UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF NEW YORK
November 17, 1994
EUGENE HOLMES, MARGARET HOLMES and MARK HOLMES, Plaintiffs,
UNITED STATES OF AMERICA, Defendant.
The opinion of the court was delivered by: JOHN T. ELFVIN
MEMORANDUM and ORDER
Presently before this Court is a renewal of the defendant's motion for judgment as a matter of law pursuant to Rule 50(b) of the Federal Rules of Civil Procedure ("FRCvP") or, in the alternative, for a new trial pursuant to FRCvP 59. For the reasons stated herein below, both reliefs will be denied.
Involved herein are a cooperative apartment in Brooklyn Heights, N.Y. and the tax deductions taken by the above-named plaintiffs -- a mother and her son
-- pursuant to their partnership's shares in the cooperative corporate owner of the building wherein the apartment is located. Before purchasing these shares, the son had rented this apartment with the knowledge that it would eventually "go co-op" -- that is, the building wherein it was located would be sold to a cooperative corporation which in turn would sell shares quantitatively corresponding to the right to use particular apartments within the building.
A current tenant would expect to be offered such shares at a discounted, or "insider" price and plaintiff Mark Holmes, the son, decided to take advantage of this opportunity. Mark had entered upon his occupancy of the apartment under a lease controlled by New York City's rent stabilization law. When the building did go co-op, he and his parents formed a partnership to secure financing in order to buy the shares at the discounted price. While the partnership's initial costs exceeded its income, the partners understood that such an apartment potentially represented a very profitable investment, a reasonable understanding considering the state of the New York City metropolitan area's real estate market in the 1980s. Mark continued to pay rent on the apartment after the purchase and during the two years in question -- 1985 and 1986.
For these two years, the plaintiffs' tax returns reflected the partnership's income and losses generated by the apartment. The plaintiffs were subjected to an Internal Revenue Service audit for those years and were disallowed most of the losses on the asserted grounds that the rent charged by the partnership to Mark was not a fair rent and that the partnership itself was not engaged in an activity for profit. The IRS also assessed interest and penalties, asserting that the plaintiffs were negligent in claiming these deductions. The plaintiffs paid the full amount assessed and filed for refunds. On some issues (not pertinent herein) the plaintiffs prevailed and received partial refunds.
Thereafter, they brought this civil suit seeking the return of the remaining amount paid to the IRS because of these assessments. On August 26, 1993 a jury returned a special verdict -- comprised of four questions, all of which were answered in the affirmative -- in the plaintiffs' favor. The jury unanimously determined that, for each of 1985 and 1986, the partnership was engaged in an activity for profit, and had charged a fair rent. In other words, the plaintiffs prevailed on the trial. Dissatisfied with this result, the IRS now renews said motion.
A motion pursuant to FRCvP 50
for judgment as a matter of law should be denied " unless the jury reached a verdict reasonable jurors could not have reached." Milbank, Tweed, Hadley & McCloy v. Boon, 13 F.3d 537, 542 (2d Cir. 1994). It would be improper for this Court to grant such motion unless there was such a complete absence of evidence supporting the verdict that the jury's findings could only have been the result of sheer surmise and conjecture. Ibid. Even a cursory review of the record, however, shows that there is ample evidence for a jury to reasonably conclude that the partnership was in fact engaged in an activity for profit and did charge a fair rent.
Thus, the defendant's motion is groundless and accordingly will be denied.
The defendant, in support of its motion for judgment as a matter of law, presents an alternative ground which is an issue of first impression. In its simplest form, the issue is whether section 280A of the Internal Revenue Code ("the Code") applies to the shares of a cooperative apartment. Based on its language, its legislative history, the limited scope of 26 U.S.C. § 216 and the case law prior to the enactment of that provision, this Court must conclude that section 280A does not apply to the ownership of shares of a cooperative corporation. Thus, to the extent that the defendant is renewing its earlier motion, this alternative ground must also fail. Contrary to the predictable assertion of the IRS, Section 280A of the Code does not entitle it to judgment as a matter of law.
Section 280A states in part:
"Disallowance of certain expenses in connection with business use of home, rental of vacation home, etc.
"(a) General Rule. -- Except as otherwise provided in this section, in the case of a taxpayer who is an individual or an S corporation, no deduction otherwise allowable under this chapter shall be allowed with respect to the use of a dwelling unit which is used by the taxpayer during the taxable year as a residence."
The defendant's motion must fail because it does not recognize the unique form of ownership cooperative housing presents -- of corporate shares, not of real property.
The shares of the cooperative corporation are not "a dwelling unit" and the deductions were not taken for the use of the dwelling unit but for the ownership of the shares. Section 280A(f)(1)(A) defines a dwelling unit as including "a house, apartment, condominium, mobile home, boat, or similar property, and all structures or other property appurtenant to such dwelling unit."
It would be illogical to conclude that shares in or of a cooperative corporation, even though they correlate to the use of a particular apartment, were "similar property" under the above definition. The defendant claims that the "doctrine of substance over form" requires that the plaintiffs be treated as the owners of the apartment -- i.e., that the deductions were taken with respect to a dwelling unit -- and not as the owners of the shares allocated to the use of the apartment. There is no citation of authority for such a proposition, and this Court could not locate any. To the contrary, the defendant, as well as the courts, have historically recognized the distinction between the actual ownership of real property as opposed to shares in a corporate owner of real property -- often to the disadvantage of the taxpayer. See, e.g., Wood v. Rasquin, 21 F. Supp. 211, 213-214 (E.D.N.Y. 1937), aff'd without op., 97 F.2d 1023 (2d Cir. 1938). Cf., Stockton v. Lucas, 482 F.2d 979, 983-985 (Temp.Emer.Ct.App. 1973). Such was the congressional motivation underlying the enactment of 26 U.S.C. § 216, the purpose of which was to give certain "tenant-stockholders" of cooperative housing corporations some of the same tax deductions as homeowners.
