™Regarding Income-Tax Benefits Re. the ©Equity Holding Corp. Trust Transfer System™
Interestingly, ‘due to Equity Holding Corp’s length time in business, we’ve been subjected to more than a few proverbial “rodeos,” and have learned a lot about what our early naysayers used to pull out of their equally proverbial lawyer-hats in order to refute our (quite valid) claims: ‘most often in order to switch a client to something they knew more about, and for which they could rack up billing hours…’and… in so doing avoid the unprofitable trip to the law library or a few hours of (‘unpaid but honest) web research.
An Early example of who was right and who was in error is the Belden Case below.
Belden is essentially an unsuccessful charge by the IRS, which at first glance may appear less than remarkable for our own purposes, in that the Equity Holding Transfer™ is not involved. Although, due to the subject matter of the case (i.e., a lease-purchase arrangement), the claimant was initially refused his income-tax deduction for property taxes and loan interest under the Qualified Property rules of IRC §163. However, the final decision in this case presented an early break-through for us and the EHTransfer™ relative to whether or not a property that was vested in, and leased from, a land trust trustee would be deemed a Qualified Property under §163 if challenged.
The case dealt with a simple lease-purchase arrangement wherein the tenants, Mr. Belden and his wife, were contracted to buy the property outright at a future time, and during the interim to make all mortgage payments and cover all expenses of ownership until the agreed-upon time of purchase. Belden presumed that his tax deduction benefits were supported by IRS Code §163 and its various subsets, including §163(h()4(D), which we refer-to frequently in the promotion of the Equity Holding Trust Transfer™.
In reviewing the case (which is digested to save you some time), ‘note that the initial refusal by the IRS to honor Mr. Belden’s claim of deductibility was based on the fact that the tax payer’s name was not on the property’s deed of title (‘ergo no proof of ownership), and neither was his name on the property’s mortgage (‘ergo no proof of any contractual mortgage obligation).
IRC §163 (h)4(D): Special Rules For Estates And Trusts
For purposes of determining whether any interest paid or accrued by the owner of an estate or trust is qualified residence interest; and any residence held by such estate or trust shall be treated as a qualified residence of such estate or trust if such estate or trust establishes that such residence is a qualified residence of a beneficiary who has a present interest in such estate or trust, or has an interest in any residuary thereof (re. funds remaining after a payoff pertinent to a particular occurrence, such as probate, insurance or lawsuit settlement).
All of this is essentially to say that a beneficiary of the Equity Holding Transfer Trust (a land trust), who is living in, caring for and paying for, the property, is entitled to mortgage interest and property tax deductions: ‘the criterion being 1) residing in the property as a permanent residence; 2) having a bona fide contractual obligation to pay all related interest and property taxes 3) holding either – a) ‘the equitable interest in the property, OR b) holding the equitable interest in an estate or a trust that holds the equitable interest in the property.
Note here that these qualifications do not require the tax payer to be named on the property’s deed, or to be a guarantor on the underlying financing.
Re. Wendell D. Belden, et ux (et ux = “and wife”). v. Commissioner,
TC Memo 1995-360 , Code §§163 etal.
WENDELL D. BELDEN AND SANDRA J. BELDEN.
|Code Sec(s):||163[pg. 95-2194]|
|Docket:||Dkt. No. 4747-93.|
|Judge:||Opinion by Gerber, J.|
|Tax Year(s):||Years 1989, 1990.|
|Disposition:||Decision for Taxpayer.|
|Cites:||TC Memo 1995-360, RIA TC Memo P 95360, 70 CCH TCM 274.|
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined income tax deficiencies for petitioners’ 1989 and 1990 tax years in the amounts of $12,488 and $5,040, respectively. Respondent also determined penalties under section 6662 for 1989 and 1990 in the amounts of $2,498 and $1,008, respectively. The issues for our consideration are: (1) Whether petitioners are entitled to claim interest deductions under code section 163 for 1989 and and 1990; and (2) whether petitioners are liable for the penalty under section 6662 for negligence and/or disregard of the rules or regulations for either 1989 or 1990.
Petitioners Wendell D. and Sandra J. Belden are husband and wife, and they resided in Tulsa, Oklahoma, at the time their petition was filed in this proceeding. Petitioner Wendell D. Belden was a registered investment adviser during 1988. At all relevant times, petitioners reported their income and deductions on the cash method of accounting. On December 19, 1988, petitioners entered into a contract for the purchase of a residence (Crown Pointe property) and took possession within two weeks thereafter. On January 16, 1989, petitioners and the seller, Ahrend Homes, Inc. (Ahrend), entered into an occupancy agreement as a supplement to the contract for purchase, providing petitioners with immediate rights of occupancy.
