US-CT-APP-9, [79-2 USTC ¶9541], T. J. Starker, Appellant v. United States of America, Appellee , Interest: Disguised: Growth factor in “three corner” exchange.--, (Aug. 24, 1979)
[79-2 USTC ¶9541]T. J. Starker, Appellant v. United States of America, Appellee (CA-9), U. S. Court of Appeals, 9th Circuit, No. 77-2826, 602 F2d 1341, 8/24/79, Affirming, reversing and remanding District Court, 77-2 ustc ¶9512, 432 F. Supp. 864
[Code Secs. 61 and 451]
Interest: Disguised: Growth factor in “three corner” exchange.--The contractual six-percent growth factor in the taxpayer’s account in connection with a “three corner” exchange of property compensated the taxpayer for any delay in excess of one year in the selection and transfer of the property to be received in exchange. Such growth factor amount received by the cash-basis taxpayer constituted disguised interest that was includible in his gross income in the year the payments were received rather than in the year the interest began to accrue. BACK REFERENCES: 79FED ¶666.284 and 79FED ¶2830.01.
[Code Sec. 451]
Taxable year of inclusion: Exchange of property: Capital gain.--A taxpayer had to include capital gain from an exchange of real estate that did not qualify for deferment of tax in the year the taxpayer conveyed his property to another party even though the real estate that the taxpayer received in exchange and the events that disqualified the transaction for deferment of taxation occurred in a later year. BACK REFERENCES: 79FED ¶2830.01.
[Code Sec. 1031]
Exchange of property: Investment property exchanged for residence and for contractual right to purchase other property: Continuity of title.--The conveyance by a taxpayer of timberland to a corporation in exchange for its agreement to locate and purchase parcels of real estate for the taxpayer, under which agreement twelve such parcels valued at $1,577,387 were located, was a tax-free exchange of like-kind property, with the exception of two parcels. Two of the parcels did not qualify because the corporation conveyed the parcels directly to the taxpayer’s daughter at his instruction rather than to the taxpayer. In addition, one of these parcels was a personal residence that did not qualify as like-kind property. A third parcel was given special consideration by the court because the taxpayer received a contractual right to purchase a certain parcel of land rather than the real estate itself. This transaction qualified for non-recognition because the right to purchase land was in essence the equivalent of a fee-interest ownership, i. e., the right to control. BACK REFERENCES: 79FED ¶4606.072.
[Code Sec. 7422]
Civil actions for refund: Procedure and practice: Collateral estoppel.--The Commissioner was collaterally estopped from refusing a tax refund to the taxpayer where it had conceded a tax refund to the taxpayer’s son in a case involving identical facts and issues relating to the tax-free exchange of investment real estate for investment real estate in non-simultaneous transfers. However, three parcels of land were not subject to collateral estoppel because they involved a slightly different fact pattern: two parcels had been transferred to the taxpayer’s daughter rather than to the taxpayer, and, with respect to the third parcel, the other party only purchased the right to purchase the land and transferred that right to the taxpayer-father. BACK REFERENCES: 79FED ¶5781.5342, 79FED ¶5781.5348, 79FED ¶5781.5376, and 79FED ¶5781.5379.
[Code Sec. 1031]
Like-kind exchanges of property: Possibility of receiving cash in lieu of the property.--In the transfer of one parcel in which the taxpayer received the equivalent of a fee interest subject to conditions precedent which could void the transaction and result in a cash payment to the taxpayer, the court held that the possibility of receipt of cash did not prevent the application on nonrecognition treatment under Code Sec. 1031. The evidence indicated that it was the taxpayer’s intention at the onset of the transaction to receive nothing but like-kind property and he never handled any cash in the course of the transactions. The fact that there was a “three corner” exchange (i. e., the taxpayer transferred his property to another person in return for the latter’s obtaining the right to another property and transferring such right to the taxpayer) did not change the court’s holding. BACK REFERENCES: 79FED ¶4606.072.
