*292 Decision will be entered under Rule 155.
P entered into an agreement to purchase a vacation condominium for a stated purchase price in excess of $ 1.5 million. P executed an installment note calling for two payments of the stated purchase price, the first installment due in just over 6 months and the second due in 30 years. P claims that the first installment is a payment to which
MEMORANDUM OPINION
HALPERN, Judge: By notice of deficiency dated August 21, 1987, respondent determined a deficiency in petitioners' Federal income tax in the amount of $ 29,015, for the taxable year 1983, together with an addition*293 to tax under section 6661. In an amended answer filed on September 26, 1988, respondent increased the deficiency to $ 61,011.50 and conceded that section 6661 was inapplicable. The deficiency at issue derives from respondent's disallowance of a deduction for unstated interest claimed by petitioner Lloyd E. Williams, Jr., in connection with his purchase of a one-half interest in a Utah condominium unit. We focus here on whether the sale to him of the one-half interest in the condominium occurred in June 1983. Petitioners claim that it did, such that the interest component of an installment payment of the purchase price made on December 30, 1983, is computed pursuant to
Some of the facts have been stipulated and are so found. The stipulation of facts filed by the parties and attached exhibits are incorporated herein by this reference. Unless otherwise noted, all section references are to the Internal Revenue Code of 1954 in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Background
At the time the petition in this case was filed, petitioners Lloyd E. Williams, Jr., and Mildred*294 A. Williams resided in Kenilworth, Illinois. Hereinafter, the term "petitioner", when used in the singular, will refer to petitioner Lloyd E. Williams, Jr.
Purchase Agreement
The Pinnacle at Deer Valley (The Pinnacle) is a condominium project located in Deer Valley, Park City, Utah. Deer Valley contains a ski resort. RDG Associates, a Utah limited partnership, is the developer of The Pinnacle and, during all times here relevant, marketed condominium units in The Pinnacle. 1 On June 22, 1983, petitioner, a lawyer, and C. Barry Montgomery, one of petitioner's law partners (together, Buyers), entered into a condominium purchase agreement (the Purchase Agreement) with RDG Associates (Seller) to purchase a condominium unit in The Pinnacle.
*295 Among other terms, the Purchase Agreement provides that the Buyers are purchasing, and the Seller is selling, Unit 37, a residential condominium, in The Pinnacle (the Condominium). The stated purchase price is $ 1,514,000. The Purchase Agreement requires the Buyers immediately to pay $ 10,000, as a downpayment, with the balance of the purchase price, or $ 1,504,000, to be paid in installments, in accordance with the terms of a promissory note (the Installment Note), to be described.
The Purchase Agreement requires certain documents to be placed in escrow, to be delivered by the escrow agent (Escrow Agent) on December 30, 1983, the "Settlement Date" (Settlement Date). The Seller was to place in escrow a warranty deed conveying to the Buyers title to the Condominium (Warranty Deed). The Buyers were to place in escrow a deed of trust, along with a rider to the deed (together, Second Deed of Trust), and a quitclaim deed reconveying the Condominium from the Buyers to the Seller (Quitclaim Deed). The Warranty Deed, Second Deed of Trust, and Quitclaim Deed were executed by the appropriate persons on June 23, 1983, and placed in escrow.
The Purchase Agreement states further that the*296 Buyers entered into possession of the Condominium as of June 22, 1983, and that the parties would enter into a Memorandum of Condominium Purchase Agreement (Memorandum of Purchase Agreement). The Memorandum of Purchase Agreement is described as "evidencing Buyer's purchase of, and equitable title to, the Condominium". The memorandum was executed on June 23, 1983, and recorded on June 27, 1983. Upon recordation of the Memorandum of Purchase Agreement, the Seller was obligated to deliver to the Buyers a commitment to issue a title insurance policy. The Purchase Agreement provides that real estate taxes are to be prorated as of June 22, 1983, to reflect that the benefits and burdens of ownership have transferred to the Buyers. Further, the Buyers have no right to assign or transfer the Purchase Agreement or their rights under that agreement without the Seller's prior written consent.