The purchase contract committed petitioners to paying $500,000 for the property, $20,000 of which was paid to Ahrend as earnest money. Petitioners were to obtain $400,000 of permanent financing. The $80,000 balance was to be supplied by petitioners in the form of a promissory note to Ahrend at closing. The purchase contract was subject to the condition-subsequent that Ahrend obtain suitable financing for the $400,000 under terms acceptable to petitioners. In that regard, petitioners were required to be reasonable in their acceptance or rejection of the final financing secured by Ahrend. There was no stated time limit within which financing could be obtained. The parties had not contemplated the amount of time it might take to secure permanent financing.
Until arranging for permanent financing, the occupancy agreement with Belden required petitioners to pay Ahrend $3,500 monthly, commencing February 1, 1989. The $3,500 was in the same amount as the interest Ahrend was paying on its outstanding construction loan on the Crown Pointe property. It was the parties’ understanding that petitioners would bear the $3,500 construction mortgage interest as long as they possessed the house and until permanent financing could be obtained. The $3,500 payment was designated “interest only” in the occupancy agreement and terminated upon completion of the sale. During 1989 and 1990, petitioners’ $3,500 monthly payments totaled $42,000 and $18,000, respectively. All utilities were to be placed in petitioners’ names, and petitioners agreed to obtain liability and contents insurance. Following a 2-month transition period, petitioners were responsible for the costs of repairs to plumbing, heating, cooling, electrical equipment, and appliances. Ahrend was given the option of obtaining insurance on its interest in the residence, and was required to pay the local real estate taxes on the Crown Point property. Petitioners and Ahrend complied with all terms of the occupancy agreement.
The Crown Pointe property had been vacant for several years and had fallen into poor repair prior to petitioners’ agreeing to purchase it. Petitioners paid in excess of $13,000 to repair, maintain, or improve the property during 1989. The occupancy agreement provided that petitioners would be reimbursed for improvements that they made to the property, in the event that petitioners were not the ultimate legal title holders of the Crown Pointe property. If the sale was ultimately unsuccessful, petitioners were liable for any damage (which exceeded normal wear and tear) that they caused to the property.
Petitioners and Ahrend did not close on the purchase contract, title was not transferred from Ahrend to petitioners, and fi nancing was not obtained. These events did not occur because of the bank’s foreclosing on Ahrend’s construction mortgage on the Crown Pointe property. Ultimately, petitioners purchased the property from the foreclosing bank, receiving title on February 1, 1991. Petitioners were named as defendants in the foreclosure action because of their equitable or possessory interest in the Crown Pointe property. After commencement of the foreclosure proceeding, and prior to petitioners’ purchase of the Crown Pointe property from the bank, petitioners paid the $3,500 monthly payments directly to the bank. On February 1, 1991, petitioners obtained a $297,000 mortgage on the Crown Pointe property with a bank that had not previously been involved with the property.
On their 1989 and 1990 Federal income tax returns, petitioners claimed the $3,500 monthly payments made in connection with the Crown Pointe property as deductible interest payments. These payments were made pending the closing of the residential real estate transaction in which the seller was to obtain permanent financing for the buyer, while the buyer had possession and the benefits of full use of the property as a personal residence. Respondent argues that the payments made by petitioners to Ahrend and the bank were rent and not interest. Petitioners bear the burden of showing that they were entitled to the deductions in question. Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435 [13 AFTR 1180] (1934).
Generally, section 163 provides for the allowance of a deduction for all interest paid on indebtedness. Personal interest, however, is generally not deductible. Sec. 163(h). “Qualified residence interest”, however, is excepted from the definition of “personal interest” within section 163. Sec. 163(h)(2)(D). “Qualified residence interest” includes interest paid during the taxable year on acquisition indebtedness with respect to a qualified residence. Sec. 163(h)(3)(A)(i). A “qualified residence” includes a taxpayer’s principal residence within the meaning of section 1034. Sec. 163(h)(4)(A).
In order to constitute “acquisition indebtedness”, the debt must be “incurred in acquiring, constructing, or substantially improving any qualified residence and [it must be] secured by such residence.” Sec. 163(h)(3)(B)(i). Generally, to be deductible interest under section 163(h)(3), a payment must be made with respect to indebtedness that is secured by the taxpayer’s qualified residence. Secs. 163(a), 163(h)(3)(B); sec. 1.163- 10T(o)(1)(i), Temp. Income Tax Regs., 52 Fed. Reg. 48410 (Dec. 22, 1987).