Charles P. Duffy, Duffy, Georgeson, Kelel & Benner, 1100 S. W. Sixth Ave., Portland, Ore. 97204, for appellant. M. Carr Ferguson, Assistant Attorney General, Francis J. Gold, Department of Justice, Washington, D. C. 20530, for appellee.
Before Goodwin and Anderson, Circuit Judges, and Jameson*, District Judge.
Goodwin, Circuit Judge:
T. J. Starker appeals from the dismissal, on stipulated facts, of his tax refund action. We affirm in part and reverse in part.
On April 1, 1967, T. J. Starker and his son and daughter-in-law, Bruce and Elizabeth Starker, entered into a “land exchange agreement” with Crown Zellerbach Corporation (Crown). The agreement provided that the three Starkers would convey to Crown all their interests in 1,843 acres of timberland in Columbia County, Oregon. In consideration for this transfer, Crown agreed to acquire and deed over to the Starkers other real property in Washington and Oregon. Crown agreed to provide the Starkers suitable real property within five years or pay any outstanding balance in cash. As part of the contract, Crown agreed to add to the Starkers’ credit each year a “growth factor”, equal to six percent of the outstanding balance.
On May 31, 1967, the Starkers deeded their timberland to Crown. Crown entered “exchange value credits” in its books: for T. J. Starker’s interest, a credit of $1,502,500; and for Bruce and Elizabeth’s interest, a credit of $73,000.
Within four months, Bruce and Elizabeth found three suitable parcels, and Crown purchased and conveyed them pursuant to the contract. No “growth factor” was added because a year had not expired, and no cash was transferred to Bruce and Elizabeth because the agreed value of the property they received was $73,000, the same as their credit.
Closing the transaction with T. J. Starker, whose credit balance was larger, took longer. Beginning in July 1967 and continuing through May 1969, Crown purchased 12 parcels selected by T. J. Starker. Of these 12, Crown purchased 9 from third parties, and then conveyed them to T. J. Starker. Two more of the 12 (the Timian and Bi-Mart properties) were transferred to Crown by third parties, and then conveyed by Crown at T. J. Starker’s direction to his daughter, Jean Roth. The twelfth parcel (the Booth Property) involved a third party’s contract to purchase. Crown purchased that contract right and reassigned it to T. J. Starker.
The first of the transfers from Crown T. J. Starker or his daughter was on September 5, 1967; the twelfth and last was on May 21, 1969. By 1969, T. J. Starker’s credit balance had increased from $1,502,500 to $1,577,387.91, by means of the 6 per cent “growth factor”. The land transferred by Crown to T. J. Starker and Roth was valued by the parties at exactly $1,577,387.91. Therefore, no cash was paid to T. J. Starker, and his balance was reduced to zero.
In their income tax returns for 1967, the three Starkers all reported no gain on the transactions, although their bases in the properties they relinquished were smaller than the market value of the properties they received. They claimed that the transactions were entitled to nonrecognition treatment under section 1031 of the Internal Revenue Code (I. R. C. §1031), which provides in part:
(a) Nonrecognition of gain or loss from exchanges solely in kind.
No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidence of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.
The Internal Revenue Service disagreed, and assessed deficiencies of $35,248.41 against Bruce and Elizabeth Starker and $300,930.31 plus interest against T. J. Starker. The Starkers paid the deficiencies, filed claims for refunds, and when those claims were denied, filed two actions for refunds in the United States District Court in Oregon.
In the first of the two cases, Bruce Starker v. United States (Starker I), 75-1 ustc (CCH) ¶8443 (D. Or. 1975), the trial court held that this court’s decision in Alderson v. Commissioner [63-2 ustc ¶9499], 317 F. 2d 790 (9th Cir. 1963), compelled a decision for the taxpayers. Bruce and Elizabeth Starker recovered the claimed refund. The government appealed, but voluntarily dismissed the appeal, and the judgment for Bruce and Elizabeth Starker became final.
