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Rothstein v. United States

decided: May 21, 1984.

HAROLD ROTHSTEIN AND DAVID M. ROTHSTEIN AS EXECUTORS OF THE ESTATE OF ALEXANDER ROTHSTEIN, DECEASED, AND REBA ROTHSTEIN, PLAINTIFFS-APPELLANTS,
v.
UNITED STATES OF AMERICA, DEFENDANT-APPELLEE



Appeal from a judgment of the District Court for Connecticut, Warren W. Eginton, Judge, dismissing an action for a refund of income taxes. Reversed and remanded. In an opinion by Judge Friendly, joined in this respect by Judge Oakes, a majority of the panel held the transaction here in question involved a borrowing from the trust under I.R.C. § 675(3); Chief Judge Feinberg filed an opinion dissenting from this. Judge Friendly held that despite this, because of I.R.C. § 671, the taxpayer acquired a new basis for assets acquired from the trust, Judge Oakes filed an opinion dissenting from this, and Chief Judge Feinberg agreed with Judge Friendly although believing that the point should not be reached.

Feinberg, Chief Judge, Friendly and Oakes, Circuit Judges. Feinberg, Chief Judge (concurring and dissenting). Oakes Circuit Judge (dissenting).

Author: Friendly

FRIENDLY, Circuit Judge:

Harold and David M. Rothstein, as executors of the estate of Alexander Rothstein, and Reba Rothstein, his widow, appeal from a judgment of the District Court for Connecticut, which dismissed their action for a tax refund after trial before Judge Eginton and an advisory jury, 574 F. Supp. 19. Appellants urge two grounds for reversal. One involves the interpretation of §§ 453, 671 and 675 of the Internal Revenue Code ("IRC"); the other relates to the judge's having sua sponte stricken from the jury panel eleven veniremen solely because they had some experience with rental property or connection with closely held corporations. In the view we take of the case only the first requires statement and discussion.

The district court found the facts to be as follows: In 1951 decedent Alexander Rothstein ("taxpayer") and Abraham Savin formed a real estate holding company known as Industrial Developers, Inc. ("IDI"). They purchased, at a cost of $30,000 each, a parcel of land in East Hartford, Connecticut, which they conveyed to the corporation, each receiving 300 shares of IDI stock. The corporation constructed, at a cost not disclosed in the record, warehouses which were used as rental property.

On February 18, 1957, taxpayer contributed his 300 shares of IDI to an irrevocable trust he established for the benefit of his three children, Harold, David and Edna. Taxpayer's wife Reba was the trustee. Although the trust was required to distribute any dividends received on the IDI stock, which was its sole asset, to the beneficiaries at least semi-annually, no dividends were ever paid.

In October 1964, taxpayer bought Savin's 300 shares of IDI for $500,000, agreeing to pay the purchase price at a later date. On November 13, 1964, he purchased from his wife as trustee the trust's 300 shares for $320,000. Payment was made by an unsecured promissory note bearing an interest rate of 5% per annum, payable semi-annually beginning May 13, 1965. These payments were duly made. Principal payments were scheduled to be made as follows: $25,000 on or before November 13, 1969; $25,000 on or before November 13, 1970; $50,000 on or before November 13, 1971; and $50,000 on or before November 13 of each calendar year thereafter until the full sum of $320,000 had been paid.

In January 1965, taxpayer, having become owner of all of IDI's stock as a result of the transactions with Savin and the trust, dissolved IDI and had all its assets transferred to himself. He then refinanced the property, replacing an existing mortgage of less than $200,000 with a new $700,000 mortgage to Equitable Life Insurance Company and using the approximately $500,000 excess of the new mortgage over the old to discharge his debt to Savin. On February 8, 1965, he gave a second mortgage of $320,000 to his wife as trustee to secure the promissory note of that amount given in exchange for the trust's IDI shares three months before.

In their joint federal income tax return for 1965 taxpayer and his wife claimed deductions for (1) $16,600 in interest paid to the trust on the promissory note, and (2) a short-term capital loss of $33,171 on the liquidation of IDI, determined as follows:

Fairmarket value of

property received

upon liquidation $1,054,580

Less:

IDI liabilities as-

sumed $267,751

Cost of stock ac-

quired from Savin ...


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