Petitioners were contractually bound to purchase and Ahrend was bound to sell the subject realty. The contract contained a condition subsequent by requiring that Ahrend find acceptable financing for petitioners, but petitioners were required to be reasonable in approving the financing located by Ahrend. Respondent characterizes the contract as being conditional, implying that petitioners controlled the outcome (they could avoid their obligation to take title and pay the remaining $480,000) by refusing to accept any financing obtained by Ahrend. Petitioners counter that they were bound to purchase, had possession of, and were the equitable owners of the realty. Respondent, on the other hand, argues that ownership of the realty is not the deciding factor, and thus, petitioners did not incur any indebtedness in 1989 or 1990 within the meaning of section 163(h)(3). Respondent contends that petitioners did not incur indebtedness until 1991, when title was received from the foreclosing bank and petitioners obtained a $297,000 mortgage. In that regard, respondent argues that Ahrend’s indebtedness cannot be relied on by petitioners to satisfy this requirement. Petitioners counter that they were equitable owners of the property, and that their payments to Ahrend were for interest on the construction loan as set forth in the agreements between the parties.
For petitioners to be entitled to the claimed interest deductions for 1989 and 1990, section 163(h)(3) requires that they show: (1) The interest was paid on “acquisition indebtedness” (i.e., debt “incurred in acquiring, constructing, or substantially im proving any qualified residence”); 3 and (2) the indebtedness was secured by such qualified residence.
Petitioners made the $3,500 payments either to Ahrend (which in turn made them to the bank) or directly to the bank after the time of the foreclosure. The occupancy agreement between petitioners and Ahrend designated those payments as interest on Ahrend’s construction loan, which was incurred to build the qualified residence (Crown Pointe property). The construction loan was secured by a mortgage on the Crown Pointe property, and that mortgage was foreclosed by the bank from which petitioners ultimately obtained legal title. We must now decide whether petitioners are entitled to deduct interest on debt that they are not personally obligated to repay.
Section 1.163-1(b), Income Tax Regs., provides that “Interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness.”
See also Baird v. Commissioner, 68 T.C. 115, 123 (1977). Respondent argues that the contractual relationship between petitioners and Ahrend was conditional such that petitioners could not become the legal or equitable owners until the property was deeded to them. In a Federal tax proceeding, the question of when a sale is completed is to be resolved by the facts and circumstances in each case, and no one factor is controlling. Id. at 124; Clodfelter v. Commissioner, 426 F.2d 1391 [25 AFTR 2d 70-1254] (9th Cir. 1970), affg. 48 T.C. 694 (1967). Concerning real property, a sale is completed at the earlier of transfer of legal title or the practical assumption of the benefits and burdens of ownership. Baird v. Commissioner, supra at 124; Dettmers v. Commissioner, 430 F.2d 1019 [26 AFTR 2d 70-5280] (6th Cir. 1970), affg. Estate of Johnston v. Commissioner, 51 T.C. 290 (1968). Our factual inquiry must focus upon the shift of the benefits and burdens of ownership. Baird v. Commissioner, supra at 124; Merrill v. Commissioner; 40 T.C. 66 (1963), affd. per curiam 336 F.2d 771 [14 AFTR 2d 5703] (9th Cir. 1964).
Petitioners did not acquire legal title until 1991. Accordingly, we must consider whether the benefits and burdens of ownership transferred to them prior to 1991. At the time petitioners entered into the contract with Ahrend, the only incomplete contractual requirements were: (1) Obtaining permanent financing, (2) execution and transfer of an $80,000 note from petitioners to Ahrend, and (3) transfer of legal title from Ahrend to petitioners. Petitioners had the complete right to possess and resided in the Crown Pointe property, beginning 2 weeks after the agreement was executed. While Ahrend had the option to obtain insurance on the residence and was required to pay the local real estate taxes, petitioners were required to maintain liability and contents insurance. All utilities were carried in petitioners’ names, and they bore the costs of any improvements, unless the property was ultimately sold to a different buyer. Following a 2-month transition period, petitioners were responsible for the costs of repairing the plumbing, heating, cooling, electrical equipment, and appliances.
Under Oklahoma law, if the parties enter into a contract for the sale of realty, factual inquiry must focus upon the shift of the benefits and burdens. A contract for sale, coupled with the buyer’s taking possession, constitutes a transfer of the benefits of ownership to the buyer and may constitute a transfer of an equitable interest. State Life Ins. Co. v. State, 135 P.2d 965, 967- 968 (Okla. 1942); Resolution Trust Corp. v. Sudderth, 854 P.2d 375, 377 (Okla. Ct. App. 1993); King v. Lunsford, 852 P.2d 821, 823 (Okla. Ct. App. 1993). In State Life Ins. Co. v. State, supra, the Oklahoma Supreme Court, in finding the transfer of equitable interest when legal title had not yet passed between parties who contracted for the sale of realty and transferred possession, stated that:
It may be that a mere contract or provision in a contract agreeing to sell real estate at some future date is insufficient of itself to create a present equitable estate in the vendee. But, as in all contracts, the intention of the parties, especially the vendor, governs. If the contract as a whole shows that the intention was to convey a present equitable estate the courts will give effect to such intention regardless of the separate meaning of particular or isolated words.