The government, however, did not capitulate in T. J. Starker v. United States (Starker II) [77-2 ustc ¶9512], the present case. The government continued to assert that T. J. Starker was not entitled to section 1031 nonrecognition. According to the government, T. J. Starker was liable not only for a tax on his capital gain, but also for a tax on the 6 per cent “growth factor” as ordinary income (interest or its equivalent).
The same trial judge who heard Starker I also heard Starker II. Recognizing that “many of the transfers here are identical to those in Starker I”, the court rejected T. J. Starker’s collateral-estoppel argument and found for the government. The judge said:
I have reconsidered my opinion in Starker I. I now conclude that I was mistaken in my holding as well in my earlier reading of Alderson. Even if Alderson can be interpreted s contended by plaintiff, I think that to do so would be improper. It would merely sanction a tax avoidance scheme and not carry out the purposes of §1031. T. J. Starker v. United States, 432 F. Supp. 864, 868, 77-2 ustc (CCH) ¶9512 (D. Or. 1977).
Judgment was entered for the government on both the nonrecognition and ordinary income (interest) issues, and this appeal followed.
T. J. Starker asserts that the district court erred in holding that: (a) his real estate transactions did not qualify for non-recognition under I. R. C. §1031; (b) the government was not collaterally estopped from litigating that issue; and (c) the transactions caused him to have ordinary income for interest, in addition to a capital gain.
II. Collateral Estoppel
T. J. Starker argues that the decision in Bruce Starker v. United States collaterally estops the government from litigating the application of section 1031 to his transactions with Crown. The government urges this court to affirm the trial court on this point, claiming that the two cases presented different legal questions, facts, and parties.
A. Legal question presented. In order for collateral estoppel to apply, the issue to be foreclosed in the second litigation must have been litigated and decided in the first case. The government argues that the legal question presented in T. J. Starker is different than that in Bruce Starker. According to the government, Bruce Starker merely decided that the term “exchange” in section 1031 does not require a simultaneous exchange of title or benefical ownership. By contrast, it argues, T. J. Starker presents the question whether the lack of a simultaneous exchange and the possibility of the taxpayer’s receiving cash render the consideration given the taxpayer something other than “property of a like kind”.
The first problem, then, is that of defining the legal “issue” for purposes of collateral estoppel. Stated broadly, the legal “issue” decided in Bruce Starker was whether section 1031 applied to the transfers pursuant to the Starker-Crown contract. Defined narrowly, the issue was, as the government argues, whether the term “exchange” contains a notion of simultaneity.
While there is a sizeable body of authority on the other aspects of the government’s collateral estoppel arguments, there is little clear precedent on the scope of a legal “issue”. However, the emerging Restatement (Second) of Judgments, now in draft, marks the way through this murky area. Section 68 of Tentative Draft No. 4 (1977) states four factors to be considered by the court in deciding what the issue decided in the prior action was:
(1) Was there a substantial overlap between the evidence or argument advanced in the second proceeding and that advanced in the first?
(2) Does the new evidence or argument involve the application of the same rule of law as that involved in the prior proceeding?
(3) Could pretrial preparation and discovery in the first proceeding reasonably be expected to have embraced the matter to be presented in the second?
(4) How closely related are the claims?
As T. J. Starker pointed out below, the government’s evidence and argument in his case are quite similar to those presented in Bruce Starker v. United States [75-1 ustc ¶9443] (Starker I). There, the government argued, just as it does here, that in 1967, the Starkers received mere promises, not real property, in consideration for their timberland. From that point, the government went on to argue in Starker I that there was no “exchange” because the reciprocal transfers of land came later. Hence, it concluded, section 1031 did not apply. Here, the government’s first point and conclusion remain exactly the same: T. J. Starker received a mere promise, and section 1031 does not apply. Only the connecting argument between these two assertions differs in the two cases. Here, instead of declaring that no “exchange” took place because the transfers were not simultaneous, the government asserts that if there was an “exchange”, it was not of “property of a like kind” because the transfers were not simultaneous.