The Purchase Agreement requires the Condominium to be completed and equipped according to certain specifications reviewed by the Buyers, but it grants the Seller the right to make certain changes provided that such changes do not materially diminish the Condominium's value. The Purchase Agreement *297 obligates the Seller to use reasonable efforts to have the Condominium fully constructed and ready for occupancy by December 30, 1983, and requires the Seller to complete the Condominium, and the entire building of which the Condominium is a part, within 200 or fewer days, or by early January 1984. On June 23, 1983, the Buyers paid the sum of $ 10,659.72 to the Seller, which sum included the downpayment ($ 10,000), an estimated proration of taxes ($ 259.72), and a homeowner's capitalization fee ($ 400). Petitioner paid one-half of that sum. On June 23, 1983, the residential unit of the Condominium had not yet been constructed. On that date, excavation for the building containing the residential unit had been completed and a few supports and beams had been placed. The residential unit was not completed until after January 1, 1984.
Installment Note and Judgment Note
The Installment Note, dated June 23, 1983, has a stated face amount of $ 1,504,000. It calls for two payments. The first payment (first installment), in the amount of $ 477,000, is due on the Settlement Date, December 30, 1983, and the second payment (second installment), in the amount of $ 1,027,000, is due*298 on July 24, 2013. The Installment Note states: "No interest shall be charged on the face amount owed hereunder during the term thereof."
To secure partially their obligation to make the first installment (due on the Settlement Date), the Buyers executed contemporaneously with the Installment Note a judgment note, in the amount of $ 50,000 (Judgment Note). Upon payment of the first installment, the Seller was to return the Judgment Note to the Buyers.
The Installment Note contemplates that the Buyers might finance the first installment ($ 477,000). It provides that the obligation to pay the second installment on July 24, 2013, would be subordinate to such financing.
Default Prior To Settlement Date
The Purchase Agreement provides the Seller with two remedies in the event of a default by the Buyers prior to the Settlement Date (Pre-Settlement Default):
(i) Seller may be released from all obligations in law and equity to convey fee simple title to the [Condominium] and Buyer shall become at once a tenant at will of Seller. Upon written notification from Seller, Escrow Agent shall record the Quit-Claim Deed from Buyer to Seller deposited with Escrow Agent herewith, and *299 all payments which have been made previously under this agreement by Buyer, together with the Judgment Note, shall be retained by Seller as liquidated and agreed damages for breach of this Agreement, and Seller shall be entitled in connection therewith to make demand for payment of the proceeds of the Judgment Note; or
(ii) Seller may, upon written notice to Buyer, declare the entire amount under the Installment Note at once due and payable and may elect to treat this Agreement as a note and mortgage, and tender title to Buyer subject thereto, and proceed immediately to foreclose the same in accordance with the laws of the State of Utah, and have the * * * [Condominium] sold and the proceeds applied to the payment of the balance owing, and Seller's costs and attorneys' fees; provided, however, that Seller's sole remedy in such an event shall be to foreclose Buyer's rights under this Agreement, and Buyer shall not be liable for any deficiency between the amounts owed under the Installment Note and the proceeds from such foreclosure. [Emphasis added.]
The Purchase Agreement provided the Buyers with one remedy in the event of the Seller's default prior to Settlement Date:
In the*300 event Seller defaults under this Agreement prior to the Settlement Date, Buyer's sole and exclusive remedy shall be to terminate and rescind this Agreement, whereupon Seller shall return to Buyer all sums previously paid by Buyer to Seller hereunder and any prior reservation agreement, together with interest thereon at the rate of six percent (6%) per annum, and Seller shall cancel and return to Buyer the Judgment Note, the [Installment] Note, and the Trust Deed [i.e., Second Deed of Trust]. Upon such termination, Escrow Agent shall record with the Summit County, Utah, Recorder the Quit-Claim Deed to the Condominium deposited with Escrow Agent herewith, and Seller and Buyer shall have no further obligations to each under this Agreement or any other agreement with respect to this transaction.