The present contract provided that the vendor bargained to sell and the vendee agreed to purchase
Among those terms was the immediate surrender of possession to the vendee. *** In such case rightful possession carries with it the beneficial interest, and nothing remains to be done except to pay the purchase money when due and to execute the deed. In such case there is a transfer of the equitable estate ***
Viewing this record in its entirety, we conclude that the benefits and burdens of ownership shifted to petitioners when they took possession of the residence. Baird v. Commissioner, 68 T.C. at 124; State Life Ins. Co. v. State, supra.
Petitioners rely heavily on a factually similar opinion of this Court. Amundson v. Commissioner, T.C. Memo. 1990-337 [90,337 PH Memo TC]. In that case a brother was allowed to deduct interest payments on his sister’s mortgage because of an informal agreement under which the brother would acquire a 50-percent interest in the subject residence if he made mortgage payments. Having concluded that the brother/taxpayer “had a 50-percent equitable interest in the property and, in effect, [that he] had assumed liability for the mortgage”, this Court held that the brother/taxpayer was entitled to deduct the interest payments. In the instant case, respondent argues that the taxpayer had no legal obligation to the lender that would permit an interest expense deduction. But the cases cited by respondent in that regard are similar to those which, in Amundson v. Commissioner, supra, were regarded as distinguishable because those cases involved taxpayers who had guaranteed corporate loans secured by collateralizing their residences. Because of the finding in Amundson that the brother/taxpayer had an ownership interest in the property, the cited cases were there distinguished.
This case also presents a unique set of facts under which we conclude that petitioners had a possessory and an equitable interest in their residence. Through their two contracts with Ahrend, petitioners effectively assumed the obligation to pay the interest on the construction mortgage until permanent financing could be obtained. The $3,500 payments were neither rent nor payments to reduce the purchase price. Moreover, the price agreed upon between petitioners and Ahrend remained at $500,000, irrespective of the lapse of time or the total number of $3,500 monthly payments made. Petitioners agreed to carry the existing mortgage interest during the interim period in which Ahrend searched for financing. They were the equitable owners of the property during that period and are entitled to deduct the payments as interest.
Under the unique circumstances of this case, petitioners are entitled to qualified residence interest deductions in the amounts of $42,000 and $18,000 for 1989 and 1990, respectively. Having decided that petitioners are entitled to the deductions in controversy, there are no deficiencies in their income tax, and there is no need to reach the issue of whether petitioners are liable for a penalty for negligence in either year.
To reflect the foregoing,
Decision will be entered for petitioners.
The next case (‘also digested for convenience) regards one of our own Equity Holding Transfer ™ transactions that was taken to task a few years ago by the IRS when they opted to refuse our clients their rightful claim of income tax deductions for mortgage interest and property tax.
As had been their contention in the Belden case, the refusal of the tax deduction came about because the tax payer (Daniel Adams and his wife) were not named on the loan and neither were they shown on the property’s title as owners: i.e., ‘due to their trustee being the legal and equitable title holder of the property entrusted to it…’which is the nature of any title-holding (“Illinois type land trust”).
However, because they apparently don’t read their own proclamations often…’or well: in Adams they neglected to look at their own IRC163(h)4(D), which states quite succinctly and clearly that a beneficiary in a “land trust” by any other name is indeed entitled to full income tax benefits as long as the beneficiary can prove being: 1) a full time resident; 2) responsible for the full burdens of ownership; 3) pays all property taxes; taxes and all debt relative to the property, and is doing so under a bonafide contract; and 4) is holding either an equitable interest in the property…OR…an equitable interest in an estate or trust that holds the property’s equitable title interest.
As long as these qualifications are met and the verbiage in IRS’ Revenue Ruling 92-105 is adhered to, ‘no longer is there a question about a title-holding trust’s full-pay co-beneficiary’s right to income-tax deductibility.
Here’s the Adams case:
T.C. Memo. 2010-72
UNITED STATES TAX COURT
A Federal Tax Court Ruling
ANTHONY J. ADAMS, Petitioner
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 2563-08. Filed April 13, 2010.
Anthony J. Adams, pro se.
