Rev. Rul. 83-47

1983-1 C.B. 63.

                       Internal Revenue Service
                                 Revenue Ruling

       ACCELERATED COST RECOVERY SYSTEM;  TOWNHOUSES; LEASEBACK-FINANCING
                                  ARRANGEMENT

                           Published: March 21, 1983

SECTION 168. - -ACCELERATED COST RECOVERY SYSTEM

  Accelerated cost recovery system;  townhouses; leaseback-financing arrangement.  Investors are not entitled to deductions under the accelerated cost recovery system for townhouses that are purchased and immediately leased back with the stipulation that they will be resold to the original seller a year and a day following the original sale at a predetermined price.

ISSUE

  Are investors entitled to deductions under the accelerated cost recovery system and deductions for other expenses related to townhouses acquired under the circumstances described below?

FACTS

  X, a corporation that builds townhouses and sells them to the public, devised the following arrangement to provide financing for potential buyers who are otherwise unable to obtain mortgage loans.  X will sell the townhouses to investors and immediately lease back the property.  X will then sublease these townhouses to potential buyers who cannot qualify for mortgage loans.  X anticipates that after 1 year the sublessees will establish good credit histories and qualify to purchase the townhouses held by the investors.  At that time X will repurchase the townhouses from the investors and sell them to the sublessees.

  Under the agreement between X and the investors, X is required to pay rent equal to the sum of all payments the investors are obligated to make for the townhouses, whether or not X subleases the property.  In addition, under the contract terms, investors must resell and X must repurchase the townhouses from the investors a year and a day after the original sale at the original purchase price less X's commission.

  X arranged for lenders to provide investors with mortgage loans for 80 percent of the purchase price of the property.  X will lend the investors 20 percent of the purchase price by means of a second trust with an 18 percent interest rate.  The second trust will be treated as a down payment.  Only interest payments are due in the first year.

  In the promotional materials X represents that investors own the townhouses for tax purposes and therefore are entitled to deductions under the accelerated cost recovery system and deductions for other expenses related to the properties.

LAW AND ANALYSIS

  Section 168 of the Code provides an accelerated cost recovery system under which the taxpayer is permitted a deduction for recovery property held for the production of income or used in a trade or business.

  The passage of legal title is not controlling in determining when a transfer of property is deemed to occur for tax purposes.  An arrangement in sale and leaseback form will be honored only when it is a genuine multiple-party transaction with economic substance that is compelled or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by tax avoidance features that have meaningless labels attached. Frank Lyon Co. v. United States, 435 U.S. 561 (1978), Ct.D.1991, 1978-1 C.B. 46.

  In Rev. Rul. 72-543, 1972-2 C.B. 87, a shipping corporation sold a vessel under a purported sale and leaseback arrangement to an unrelated corporation.  The beneficial ownership remained in the seller while the purchaser held legal title.  The ruling concludes that the substance of the transaction, when viewed in its entirety, was a financing arrangement, not a sale and leaseback.  Accordingly, the ruling holds the seller to be the owner of the ship for federal income tax purposes.  See Rev. Rul. 68-590, 1968-2 C.B. 66.

  The substance of the transaction in the present situation, when viewed in its entirety, is a financing arrangement with beneficial ownership remaining in X and bare legal title passing to investors for 1 year solely to obtain mortgage financing for potential townhouse buyers.

  The agreement to repurchase the property from the investors in 1 year's time at the original price paid for it insures that X, not the investors, will suffer from any decline in the property's value.  All the investors' financing is arranged for by X.  X is obligated to put up 20 percent of the financing so that the investors will be able to borrow all that they contribute to this venture.  Even though the investors execute notes, they are guaranteed their money back through X' § obligation to pay rent equal to the amount of expense incurred with respect to the property and X's contract to repurchase in 1 year's time.  Thus, X retains all the risks of ownership.

  In addition, the transaction has no economic benefit for investors independent of tax considerations.  The investors cannot benefit from any appreciation in value of the property because X has contracted to repurchase the property at the original price for which they purchased it from X.  Since X's rental payments will equal the investors expenses, the investors also cannot profit by means of a cash flow.  Therefore, the form designated by the parties will not be honored.

HOLDING

  For federal income tax purposes, there has been no transfer of property, rather the transaction is merely a financing arrangement. Because in substance the investors never owned the property, the purported rental payments are actually payments by X for expenses related to the townhouses beneficially owned by X.  The investors, therefore, will not have any rental income and because they do not own the property for federal income tax purposes, they are not entitled to deductions under the accelerated cost recovery system or deductions for other expenses related to the townhouses.

Rev. Rul. 83-47, 1983-1 C.B. 63.