Side Agreement
The Seller and the Buyers signed a letter dated June 23, 1983, containing handwritten revisions and additions that modified the terms of the transaction. Later, that letter was retyped, and a few other revisions and additions were made. The retyped letter, dated September 15, 1983, was then executed by the parties. We shall refer to those two letters collectively as *301 the "Side Agreement".
Under the Side Agreement, the Seller could not sell the Installment Note for 5 years and could not exercise any right to demand payment of the second installment under the Installment Note prior to July 24, 2013. The Side Agreement further provided that the Seller was willing to sell the Installment Note back to the Buyers at a present-value price (determined by a 10-percent semiannual compounding of interest). Also, the Side Agreement obligated the Seller to deliver to the Buyers a commitment from a financial institution to finance the first installment.
Under the Side Agreement, if the Condominium was not ready for occupancy by December 31, 1983, the Seller was obligated to lease the Condominium from the Buyers until its completion, at a rent equal to the interest incurred on the Buyers' financing of the first installment. In turn, the Buyers agreed that the Seller would not be deemed in default under the Purchase Agreement unless the Condominium were not completed by March 15, 1984.
Co-Ownership Agreement
On August 1, 1983, the Buyers executed a co-ownership agreement (the Co-Ownership Agreement): "to memorialize their agreement that each will *302 be liable to the other to pay one-half of the purchase price and any debts incurred by them in the course of paying the purchase price". The Co-Ownership Agreement provided that each Buyer owned an undivided one-half interest in the Condominium as a tenant-in-common and in any income earned with respect to the Condominium. Under the Co-Ownership Agreement, each Buyer granted the other a lien on the other's interest in the Condominium to secure repayment of any excess payments with respect to the Condominium's ownership and operation. The lien was subject to foreclosure if a Buyer failed to reimburse the other Buyer for an excess payment within 60 days following demand by the other Buyer for reimbursement.
Buyers' Financing of the First Installment Payment
The Buyers obtained partial financing from Columbia Savings and Loan Association, Irvine, California (Lender), for payment of a portion of the first installment. Before financing the Buyers' payment of the first installment, the Lender obtained an appraisal of the Condominium. The appraisal report estimated that, as of November 11, 1983, the Condominium's market value was $ 500,000, with a range of $ 471,500 to $ 538,500.
*303 On December 15, 1983, the Buyers borrowed $ 400,000 from the Lender and executed a Balloon Payment Fixed Rate Note payable to Lender, with a face amount of $ 400,000 (Fixed Rate Note), and with joint and several liability. The Fixed Rate Note was secured by a Deed of Trust, with the Lender as the beneficiary (First Deed of Trust).
Settlement Date
On the Settlement Date, the Buyers paid to the Seller the first installment of $ 477,000. The Escrow Agent returned to the Buyers the Quitclaim Deed and delivered to the Buyers, and recorded in the appropriate land records, the Warranty Deed and the Second Deed of Trust.
In turn, pursuant to the Purchase Agreement, the Seller returned to the Buyers the Judgment Note and delivered to the Buyers an owner's title insurance policy insuring the Buyers' title to the Condominium. The title insurance policy was issued by the Escrow Agent in the amount of $ 519,200.
Buyers' Default After Settlement Date
The Purchase Agreement provides that, if the Buyers default after the Settlement Date either in the payment of any amounts owing under the Installment Note or in performing any obligation under the Second Deed of Trust (Post-Settlement*304 Default), the Seller may exercise any and all remedies in the Installment Note or the Second Deed of Trust.
The Installment Note provides that, in the event of a Post-Settlement Default, the Seller may declare to be immediately due and payable all amounts under the Installment Note. Consistent with the Installment Note, the Second Deed of Trust provides that, upon a Post-Settlement Default, the Seller "may execute or cause * * * [the trustee under the Second Deed of Trust] to execute a written notice of default and of election to cause * * * [the Condominium] to be sold to satisfy the obligations hereof, and * * * [said trustee] shall file such notice for record in each county" in which the Condominium is located. The Second Deed of Trust also provides that, in the event of a default, the Seller could "declare all sums secured hereby immediately due and payable and foreclose this Trust Deed in the manner provided by law for the foreclosure of mortgages on real property."
