Court affirmed denial of investment tax credit where noncorporate lessor failed to prove realistic contemplation that lease would be less than fifty percent of equipment's useful life.

What happened

The facts of the case, in plain language.

The leases' written terms were twelve months, and the computer equipment's useful life was six years.

The Borcherses controlled Decision Systems, Inc., and Richard leased computer equipment only to Decision Systems in 1982.

In 1983, Richard again leased to Decision Systems all the equipment purchased and leased to the corporation in 1982.

Richard had leased other computer equipment to Decision Systems in 1981, renewed all these leases in 1982, and renewed some of the leases again in 1983.

What the court decided

Richard and Jane Borchers appealed a tax court decision denying them an investment tax credit on computer equipment Richard leased to Decision Systems, Inc., their wholly-owned corporation, in 1982. This was the second appeal of the same case—the Eighth Circuit had previously vacated and remanded for lack of adequate tax court analysis. On remand, the tax court disallowed the credit. The court affirmed, holding that under the realistic contemplation test, noncorporate lessors seeking an investment tax credit must prove they realistically contemplated the lease would cover less than fifty percent of the equipment's useful life. Although the written lease terms were twelve months (less than fifty percent of the six-year useful life), the tax court found the Borcherses' pattern of repeated leasing to their controlled corporation, with multiple renewals, demonstrated they did not realistically contemplate a short-term lease.

1. Under 26 U.S.C. § 46(e)(3)(B), a noncorporate lessor seeking an investment tax credit must prove the leased property is used for less than 50% of its useful life, determined not by written lease terms but by the 'realistic contemplation' of the parties at the time the property is first put into service, examining all surrounding facts and circumstances. (*23)
2. A noncorporate lessor claiming an investment tax credit under § 46(e)(3)(B) bears the burden of proving the parties realistically contemplated the lease would cover less than half of the property's useful life; a pattern of renewals of leases to a controlled corporation defeats that showing. (*23)
3. A lower court on remand is free to revisit any issue—and may change its prior result—on any question the appellate court did not expressly or impliedly decide in vacating the earlier decision. (*23)

How the court reached its decision

The court's reasoning, step by step.

Whether the tax court clearly erred in finding, under the realistic contemplation test, that the Borcherses failed to prove the parties realistically contemplated leases covering less than 50% of the equipment's useful life. Although the written lease terms (twelve months) were less than 50% of the equipment's six-year useful life, the Borcherses controlled Decision Systems; Richard leased equipment exclusively to Decision Systems in 1982; in 1983 Richard again leased to Decision Systems all equipment purchased and leased in 1982; Richard had leased other equipment to Decision Systems in 1981 and renewed those leases in 1982 and again (some) in 1983—a pattern of repeated renewals to a controlled entity inconsistent with a realistic contemplation of short-term leasing. The court found no clear error in the tax court's determination that the Borcherses failed to prove realistic contemplation that the leases would cover less than half of the equipment's useful life, and affirmed the denial of the investment tax credit.

Whether the tax court on remand was limited to explaining its original decision favorable to the taxpayers, or was free to change the result and disallow the investment tax credit. The prior Eighth Circuit decision vacated solely because the tax court's failure to provide analysis made review impossible; it did not decide whether the Borcherses were entitled to the credit, nor did it confine the tax court to explaining its first decision. Because the prior remand left the merits undecided, the tax court was free on remand to reverse its result and disallow the investment tax credit.

Key quotes from the opinion

Notable passages from the opinion, in the court's own words.

Cases the court relied on

Earlier decisions the court cited as authority for its ruling.

• Connor v. Commissioner (847 F.2d 985 (1st Cir. 1988)) — First Circuit decision establishing that written lease terms are not dispositive under the realistic contemplation test, that all surrounding facts and circumstances are examined, that the taxpayer bears the burden of proving realistic contemplation, and that the clearly erroneous standard governs appellate review—all rules the court directly adopted and applied.
• Owen v. Commissioner (881 F.2d 832 (9th Cir. 1989)) — Ninth Circuit decision supporting the realistic contemplation test's focus on the parties' contemplation at the time the property is first put into service.
• McEachron v. Commissioner (873 F.2d 176 (8th Cir. 1988)) — Prior Eighth Circuit decision adopting the realistic contemplation test in the context of a challenged lease containing no definite term, establishing circuit precedent for application of the test.
• Borchers v. Commissioner (889 F.2d 790 (8th Cir. 1989)) — Prior Eighth Circuit decision in this same case vacating the tax court's initial grant of the investment tax credit because the absence of any analysis made appellate review impossible, providing the procedural basis for the remand at issue.
• Newball v. Offshore Logistics Int'l (803 F.2d 821 (5th Cir. 1986)) — Fifth Circuit authority for the mandate rule principle that a lower court on remand is free to address any issue not expressly or impliedly decided by the appellate court, used to sustain the tax court's authority to change its result on remand.