’s position is the concept that, by virtue of the leases and financing transactions, the corporations divested themselves of all but bare legal title to the properties. Following this concept to its logical conclusion would require a determination either that the corporations thereby deprived themselves of any presently depreciable interest or that their right to deduct the cost of the buildings should be by way of amortization over the lease terms. But both possibilities are belied by respondent’s basic argument that the corporations retained such an interest in the properties as against their transferees that they, and not the latter, should be held accountable for the income from the properties and be entitled to the depreciation deduction.7 Compare Harriet M. Bryant Trust, 11 T.C. 374 (1948). See also sec. 1.167(a)-4, Income Tax Begs, (capital expenditures for buildings by a lessor are recoverable through depreciation allowances over the life of the buildings and not the term of the lease). The assignments of the leases, like the mortgages, were transfers solely for security and did not relieve the corporations from being charged with the rents for income tax purposes. Ethel S. Amey, 22 T.C. 756 (1954). Each lease was part and parcel of the ownership of the particular property the legal and beneficial ownership of which was vested at the outset in the appropriate corporation. Cf. LeBelle Michaelis, 54 T.C. 1175 (1970). It is this critical factor which distinguishes the cases, relied upon by respondent, dealing with the right of a lessor to depreciate buildings constructed on his land by the lessee. The lessee, by virtue of his expenditure, was clearly entitled either to depreciation of the building or amortization of its costs over the term of the lease. The question presented was whether the lessor, as the legal owner of the building, could also claim depreciation. Thus, unlike the instant situation, where both parties agree that only the corporations or the transferees, but not both, are entitled to depreciation, the courts were faced with the possibility of a double deduction. The beneficial ownership of the buildings was held to be vested in the lessee and the technical vesting of legal title in the lessor by virtue of the ownership of the land was not deemed sufficient to permit the conclusion that the lessor had a depreciable interest. See the discussion in World Publishing Co. v. Commissioner, 299 F. 2d 614 (C.A. 8, 1962), reversing 35 T.C. 7 (1960), and in Albert L. Rowan, 22 T.C. 865 (1954). See also Buzzell v. United States, 326 F.2d 825 (C.A. 1, 1964); Catharine B. Currier, 51 T.C. 488 (1968). Such lack of depreciable interest in the lessor has generally been the foundation for denying a depreciation allowance to the lessor’s transferee — at least where the transfer was by way of inheritance. Albert A. Rowan, supra, and cases cited therein.8
In short, as we see the situation, the real question to be decided is what was petitioner’s basis in each of the properties. Before proceeding to a discussion of this question, we need to dispose of certain preliminary contentions on the part of respondent. First, he contends that petitioner has not proved by what means he acquired his claimed interests in the properties — whether as a purchaser or as a shareholder in receipt of corporate distributions by way of dividends, in liquidation, or otherwise. Ancillary to this argument and also in an attempt to avoid the impact of Crane v. Commissioner, supra, respondent argues that petitioner has failed to prove that the fair market value of the properties, at the time of his acquisition, was equal to or in excess of the face amounts of the mortgages. In respect of the latter contention, whatever may be the state of the record herein as to the value of the properties without regard to the leases or at dates subsequent to those on which the corporations made the transfers, we are satisfied both independently on the facts revealed by the record and also on the basis of respondent’s stipulation at the trial that, at the time of transfer by the corporations, the fair market value of each property, taking the existing lease into account (cf. LeBelle Michaelis, supra), at least equaled the remaining principal balance of the unassumed mortgage. Such being the case and considering the fact that neither party claims any value in excess of such unpaid balance, it seems clear to us that if that unpaid balance is deemed part of petitioner’s basis, that cost and the fair market value of each property will be in the same amount and it will be immaterial whether petitioner’s basis is determined under section 1012 (cost) or under section 301(d) or 334 (a) (fair market value). It is, therefore, unnecessary for petitioner to prove, or for us to decide, whether petitioner took title as purchaser or shareholder.
This brings us to the final question to be considered, namely, should the unpaid balance of each mortgage be deemed part of petitioner’s basis even though petitioner and his associates assumed no liability in respect thereto. Had petitioner accepted personal liability for the mortgage debt, instead of merely taking the leased property subject to the lien but without personal liability, there would be no legitimate question that the debt as assigned was part of the basis of the property. Thus, the issue is whether the absence of such personal liability should produce a different result. In Crane v. Commissioner, supra, the Supreme Court held that the amount of a mortgage encumbering inherited property should be included in the devisee’s basis for such property, whether or not the devisee assumes personal liability for the mortgage. In Blackstone Theatre Co., 12 T.C. 801 (1949), we applied the doctrine of Orane to a purchase and held that the amount of an unassumed lien on acquired property should be included in the cost of the property. Cf. Parker v. Delaney, 186 F. 2d 455 (C.A. 1, 1950). We reiterated this conclusion in Manuel D. Mayerson, 47 T.C. 340 (1966), where a purchase-money mortgage without personal liability was included in the amount of basis for purposes of depreciation. In so doing, we were not deterred by the fact that the taxpayer made only a nominal cash investment. We explained that the effect of the Orame doctrine is:
to give the taxpayer an advance credit for the amount of the mortgage. This appears to be reasonable, since it can be assumed, that a capital investment in the amount of the mortgage will eventually occur despite the absence of personal liability. * * * [See 47 T.C. at 352. Emphasis added.]