Petitioners' 1983 Federal Income Tax Return
On their 1983 tax return, petitioners claimed an interest deduction in the amount of $ 145,075 arising in part from the Buyers' payment in December 1983 of the*305 first installment of $ 477,000. 2
Procedural History
By notice of deficiency dated August 21, 1987, respondent determined a deficiency for the taxable year 1983 in petitioners' Federal income tax in the amount of $ 29,015, together with an addition to tax under section 6661. The sole adjustment giving rise to the deficiency at issue is respondent's disallowance of the interest expense of $ 145,075, computed by petitioners pursuant to
In March 1990, this Court issued an opinion in response to the parties' cross-motions for partial summary judgment.
Later, in August 1990, respondent filed a motion for leave to file a
Discussion
Are We Precluded From Considering
At trial, we asked the parties to address in their briefs the question of whether our opinion in
In Williams I, we considered the parties' cross-motions for partial summary judgment, filed under Rule 121. We specifically noted that unresolved issues of fact precluded final resolution of the case.
Petitioners' res judicata argument has no merit. Res judicata is a common-law doctrine that serves to promote judicial economy and the repose of disputes.
The general rule of res judicata applies to repetitious suits involving the same cause of action. * * * The rule provides that when a court of competent jurisdiction has entered a final judgment on the merits of a cause of action, the parties to the suit and their privies are thereafter bound "not only as to every matter which was offered and received to sustain or defeat the claim or demand, but as to any other admissible matter which might have been offered for that purpose." The judgment puts an end to the cause of action, which cannot again be brought into litigation between the parties upon any ground whatever, absent fraud or some other factor invalidating the judgment. [Citations omitted.]
The application of res judicata requires a final judgment.
Further, petitioners' law-of-the-case argument is also not successful. See 1B Moore, Moore's Federal Practice, par. 0.404[1], [4.-1] at 117, 124 (2d ed. 1991). Although in Williams I we styled the issues that we were dealing with as the "
Finally, on brief, petitioners also argue that they have been caught by surprise by respondent's claim that the first installment is not a payment for which unstated interest is determined under
In her notice, respondent further describes that adjustment, as follows: "Full disallowance of interest expense of
In their petition, petitioners did not restrict their assignment of errors, and statement of facts in support of those errors, to the three particular*313 reasons described in the above quoted explanation. In full, paragraph 4 of the petition provides as follows:
The determination of tax set forth in the said notice of deficiency is based upon the following errors:
a. The Commissioner erred in disallowing as interest expense the sum of $ 145,075, which sum was deducted pursuant to
b. The Commissioner erred in alleging the petitioner violated the provisions of
c. The Commissioner erred in alleging the petitioners income was not clearly reflected as required by
d. The Commissioner erred in alleging that the transaction which gave rise to the disallowed deduction lacked economic substance and reality.
As facts in support of the first assignment of error, petitioners continue for over three pages, explaining in detail the transaction in question. After quoting a portion of
In her answer, respondent denied that she erred, as alleged by petitioners in paragraph 4(a)-(d) of the petition.
We think that whether or not respondent's notice raises adequately the issue of
Questions Presented
Having disposed of what might be termed preliminary, procedural matters, we now turn to the substantive aspects of this case. Respondent presents nine questions to be answered, which can be distilled into three assertions:
1. The first installment is due 6 months or less after the date of sale or exchange of the condominium.
2. The transaction*315 was a tax avoidance scheme devoid of economic substance.
3. Because construction period interest must be amortized, petitioners' interest deduction is limited.
Since we agree with the first assertion, we need not reach either of the second two, and respondent's determination must be sustained. We will begin our analysis by exploring in some detail the workings of
for the sale or exchange of property there shall be treated as interest that part of a payment to which this section applies which bears the same ratio to the amount of such payment as the total unstated interest under such contract bears to the total of the payments to which this section applies which are due under such contract.
*316 After the imputed interest is determined, it is allocated to the principal payments of the debt on a pro rata basis.