Despite a switch in the verbal formula, the government’s argument here is substantially identical to that in Bruce Starker v. United States [75-1 ustc ¶9443]. The government’s appeals to the purposes and legislative history of I. R. C. §1031 are the same. And even if its argument here can be said to differ from that in the first case, under the draft Restatement approach, supra, the pretrial preparation of Bruce Starker could reasonably be expected to have alerted the government to both verbal formulations of its argument.
If the government were arguing from the language of the statute, i.e., on the plain meaning of “exchange” or “like kind”, then the difference in the statutory language it chooses to emphasize would be relevant. But it has chosen to rely on other arguments--precedent and legislative history--in both T. J. Starker and Bruce Starker. In both cases, the government relies on the same sentence, the same subsection of the Code, for the same result. Hence, the government’s attempts to sever the legal questions in Starker I and Starker II are unconvincing. We reject them.
B. Facts. The second prong of the government’s argument in support of the district court’s ruling on collateral estoppel is that the facts in Bruce Starker v. United States [75-1 ustc ¶9443] are sufficiently separable from those in the instant case to make the estoppel doctrine inapplicable. A prominent case on the identity of facts required for collateral estoppel is Commissioner v. Sunnen [48-1 ustc ¶9230], 333 U. S. 591 (1948). At the time this case was argued, both parties admitted Sunnen controlled.
In Sunnen, an inventor licensed his invention, and assigned the license contracts and royalties thereunder to his wife. The question presented to the court was whether the inventor was liable for taxes on the income paid to his wife by the licensee under this arrangement in the years 1937 to 1941. In previous litigation, the Board of Tax Appeals (now the Tax Court) had held that for the years 1929 to 1931, the taxpayer was not liable for payments made to his wife under a set of licenses entered into in 1928. In the second case, both the 1928 contracts and other contracts were involved.
The Supreme Court began by noting that res judicata was inapplicable. That doctrine, it said, required that both suits involve the same cause of action, and suits over tax liabilities in two different years were two separate causes of action. 333 U. S. at 597-98.
The Court went on to hold that, except for payments made under the 1928 contracts, collateral estoppel could not apply, either. Relying on what it termed the traditionally accepted concepts of collateral estoppel, it declared that even though the license contracts may have been substantively identical, the fact that they were separate documents made each contract a part of a different issue for collateral estoppel purposes:
“* * * [I]f the relevant facts in the two cases are separable, even though they be similar or identical, collateral estoppel does not govern the legal issues which recur in the second case. Thus the second proceeding may involve an instrument or transaction identical with, but in a form separable from, the one dealt with in the first proceeding. In that situation, a court is free in the second proceeding to make an independent examination of the legal matters at issue. * * * Before a party can invoke the collateral estoppel doctrine in these circumstances, the legal matter raised in the second proceeding must involve the same set of events or documents and the same bundle of legal principles that contributed to the rendering of the first judgment.” 333 U. S. at 601-02 (footnote omitted).
The Court thus concluded that collateral estoppel could not apply to any of the payments before it except those made pursuant to the 1928 contracts. Moreover, it held that although collateral estoppel ordinarily would bar relitigation of the payments under the 1928 contracts, the law regarding the taxability of assigned income payments had so changed since the Board of Tax Appeals’ decision that the case fit into an exception to the collateral estoppel doctrine. 333 U. S. at 602-07. 1
The Supreme Court’s recent decision in Montana v. United States, 47 U. S. L. W. 4190 (U. S., Feb. 22, 1979), calls Sunnen into question. Although Montana did not expressly overrule Sunnen, the Court ignored Sunnen’s rigid “separable facts” test. It held collateral estoppel applicable even though some facts differed in the two cases at issue, because the differing facts were not “essential to the judgment” or “of controlling significance” in the first case. 47 U. S. L. W. at 4194. In Montana, the Court held that the United States’ federal court challenge to a state tax on public contractors was precluded by a prior state court challenge to the same tax. The first suit was brought by a contractor, but the United States, to whom the tax had been passed on, financed and controlled the first suit. When the State of Montana won the first case, the United States decided, as it did in Starker I, not to pursue an available appeal. The Court found that the United States’ control of the first action put it in the same position it would have occupied had it instituted both actions in its own name.