Respondent argues that such an assumption is unreasonable under the facts of the present case. He asserts that petitioner has no reason to protect his interest in the property involved herein, since his cash flow is minimal and the property is mortgaged to the full extent of its value. Such assertion ignores the fact, however, that petitioner’s equity in the property increases as the rents under the lease are paid in amortization of the mortgage. This increase in equity will benefit petitioner either by way of gain in the event of a sale or the creation of refinancing potential. Moreover, petitioner will seek to protect his interest in the property in order to retain the benefits of any appreciation in its fair market value.
To claim, as respondent does, that petitioner will be making no investment in the property during the term of the lease merely begs the question. The rents are includable in his income even though they are assigned as security for the payment of the mortgage. See Ethel S. Amey, supra. As we stated in the Mayerson case, the Orane doctrine permits the taxpayer to recover Ms investment in the property before he has actually made any cash investment. Every owner of rental property hopes to recoup his investment, plus a profit, from the receipt of rental income. In the normal case, he applies part of this income to the amortization of any mortgage encumbering the leased property, retaining any excess over the mortgage payments as Ms cash flow. As Mayerson makes clear, petitioner’s case should not be treated differently merely because his acquisition of the property is completely financed and because his cash flow is minimal.
Similar reasomng disposes of respondent’s argument that, under the circumstances of tMs case, the likelihood that petitioner will ever be called upon to make any payments on the mortgages is so speculative as to require that the mortgage obligation be characterized as a contingent obligation and not included in cost under the principle enunciated in Columbus & Greenville Railway Co., 42 T.C. 834 (1964), affd. 358 F. 2d 294 (C.A. 5, 1966); Albany Car Wheel Co., 40 T.C. 831 (1963), affd. 333 F. 2d 653 (C.A. 2, 1964); and Lloyd H. Redford, 28 T.C. 773 (1957). We dealt with those cases in Mayerson and distinguished them on the ground that the underlying obligations, by their terms, were contingent. See 47 T.C. at 353-354. Such is not the situation herein.
Finally, our finding that the unpaid principal balance of each mortgage was equivalent with the fair market value of the property at the time of transfer by each corporation obviates the need to consider whether the Grane doctrine should apply where that circumstance does not exist. See Crane v. Commissioner, 331 U.S. at 12, fn. 37; Parker v. Delaney, 186 F. 2d at 458; compare Edna Morris, 59 T.C. 21 (1972).
The combination of the benefits of accelerated depreciation and the Grane doctrine produces a bitter pill for respondent to swallow. We see no way of sugarcoating that pill, short of overruling Crane v. Commissioner, supra, which we are not at liberty to do.9
Because of the various concessions made by the parties and to reflect our conclusions herein,
Decisions will be entered under Rule 50.
Reviewed by the Court.
All statutory references are to the Internal Revenue Code of 1954, as amended.
They have simply pointed to' these variations as supportive of their arguments In respect of the two Indicated Issues, we will accordingly treat these variations in the same fashion.
In the ease of the Etiwanda, Calif., and the Rockford, Ill., properties, there is nominee language in the pertinent documents, but, in our opinion, such language does not overcome the numerous other elements which have a more than counterbalancing effect. See Fort Hamilton Manor, Inc., 51 T.C. 707 (1969), affd. 445 F. 2d 879 (C.A. 2, 1971). In any event, as we have previously pointed out, neither party has sought separate treatment for particular transactions.
In so concluding, we have taken into account that, in situations such as are involved herein, the taxpayer may have less freedom than the Commissioner to ignore the transactional form that he has adopted. See Commissioner v. State-Adams Corporation, 283 F.2d 395, 398-399 (C.A. 2, 1960). Compare Higgins v. Smith, 308 U.S. 473 (1940); Aldon Homes, Inc., 33 T.C. 582, 596 (1959).
Respondent concedes that the leases involved should he recognized as such and makes no argument that the lessees are the ones to whom the benefit of a depreciation deduction should inure. Cf. Helvering v. Lazarus & Co., 308 U.S. 252 (1939).
Respondent does not indicate bis position vis-a-vis the land involved, presumably because it is in any event not subject to an allowance for depreciation.
As previously pointed out, respondent does not attack the validity of the leases. See fn. 5 supra.
In this connection, we note that the position of the lessor is sometimes also discussed in terms of his not haring any basis. What is more, such discussion sometimes confuses the two questions, i.e., existence of a depreciable interest and the measure of basis, of which respondent’s briefs herein furnished an excellent example. See also, e.g., M. De Matteo Construction Co. v. United States, 433 F. 2d 1263 (C.A. 1, 1970). Where the transfer is by way of sale, the authorities are divided. Compare World Publishing Co. v. Commissioner, 299 F. 2d 614 (C.A. 8, 1962), reversing 35 T.C. 7 (1960), with M. DeMatteo Construction Co. v. United States, supra. Since, in our view, the instant case is distinguishable, we need not now decide which line of authority to follow.
Crane has been the subject of extensive discussion, some of it critical. See Andrews, ‘‘Personal Deductions in an Ideal Income Tax,” 86 Harv. L. Rev. 309, 379, fn. 122 (1972) ; Perry, “Limited Partnerships and Tax Shelters: The Crane Rule Goes Public,” 27 Tax L. Rev. 525 (1972) ; Adams, “Exploring the Outer Boundaries of the Crane Doctrine: An Imaginary Supreme Court Opinion,” 21 Tax L. Rev. 159 (1966).