Thus, the amount to be treated as interest under
*317
Pursuant to
Respondent argues that the sale of the Condominium occurred after June 1983, so that the first installment, due on the Settlement Date (December 30, 1983), was due less, not more, than 6 months after the sale. Petitioners' position is to the contrary. We agree with respondent that a sale of the Condominium did not occur prior to the end of June 1983. Therefore, the first installment is not a payment to which
Benefits and Burdens of Ownership
The term "sale" is not used in any unusual sense in
We do not doubt that, at some point, the Buyers purchased the Condominium. The question is when. When a sale is complete for tax purposes is essentially a question of fact to be ascertained from the intention of the parties as evidenced by the written agreements read in light of the attendant facts and circumstances, no single one of which is controlling.
In
(1) Whether legal title passes; (2) how the parties treat the transaction; *320 (3) whether an equity was acquired in the property; (4) whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments; (5) whether the right of possession is vested in the purchaser; (6) which party pays the property taxes; (7) which party bears the risk of loss or damage to the property; and (8) which party receives the profits from the operation and sale of the property. * * * [Citations omitted.]
We consider those factors that are relevant in light of petitioner's situation.
-- Legal Title
A warranty deed in favor of the Buyers was executed on June 23, 1983. Nevertheless, the Buyers did not receive legal title to the Condominium in June 1983, as the Warranty Deed was placed in escrow at that time. While passage of legal title is not the determinative factor in deciding when ownership has passed, it is certainly an important consideration.
-- Equity in the Condominium
In the absence of legal title, the acquisition of an*322 equity interest in property generally signifies ownership for tax purposes. See
*324 -- Present Obligations
In June 1983, neither the Buyers nor the Seller had any unconditional obligations under the Purchase Agreement. See
Further, under the Side Agreement, the Seller was obligated to deliver to the Buyers, prior to Settlement Date, a commitment from a financial institution to finance the Buyers' payment of the first installment. That provision of the Side Agreement appears to be a condition of sale, such that the Buyers' obligation was not fixed or unconditional in June 1983. In sum, petitioners have failed to carry their burden of showing that, in June 1983, the parties to the Purchase Agreement had unconditional present obligations to fulfill.
-- Right to Possession
The Purchase Agreement provides that the Buyers entered into possession of the Condominium as of June 1983. Petitioners have not, however, met their burden of producing evidence that would support that conclusion. Possession of real property serves to place all persons on constructive notice of the rights of the possessor and serves to charge all such persons with the duty to inquire as to the rights of the possessor.
No deed had been delivered to the Buyers in June 1983. The recordation of a deed to them as grantees would have signified their possession. The Buyers have not shown that they were otherwise in possession in June. They were not in physical possession of the Condominium in the sense that they were living (or could live) in the residence that the Seller was to construct.7 In June, only the excavation work and the placement of a few beams had been completed. Petitioners argue that the Buyers may have had some equitable interest in the Condominium under the doctrine of equitable conversion. See, e.g.,
*327 -- Payment of Property Taxes
Although the Purchase Agreement required the real estate taxes to be prorated as of June 1983, and although the Seller and the Buyers apparently did prorate those taxes as of that date, we do not give great weight to that fact. The real estate taxes for the second half of 1983 were only slightly more than $ 200, and that amount is insignificant in comparison to the Condominium's purchase price of $ 1,514,000 (respondent's view) or roughly $ 520,000 (petitioners' view).
-- Profits from Operation or Sale of Property
In June 1983, petitioner was in no position to receive the profits from the operation of the Condominium. As we have stated, petitioner's interest in, and the benefits of ownership of, the Condominium derived at least in part from its potential rental value, and the Condominium was not completed until 1984. The Side Agreement required the Seller to pay rent to the Buyers if the Seller failed to complete the Condominium on time. The obligation to pay rent to the Buyers, however, arose only if the Condominium was not ready for occupancy by December 31, 1983. Further, petitioner lacked in June 1983 an unrestricted right to sell*328 the Condominium because, under the Purchase Agreement, the Buyers could not assign or transfer, voluntarily or involuntarily, the Purchase Agreement or their rights under that agreement without the Seller's prior written consent. We thus conclude that the Buyers did not own the Condominium in June 1983 in the sense that, realistically, they could profit from its operation or sale.