Bryan E. Sladek and Robert D. Heitmeyer, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: For 2003 and 2004 respondent determined deficiencies in petitioner’s Federal income taxes, additions to tax, and penalties as follow
|Year||Deficiency||Addition to TaxSec. 6651(a)(1)||PenaltySec. 6662(a)|
|Unless otherwise indicated, all section references are to the Internal Revenue Code (I.R.C.) in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.|
As an initial matter, neither party argued or was briefed whether or not:
(1) The Essex Drive trust should have claimed the mortgage interest deduction pursuant to section 163(h)(4)(D)1 and the provisions of subchapter J;
(2) Petitioner (Belden) could have claimed the mortgage interest deduction as investment interest, Re. Davies v. Commissioner, 54 T.C. 170, 176 (1970) (property that was a residence in the taxpayer’s hands was business property in the land trust’s hands); or
(3) The Essex Drive trust was a mere nominee, a sham, or should otherwise be disregarded, see Norton v. Commissioner, T.C. Memo. 2002-137 (land trusts disregarded as shams and income taxable to beneficiaries). These issues are deemed waived. See Rule 40; Muhich v. Commissioner, 238 F.3d 860, 864 n.10 (7th Cir. 2001) (issues not addressed or developed are deemed waived–it is not the Court’s obligation to research and construct the parties’ arguments), affg. T.C. Memo. 1999-192; 330 W. Hubbard Rest. Corp. v. United States, 203 F.3d 990, 997(7th Cir. 2000) (same); Larson v. Northrop Corp., 21 F.3d 1164, 1168 n.7 (D.C. Cir. 1994) (declining to reach issues neither argued nor briefed). Accordingly, our decision in the case will be based upon the extent to which section 1.163-1(b), Income Tax-Regs., applies and on the arguments the parties asserted or briefed with respect thereto.
For 2003 and 2004, respectively, respondent (the IRS) concedes that petitioner is entitled to deductions for: (1) State and local income taxes of $3,823 and $4,161; (2) real estate taxes of $3,346 and $5,020; (3) charitable contributions of $11,263 and $11,637; (4) miscellaneous expenses of $1,330 and $989 (before application of the section 67(a) 2-percent floor); and (5) “Schedule E” net losses of $81,226 and $34,645.
The issues remaining for decision for 2003 and 2004 are whether petitioner is: (1) Entitled to his claimed mortgage
interest deductions; (2) liable for the section 6651(a)(1) additions to tax; and (3) liable for the section 6662(a) accuracy-related penalties.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts is incorporated herein by this reference. Petitioner resided in the state of Michigan when the petition was filed.
- The Essex Drive Trust: Formation and Trust Agreement
In 2003 Michael and Zina Gedz transferred legal and equitable title to 325 Essex Drive (Essex Drive property) for a 5-year period to Equity Holding Corp. acting as trustee for the Essex Drive Trust, pursuant to a trust agreement. A warranty deed memorializing the transfer was recorded by the Register of Deeds,
Oakland County, Michigan.
The trust agreement provides that the purpose of the Essex Drive Trust is to hold the Essex Drive property and the proceeds and profits therefrom in trust for the beneficiaries’ use and benefit. The trustee is to deal with the Essex Drive property only when the beneficiaries authorize it to do so.
According to the trust agreement, the beneficiaries’ “interests * * * consist solely” of: (1) A power of direction to authorize the trustee to deal with the Essex Drive property; (2) the right to receive or direct the disposition of proceeds from the Essex Drive property; (3) the right to purchase, lease, manage, and control the Essex Drive property; and (4) “the obligation for expenses and disbursements relative to the trust property.” The beneficiaries’ rights to the proceeds are “deemed to be personal property”; the beneficiaries do not possess “any right, title, or interest * * * [in the Essex Drive property] either legal or equitable”
Expenses of the Essex Drive Trust are allocated among the beneficiaries according to their respective percentages of beneficial interests held, unless otherwise agreed. The beneficiaries also are required to obtain insurance for the Essex Drive property. A beneficiary’s interest passes to an executor or Administrator of his or her estate on death; otherwise, a transfer of a beneficiary’s interest to a third party is subject to the other beneficiaries’ rights of first refusal, and no assignment of a beneficiary’s interests is valid.
Unless all beneficiaries consent, a copy of the assignment is delivered to the trustee, and the trustee indicates its acceptance thereon.
The trust agreement further provides that the trustee is not obligated to file Federal income tax returns or schedules on behalf of the Essex Drive Trust, notwithstanding “section 671 of the * * * [I.R.C.] of 1954 or any other applicable regulation.”
