Tax Laws on Loan

Facts

Our problem has to do with how agency relationships between corporations and partnerships affect how operating losses are dealt with. In this problem, Kimberly has formed a partnership called Deckside Apartments and has approached The Staten Investment Fund to obtain funding for their new apartment complex. Deckside Apartments cannot legally obtain the offered 10% loan from The Staten Investment Fund because of the state usury law which states that noncorporate borrowers cannot take loans higher than 8%. In order to circumvent this obstacle, Kimberly incorporates a company named Hump Day Inc. and Kimberly is the only shareholder of the company. Deckside and Hump Day enter into an agent and primary relationship where Hump Day holds title to the apartments so that they can obtain financing. In the agreement, Hump Day assumes no liability regarding the financing of the complex, and is not held accountable for any liability that could come up as the agent for Deckside. The only way Staten Investment Fund would agree to provide financing if Kimberly personally guaranteed the note. Once the apartments are completed, Hump Day obtains permanent financing from Staten and Kimberly pays off other short-term loans that had been obtained to build the apartments. Throughout the current year, the apartments make significant operating losses. There are a few issues that we need to figure out before we can give advice on what to do with the losses. These issues are: the validity of the corporation and its involvement in the case, is the loss from the operations deductible, and how to treat the deductions of those losses if they are.

Issue 1

Is Hump Day Inc. a genuine agent for Deckside?

Conclusion 1:

Yes, the agent/principal partnership between Hump Day Inc. and Deckside Apartments was a genuine business relationship.

Reasoning 1:

In the United States Tax Case 88-1 USTC 9233, Commissioner of Internal Revenue v. Bollinger, Jr., a very similar case to ours, Bollinger is trying to get a loan for construction and creates a corporation to obtain a loan he could not otherwise get, and use this money for his construction project which was owned by his partnership. Once he incurred losses the Commissioner of Internal Revenue disallowed the losses to Bollinger because it was thought that the losses were attributable to the corporation because it owned the title to the construction project when it gained the loan. The tax court held that there was sufficient evidence that the corporation was the partnerships’ agent and that it should be disregarded for tax purposes. The IRS also argued that the corporate agent’s relationship with its principal must not be dependent on the fact that the corporation is owned by the principal, and that