Conclusion
We find that, in June 1983, the Seller did not transfer to the Buyers the benefits and burdens of ownership of the Condominium and that any sale of the Condominium occurred thereafter. Accordingly, the first installment, due on December 30, 1983, was due less than 6 months after the date of such sale. The first installment is not a payment to which
Decision will be entered under Rule 155.
Footnotes
1. Pursuant to Utah law, the term "condominium unit" includes a unit (here a residence) together with an undivided interest in the common areas and facilities appertaining to that unit.
Utah Code Ann. sec. 57-8-3(6) (1990). Each unit, together with its undivided interest in the common areas and facilities, constitutes real property under Utah law.Utah Code Ann. sec. 57-8-4↩ (1990).2. A schedule attached to petitioners' tax return calculates the interest component of that first installment paid by Buyers pursuant to
sec. 483 , as follows:PRESENT VALUE INTEREST PAYMENT % INTEREST DOWN $ 10,000 $ $ 10,000 FIRST PAY. 454,285 22,715 477,000 4.762% SECOND PAY. 54,986 972,014 1,027,000 94.646% TOTAL $ 519,271 $ 994,729 $ 1,514,000 66.1389% 1983 INTEREST $ 477,000 x 66.138907% = 315,483 FIRST MORTGAGE INTEREST 630 CONST. PERIOD INTEREST $ 519,271 x 5.00% = (25,964) NET DEDUCTION $ 290,149 [Petitioner's share of the net deduction is one-half, or $ 145,075.]↩
3. An opinion from Arthur Andersen & Company purporting to describe the tax consequences of the transaction in question illustrates those consequences as follows:
Hypothetical Illustration of Imputed Interest under
IRC Sec. 483 Assume a cash basis taxpayer enters into the proposed transaction. On the date the agreement is executed a $ 10,000 down payment and $ 100,000 irrevocable standby letter of credit are received by RDG. Further assume that a $ 450,000 noninterest-bearing cash payment is made 186 days after the date the agreement is executed and a second noninterest-bearing payment of $ 1,000,000 is made 30 years after the agreement is executed. The following illustrates the interest deductions pursuant to Reg.
Sec. 1.483-1(c)(3) :Total payments to which IRC Sec. 483 applies $ 1,450,000 Less: Present value of $ 450,000 due in 186 days. Reg. Sec. 1.483-1(g). ($ 450,000 x .95238) $ 428,571 Present value of $ 1,000,000 due in 30 years. Reg. Sec. 1.483-1(g) ($ 1,000,000 x .05354) 53,540 482,111 Total Unstated Interest $ 967,889 The total unstated interest, as illustrated above, is allocated pro rata to each installment. Consequently, a cash basis buyer would deduct $ 300,379 ((450,000 divided by 1,450,000) x 967,889) of interest in the year the first installment is paid and $ 667,510 ((1,000,000 divided by 1,450,000) x 967,889) in the year the second installment is paid.↩
4. We note that, while the Warranty Deed was recorded on Dec. 30, 1983, recordation of the Warranty Deed is not relevant for determining when the Seller transferred legal title to the Buyers. Recording laws are designed to provide third parties with notice of real property interests.
Bekins Bar V Ranch v. Beryl Baptist Church, 642 P.2d 371">642 P.2d 371 , 373↩ (Utah 1982).5. The Seller would have an economic incentive not to exercise that option if another buyer were willing to pay more than the Buyers had agreed to pay. ↩
6. It would make economic sense for the Buyers to default if their potential net loss on any resale of the Condominium exceeded the sum of the amount they already had paid plus the amount of the Judgment Note.↩
7. Respondent has not suggested that a portion of the consideration the Seller received from the Buyers pursuant to the Purchase Agreement was for the construction of improvements on property owned by the Buyers and not for the purchase of property. Since respondent has not raised that point, we will accept, without deciding, that the Purchase Agreement was not to any extent a contract for services.↩