If it becomes necessary for the Essex Drive Trust to file a Form 1041, U.S. Income Tax Return for Estates and Trusts, or other informational returns under “section 6031 of the * * * [I.R.C.] of 1954,” the trustee will not be obligated to prepare them, ‘but the trustee will sign informational returns if necessary at the
beneficiaries’ request. The beneficiaries are to report and pay all taxes on the earnings and proceeds of the Essex Drive property or which otherwise arise from their beneficial interests.
- Petitioner’s Beneficial Interest and Trust Documents
In 2003 the Gedzes assigned a 40-percent beneficial interest in the Essex Drive Trust to BOGAT Management, and a 50-percent beneficial interest in the Essex Drive Trust to petitioner and Sandra Adams.
- Beneficiary Agreement
The Gedzes, BOGAT Management, LLC (Bogert and Gatten), and petitioner and Sandra Adams entered into a beneficiary agreement that provides that the beneficiaries collectively have the: (1) Power of direction to authorize the trustee to deal with the Essex Drive property’s title; (2) “right to receive and/or direct the disposition of proceeds from rentals, mortgages, sales, or other related income sources”; (3) right and duty to manage the Essex Drive property; and (4) obligation to pay the Essex Drive property’s expenses.
The beneficiaries’ interests in the Essex Drive Trust are personal property interests. The beneficiaries share in the Essex Drive property’s earnings, gains, proceeds, and expenses according to their respective percentages of beneficial interest held. No beneficiary may make material alterations or improvements to the Essex Drive property without the trustee’s and the other beneficiaries’ prior written consent. The beneficiaries’ rights to transfer their beneficial interests are subject to the provisions of the trust agreement, and any transfer must be agreed to by a majority of the beneficiaries.
The beneficiary agreement further provides that the Essex Drive property will be sold at termination (i.e., February 28, 2008) subject to a first right to purchase (right of first refusal) held by petitioner and Sandra Adams. The terms of the right of first refusal are that the Essex Drive property is to be made available for sale to petitioner and Sandra Adams at a price equal to what would be proposed by a third party and that they have a right to offset the sale price by the value of their share of profits derived and any contributions that are agreed to have been paid by, and refundable to, petitioner and Sandra Adams.
Petitioner and Sandra Adams’ right of first refusal “begins with the date of * * * [the inception of the related beneficiary agreement (March 1, 2003) and terminates upon the Essex Drive property’s sale or other disposition.” According to “Exhibit ‘A’ to the Beneficiary Agreement”, petitioner and Sandra Adams’ refundable contribution is the sum of $12,000. Their initial contribution consists of all nonrecurring costs contributed including closing costs, contributions to existing equity “($0.00 -‘Down Payment’),” Realtor® commissions, and costs of agreed-upon expenditures for repairs and capital improvements to the Essex Drive property by petitioner and Sandra Adams. Petitioner and Sandra Adams’ contributions are deemed fully “Refundable At Termination, If Equity Permits”.
- “EHT Occupancy” Agreement
The related beneficiary agreement also provides that no beneficiary is entitled to occupy or possess the Essex Drive property unless an NEHT Occupancy agreement accompanies the beneficiary agreement. The NEHT Occupancy agreement refers to the Essex Drive Trust as “Landlord” and to petitioner and Sandra Adams as “Tenant,” and provides that Landlord agrees to lease to Tenant the Essex Drive property, whereupon Tenant is to pay rent of $2,900 per-month, which includes principal and interest on all loans secured by the Essex Drive property. Tenant is required to maintain insurance coverage for and is liable for all repairs and maintenance of the Essex Drive property. Tenant may not make material alterations to the Essex Drive property without Landlord’s consent, and expenditures for repairs are not refundable or creditable to Tenant unless done at Landlord’s written direction. Tenant may not assign or sublet its interest under the NEHT Occupancy agreement.
- Related Documents
Petitioner and Sandra Adams received other documents for the Essex Drive property. The first document, titled “Beautiful Home”, states: (1) No bank qualifying, no credit approval, and immediate tax benefits; (2) “Rent to Own”; (3) three payments and closing costs get you in at $320,000; and (4) participate in future appreciation and benefit in equity buildup. The second document, titled “How We (TK Investment Properties, LLC) Can Benefit You (the Buyer))”, states that benefits provided to a buyer include: (1) easier credit qualification and payment arrangements; (2) entitlement to all income tax deductions for “Mortgage Interest and Property Tax payments,” even though title does not pass to buyer; (3) receipt of equity buildup from reduction of the mortgage principal as payments are made; (4) receipt of appreciation of the Essex Drive property; (5) protection of the Essex Drive property from the buyer’s creditors; and (6) the pride of ownership without the rules and constraints of conventional real estate acquisition and mortgage processes. These documents include an amortization table that was provided to petitioner and Sandra Adams, and sets forth the amounts of mortgage interest and principal paid for each successive payment.