As the plaintiffs point out, however, Congress effected this change discretely. It did not redefine the meaning of real property to include cooperative apartments -- an approach that would support the defendant's position herein. Instead, Congress extended certain deductions to certain tenant-stockholders while retaining the distinction between owners of stock and owners of real property. See 26 U.S.C. § 216(a); Eckstein v. United States, 196 Ct. Cl. 644, 452 F.2d 1036, 1047-1048 (Ct.Cl. 1971). To illustrate this point, one need only consider the three most common real estate tax deductions: real property taxes, mortgage interest and depreciation. With regard to taxes, ordinary real property owners may deduct the property taxes they pay. 26 U.S.C. § 164(a)(1). In the past, co-op owners had argued that they should be allowed to take as a deduction their proportionate share of the cooperative's property taxes, relying upon the analogy of their position as shareholders to that of real property owners -- viz., that they in effect owned their apartments. As the plaintiffs point out, this analogy was routinely rejected by not only the IRS, but by the courts. "Taxes were the direct obligations of the building corporation which owned the apartment house, and were merely paid by the [tenant-stockholder] for and in its behalf. * * * In the circumstances disclosed, the payments are not allowable deductions from the gross income of the [tenant-stockholded." Holden v. Commissioner, 27 B.T.A. 530, 538 (1933). See also Wood v. Rasquin, supra, at 213 (rejecting the tenant-stockholder's "substance over form" argument, holding that taxes were not deductible by tenant-stockholder because they were the responsibility of the cooperative corporation; even though the tenant-stockholder paid the taxes, they were paid to the corporation, not to the city or to the mortgagee). Congress responded via section 216, but not by altering the way in which the rest of the Code treated real property. In short, shares still do not equate to real property.
With regard to mortgage interest, the same problems were confronted by tenant-stockholders who tried to take this type of deduction. See Wood v. Rasquin, supra, at 213:
"I can find no case that supports the [taxpayers'] contention, but it seems to me that the decisions of the Board of Tax Appeals and of the court supports the defendant's contention that the amounts paid by the [taxpayers], which represented the proportionate taxes and interest, were not properly deductible by the [taxpayers]."
Again, the approach of Congress was to maintain the distinction between apartments owned by cooperative corporations and owner-occupied dwelling units, but to allow a discrete deduction to the former to mirror the latter.
With respect to depreciation, one need only refer to the case of Lake Forrest, Inc. v. Commissioner, 22 T.C.M. (CCH) 156, T.C. Memo 1963-39, T.C.Mem. (P-H) 630039 (1963 WL 425) (Tax Ct. 1963) (memorandum opinion), for a discussion of the tenant-stockholders' entitlement vel non to a deduction for depreciation of the buildings they occupied. The answer again was in the negative. And, again, it has been only through specific legislation that cooperative tenant-stockholders were placed in the same position as owners of real property with respect to a tax matter. Without such specific legislation they have consistently been denied their requested analogy of shares to real property.
This case presents no compelling reason to ignore this historical, legislative, jurisprudential and administrative distinction. This Court will not do what Congress itself has declined to do -- viz., eliminate the distinctions between the two forms of ownership simply because the distinction now works to the detriment of the tax collector. This case also presents no compelling reason to allow the Commissioner to exercise the congressional prerogative of amending the Code, as Congress did when it enacted section 216.
While this Court believes that the above discussion entirely forecloses the defendant's motions, it should also be noted that, to the extent that it makes alternative arguments beyond whether or not the rent charged was fair and whether or not the venture was a profit-making endeavor -- i.e., that a fair rent is irrelevant because this was a family arrangement --, this Court rejects these on the additional ground that they were not presented in the defendant's FRCvP 50(a) motion and thus were not properly preserved. "[A] party is not entitled to judgment n.o.v. on any ground that he has not raised in a motion for a directed verdict * * * and the directed verdict motion must have 'stated the specific grounds therefor,' Fed.R.Civ.P. 50(a)." Smith v. Lightning Bolt Productions, Inc., 861 F.2d 363, 367 (2d Cir. 1988). The entirety of the defendant's original motion was based, in one form or another, upon the issue of fair rental. Even if section 280A was applicable (it is not), the defendant's argument based upon section 280A(d)(2)(A) (limitation on deductions imposed when family member uses dwelling unit), was not preserved in its earlier motion.
Thus, the defendant's motion for a judgment as a matter of law will be denied.
The defendant's motion for a new trial will also be denied. It claims that the verdict was against the weight of the evidence. The United States Court of Appeals for the Second Circuit Court has stated, however, that the grant of a new trial based on the weight of the evidence should be reserved for those occasions where the jury's verdict was "egregious." Dunlap-McCuller v. Riese Organization, 980 F.2d 153, 158 (2d Cir. 1992), cert. denied, U.S. , 114 S. Ct. 290, 126 L. Ed. 2d 239 (1993). As stated above, it was not. The motion will be denied.
Accordingly, it is hereby ORDERED that the defendant's motion for judgment as a matter of law is denied in its entirety and its motion for a new trial is denied.
DATED: Buffalo, N.Y.
November 17, 1994
John T. Elfvin