Although the United States claimed in Montana that “the contract at issue in [the first case] contained a critical provision which the contracts in the [second] litigation [did] not,” 47 U. S. L. W. at 4193, the Court said that collateral estoppel precluded the second, federal court, action. In the contracts at issue in the first case, contractors promised the United States that they would not take advantage of credits offered by the State as part of its tax package; in the contracts at issue in the second, the contractors could take the State credits. The United States argued that in the first action, the state court had assumed that the credits, available but for the voluntary contract provision, could have entirely offset the tax. Under the later contracts, however, even where the credits could be taken, it turned out that a complete “washout” was impossible. Therefore, citing Commissioner v. Sunnen, supra, the United States argued that its case should not have been dismissed. The Supreme Court rejected this argument. It noted that the state court had declared that its decision did not turn on the potential for a “washout”; the state court regarded that fact as “inconsequential”. 47 U. S. L. W. at 4194. Sunnen was limited by the Court to cases in which there had been a significant “change in the legal climate”, such as that worked by two Supreme Court decisions 2 that intervened between Sunnen I and Sunnen II. 47 U. S. L. W. at 4194, quoting Commissioner v. Sunnen, 333 U. S. at 606.
There was no change in the tax treatment of like-kind exchanges between Starker I and Starker II. Indeed, between the government’s abandonment of Starker I and the decision in Starker II, there was little or no litigation on the question whether simultaneity of title transfer is required for nonrecognition treatment. The only change was in the trial judge’s understanding of section 1031. 3 Therefore, Sunnen, as limited by Montana, is inapplicable to this appeal, and we must analyze the similarity of the facts of Starker I and Starker II under the later case. 4 Although Montana was not the law when this case was first briefed and argued, we have requested and received supplemental briefs. We apply the law as it exists at the time we decide the appeal before us. See Cort v. Ash, 422 U. S. 66, 76-77 (1975); United States v. Fresno Unified School District, 592 F. 2d 1088, 1093 (9th Cir. 1979) (citing cases).
The trial court’s opinion in Starker I dealt with Bruce and Elizabeth Starker’s reciprocal, but not simultaneous, transfers of title to Crown and another corporation. The Starker I court noted that at the time the Starkers transferred their land to Crown, Crown did not own the land ultimately transferred to them. If “a taxpayer disposes of all his rights in property for a promise from the transferee to convey like-kind property in the future”, the court said, that transaction is still an exchange “solely for properties of a like kind”. 75-1 ustc (CCH) at p. 87,143. The opinion said nothing to indicate that the court considered significant the amount of time elapsed between the taxpayers’ transfer of title and their receipt of title. Under a fair reading of Starker I, the length of the time lapse is inconsequential. Thus, Starker II cannot be distinguished on that ground. Indeed, in its opinion in Starker II, the court did not distinguish the facts of Starker I; it straight-forwardly overruled it, recognizing “that many of the transfers here are identical to those in Starker I.” T. J. Starker v. United States, 432 F. Supp. at 867. Hence, as to the nine properties to which T. J. Starker himself actually received title directly from Crown, collateral estoppel is warranted under Montana v. United States, supra. On the other hand, as to the three other properties received by T. J. Starker under the contract, collateral estoppel should not apply under Montana. These are the Bi-Mart, Timian, and Booth properties. Title to the Bi-Mart and Timian properties was transferred by Crown, not to T. J. Starker, but to his daughter, Jean Roth. Crown never acquired title to the Booth property; instead, it acquired a right to purchase, which it transferred to T. J. Starker. Not having such transfers before it in Starker I, the district court could not have considered the effects of such circuitous transfers on the nonrecognition issue. Indeed, the court gave the transfer to Roth as an example of “issues” in Starker II “which were not raised in Starker I.” 432 F. Supp. at 867. And, unlike the state court in Montana, the district court gave no hint that it thought such differences in facts would be inconsequential.