Determining taxpayers' 'ownership' of property In order for a taxpayer to be considered the "owner" of property for income tax purposes, it may not be sufficient that the taxpayer merely hold title to the property. Where the acquisition of the property was financed with nonrecourse indebtedness and the lender has recourse only against the property itself and not against the nominal owner, the tax law may not respect the taxpayer's nominal ownership, unless the taxpayer has an equity investment in the property which could not prudently be abandoned.

Many courts have tested for the presence of a true equity investment by comparing the amount of nonrecourse debt on the date of the property's acquisition with the fair market value of the property on that date. Where the debt exceeded that fair market value, the property might well be abandoned by the taxpayer; in such a case, therefore, the taxpayer might not be treated as the owner of the property. However, where the fair market value equalled or exceeded the amount of debt on the date of acquisition, the taxpayer's ownership would generally be respected.

A recent decision, Stiebling vs. Commissioner (9th Cir. May 14, 1997), may have somewhat altered the analysis. In 1981, Mary Lou Stiebling purchased 105 mobile homes for $1.4 million, paying $1 as a downpayment and agreeing, on a nonrecourse basis, to make a balloon payment of the balance due in 1988. (The seller retained title to the mobile homes, apparently to secure payment of the debt.) The property was leased back to the seller. Through 1983, Ms. Stiebling made payments of interest on the debt, and the seller-lessor made lease payments back to her. After 1983, she stopped making interest payments, and the seller-lessor, in return, stopped making lease payments. Nevertheless, Ms. Stiebling depreciated the full value of the mobile homes on a five-year basis from 1981 through 1985. Ms. Stiebling never took title to, or possession of, the mobile homes, never "undertook any responsibility" with respect to them, and never made further payment of the purchase price, nor did she ever seek to enforce the purchase agreement at any time after 1983.

The Internal Revenue Service challenged her entitlement to depreciation deductions on the mobile homes. The Service argued that, in light of the facts presented, Ms. Stiebling could not properly be viewed as the owner of the property.

The test for whether a taxpayer will be treated as the owner of property subject to nonrecourse debt has traditionally been seen as an entirely prospective inquiry, i.e., one made by reference to facts as they exist on the date of acquisition. Whether, years later, a taxpayer turns out to have actually defaulted on the debt has often not been perceived to be relevant. The Stiebling court found to the contrary, holding that, in applying the "imprudent abandonment" test to cases where the terms of a purchase provide for a large balloon payment to be made at a later date, it is appropriate to test the taxpayer's equity (or potential equity) not only as of the date of acquisition, but also as of the scheduled date for the balloon payment. This second inquiry is made by comparing the amount of indebtedness anticipated to be outstanding with the anticipated residual value of the property as of the balloon payment date.

It was not disputed by the parties that the purchase price approximated the fair market value of the property at the time of purchase, i.e., Ms. Stiebling met the traditional test for ownership. However, in 1988, the date for payment of the full purchase price, the mobile homes would already have been fully depreciated. As Ms. Stiebling proffered no evidence as to the purported value of the mobile homes in 1988, the court found, in light of the magnitude of the depreciation already taken, that the amount still due under the loan had to be well in excess of the 1988 residual value of the mobile homes. Therefore, the court found that Ms. Stiebling could not be viewed as the owner of the mobile homes, and denied her deductions for depreciation.

The Stiebling court also listed several other factors that militated against a finding that Ms. Stiebling owned the mobile homes -- Ms. Stiebling never took title to, or possession of, the mobile homes. Furthermore, the contract left the amount of interest due to the seller after 1983 subject to future negotiation. The court viewed the omission of this material term as a "built in contractual self-destruct device" which called into question the validity of the entire underlying agreement.

The Stiebling decision, narrowly read, mandates only (and quite reasonably) that it must be anticipated, on the acquisition date, that there will be equity in the property on a later, scheduled balloon payment date. However, were the rationale of this decision extended, its premise (that events subsequent to the acquisition date are relevant) would quickly lead to a radical departure from the existing authority. In particular, the decision suggests that Ms. Stiebling's post-acquisition "course of conduct" was a factor militating against a finding of ownership from the time of acquisition. If this suggestion is taken at face value, what happens if a taxpayer's post-acquisition actions do not conform to expectations? Will ownership come to be reliably determinable only once the taxpayer has in fact actually kept to his bargain and made payment? Can any deductions be claimed in the interim, no matter how likely it seems that the debt will be paid in the future? While we may hope ! and expect that Stiebling's loose language will not lead us to unfavorable answers to these questions, another source of concern has, at least for the moment, presented itself.

Ronald A. Morris and Elliot Pisem, members of the New York bar, are partners in the law firm of Roberts & Holland LLP, New York City and Washington, D.C.