III. Petitioner’s Occupancy
Petitioner and Sandra Adams moved into the Essex Drive property in June 2003 and resided there for 5 years. During that time petitioner made improvements to the Essex Drive property. For example, he replaced the cedar deck for about $1,700 and installed an automatic garage door opener for about $500 to $600. He re-landscaped the Essex Drive property and incurred costs of about $1,500 for “Dirt shoveling, [and] stuff like that.” He also incurred costs of about $500 to $600 to have glass block windows installed in the basement because of Michigan’s harsh winters. Since the Essex Drive property trust’s value declined, however, and at the end of the contract term petitioner did not exercise the right of first refusal to purchase the Essex Drive property. Petitioner sent Equity Management Services payments of $2,900 per-month that included principal and interest on all loans secured by the property. Petitioner credibly testified that that the fair rental value of the Essex Drive property was about $1,500 to $1,600 per month. The escrow account statements from which the mortgage payments were made, bear the Gedzes’ names as mortgagees(? sic), and the Forms 1098, Mortgage Interest Statement, also bear the Gedzes’ names as mortgagees (?). Equity Management Services, acting on behalf of Equity Holding Corp. sent petitioner copies of the escrow account statements and the Forms 1098.
- Petitioner’s Tax Returns
Petitioner filed his 2003 Form 1040, U.S. Individual Income Tax Return, in November 2005. He filed his 2004 Form 1040 in February 2006.11 For 2003 and 2004, respectively, he claimed mortgage interest deductions of $24,135 and $23,471 that respondent disallowed.
Petitioner has neither claimed nor shown that he satisfied the requirements of section 7491(a) to shift the burden of proof to respondent. Accordingly, petitioner bears the burden of proof. See Rule 142(a).
- Mortgage Interest Deductions
Section 163(h)(1) generally disallows a deduction for personal interest. An exception to this rule is qualified residence interest. Sec. 163(h)(2)(D). Qualified residence interest includes interest paid or accrued during the taxable year on acquisition indebtedness. Sec. 163(h)(3)(A). Acquisition indebtedness means any indebtedness that is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer and is secured by the residence. Sec. 163(h)(3)(B)(i). A qualified residence includes the principal residence of the taxpayer. Sec. 163(h)(4)(A).
Generally, for interest on a mortgage to be deductible the indebtedness must be an obligation of the taxpayer and not an obligation of another. Smith v. Commissioner, 84 T.C. 889, 897 (1985), affd. without published opinion 805 F.2d 1073 (D.C. Cir. 1986). But section 1.163-1(b), Income Tax Regs., provides: “Interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness.” Where a taxpayer has not established legal, equitable, or beneficial ownership of property, we have disallowed the taxpayer’s claimed mortgage interest deduction. Hynes v. Commissioner, 74 T.C. 1266, 1288 (1980); Song v. Commissioner, 2 Whatever rights or interests petitioner held in the Essex Drive property are determined under Michigan law because the property is in Michigan, see Altmann v. Commissioner, 20 T.C. 236, 252 (1953), and the trust agreement provides that it is governed by Michigan law. T.C. Memo. 1995-446; Bonkowski v. Commissioner, T.C. Memo. 1970-340, affd. 458 F.2d 709 (7th Cir. 1972).
The Court considers State law to determine the nature of the taxpayer’s property rights. United States v. Natl. Bank of Commerce, 472 U.S. 713, 722 (1985); Aquilino v. United States, 363 U.S. 509, 513 (1960).12 The Court also considers certain factors to determine whether a taxpayer is an equitable or beneficial owner of the property, including whether the taxpayer: (1) Has a right to possess the property and to enjoy the use, rents, or profits thereof; (2) has a duty to maintain the property; (3) is responsible for insuring the property; (4) bears the property’s risk of loss; (5) is obligated to pay the property’s taxes, assessments, or charges; (6) has the right to improve the property without the owner’s consent; and (7) has the right to obtain legal title at any time by paying the balance of the purchase price. Blanche v. Commissioner, T.C. Memo. 2001-63, affd. 33 Fed. Appx. 704 (5th Cir. 2002).
Under Michigan law, the term “trust” includes any express trust wherever and however created (with certain exceptions not shown here). Mich. Comp. Laws Serv. sec. 700.1107(m) (Lexis Nexis 2005). Express trusts may be created to sell, mortgage, or lease lands; to receive the rents and profits of lands and apply them to the use of any person, during the life of the person, or for any shorter term subject to the rules prescribed in Mich. Comp. Laws Serv. chapter 554; or for the beneficial interest of any person where the trust is fully expressed and clearly defined upon the face of the instrument creating it subject to the limitations as to time. Mich. Comp. Laws Serv. sec. 555.11 (Lexis Nexis 2007).
Petitioner’s property rights or interests are as follows: he is a beneficiary of the Essex Drive Trust, which meets the definition of an express trust under Michigan law; however, the trust agreement provides that he does not have any right, title, or interest in the Essex Drive property. See id. Other related documents refer to him as a buyer and certain attributes of a sale are present such as a down payment, closing costs, and petitioner’s payment of principal and interest, while other attributes of a sale are not present such as a transfer of the Essex Drive property by deed to petitioner. The NEHT Occupancy agreement refers to him as Tenant and to his monthly payments as rent. The escrow account statements, the Forms 1098, and an amortization table were sent to petitioner, even though he was not personally liable for the mortgage, and the escrow account statements and the Forms 1098 bear the Gedzes’ names. We now turn to the benefits and burdens of ownership factors. Some factors weigh in favor of finding that petitioner had assumed the benefits and burdens of ownership of the Essex Drive property while others weigh against.
Factors that indicate that petitioner assumed the benefits and burdens of ownership are:
(1) He had a duty to repair or maintain the Essex Drive property;
(2) He was responsible for insuring the Essex Drive property;
(3) He had a duty to pay the Essex Drive property’s taxes, assessments, or charges;
(4) He had a right to the Essex Drive property’s proceeds from rents, mortgages, or sales;
(5) He had the right to obtain legal title at any time by paying the balance of the purchase price: his right of first refusal having begun on the date of the beneficiary agreement and having terminated on the Essex Drive property’s sale or other disposition;
(6) He bore some risk of loss because he was required to maintain insurance on the Essex Drive property and because he could lose his refundable contribution, which may have included the value of the improvements petitioner made, if there was no equity in the Essex Drive property; and…
(7) He agreed to pay the mortgage principal and interest under the NEHT Occupancy and beneficiary agreements. See Amundson v. commissioner, T.C. Memo. 1990-337 (finding agreement to make mortgage payments created “enforceable interest-bearing debt” to taxpayer’s sister); see also Belden v. Commissioner, T.C. Memo. 1995-360.15 In short, petitioner treated the Essex Drive property as if he owned it. See Amundson v. Commissioner, supra (taxpayer’s performance of obligations as owner is indicative of ownership interest); see also Trans v. Commissioner, T.C. Memo. 1999-233 (same); Uslu v. Commissioner, T.C. Memo. 1997-551 (same).
Factors contrary to petitioner having assumes the benefits and burdens of ownership are:
(1) He could choose not to exercise his right of first refusal and to walk away from the Essex Drive property, see Randolph v. Reisig, 727 N.W.2d 388, 392 (Mich. Ct. App. 2006) (right of first refusal does not create interest in land); see also Jones v. Commissioner, T.C. Memo 2006-176 (Optionee was not entitled to mortgage interest deduction because under California law he had no ownership interest in property and because he had not acquired sufficient benefits and burdens of ownership to establish that he was equitable owner);
(2) He had to enter into an NEHT Occupancy agreement with the Essex Drive Trust in order to possess or enjoy the use of the Essex Drive property, see Ryan v. Commissioner, T.C. Memo. 1995-579; and (3) although petitioner made substantial improvements to the Essex Drive property, the beneficiary and NEHT Occupancy agreements provide that he could not make material alterations or improvements to the Essex Drive property without certain consents.
Ergo, on the unique facts of this case, we conclude that the benefits and burdens that favor ownership outweigh the factors against ownership. Petitioner has assumed the benefits and burdens of ownership of the Essex Drive property. See, e.g., Derr v. Commissioner, 77 T.C. 708, 725-728, 724 n.11 (1981) (beneficiary of an Illinois land trust possessed most attributes of ownership). Petitioner, therefore, is entitled to the mortgage interest deductions. Respondent’s determinations are not sustained.
- Section 6651(a)(1) Additions to Tax
The section 6651(a)(1) additions to tax were based on the deficiencies. Because of our holding that petitioner is entitled to the mortgage interest deductions and because respondent conceded the other deductions that he had disallowed in the notice of deficiency, see supra p. 3, petitioner is not liable for the deficiencies. As there are no deficiencies, petitioner is not liable for the additions to tax.
III. Section 6662(a) Accuracy-Related Penalties
Because of our holding that petitioner is entitled to the mortgage interest deductions and because respondent conceded the other deductions that he had disallowed in the notice of deficiency, see supra p. 3, there are no under payments of tax. Therefore, petitioner is not liable for the section 6662(a) accuracy-related penalties. Respondent’s determinations are not sustained.
To reflect the foregoing, the court’s decision will be entered forthwith under Rule 155.