Duilio Costanza owned two parcels of real estate in Flint, Michigan. On one, he operated an Italian restaurant. He built a small office plaza on the other. Together, the two properties were appraised in 1991 at $830,000. In 1992 Duilio decided to retire to his native Italy. After seeking advice from his attorney, he sold the properties to his son Michael in exchange for an $830,000 SCIN. The note, fully secured by a mortgage on the properties, provided for monthly installments over 11 years.
At his father’s request, Michael remitted the payments quarterly to ease the burden of Duilio’s having to make a monthly trip to the bank. Michael made the first quarterly payment by issuing three checks on March 8, 1993. He altered the dates on the checks to indicate they were written on January 1, February 2, and March 1, 1993.
Duilio, who had suffered from heart disease during the final 15 years of his life, died unexpectedly on May 12, 1993, due to complications from surgery. As his father’s executor, Michael filed a federal estate tax return declaring the estate had no tax liability. The return identified the SCIN as an asset of the estate but claimed the note had no value due to the cancelation-upon-death provision.
The IRS issued a deficiency notice that proposed an increase in Duilio’s gross estate because the sale was not a bona fide transaction or, alternatively, the transaction was a “bargain sale” that would increase the estate’s adjusted taxable gifts. Following a trial, the Tax Court concluded the sale was in fact not a bona fide transaction. The court questioned the parties’ sincerity, expressing concerns about the actual date the documents were signed, the date Michael made the three payments and the fact he had altered the dates on the checks. Consequently, the Tax Court held that the SCIN provided no consideration for the properties and that their full value, less the three payments Michael made, was a taxable gift from Duilio to Michael and thus includible in the father’s gross estate.
Michael appealed, contending the Tax Court erred in finding the SCIN transaction was not bona fide.
Result. For the taxpayer. The Sixth Circuit reversed the Tax Court and held that the SCIN was bona fide. According to the court, Michael effectively rebutted the presumption against the enforceability of an intrafamily SCIN by affirmatively showing a real expectation of repayment existed at the time of the transaction and the deceased’s intent to enforce collection of the indebtedness. The Sixth Circuit found that Duilio’s oral instructions about quarterly payment explained their timing and Michael’s alteration of the check dates. The appeals court also noted that Duilio’s premature death due to complications from surgery was clearly not anticipated. In addition, the Sixth Circuit explained that the fact the SCIN was fully secured by a mortgage on the properties refuted any inference the sale was not bona fide.
The IRS urged the Sixth Circuit to remand the case to the Tax Court to determine the true value of the SCIN, contending it was considerably less than the value of the properties transferred. The appeals court followed this recommendation to address the IRS’s alternative argument that the note was a bargain sale which subjected the estate to gift tax under IRC section 2512.
Estate of Costanza v. Commissioner, no. 01-2207 (6th Cir., 2/19/03).
Prepared by Claire Y. Nash, CPA, PhD, associate professor of accounting, Christian Brothers University, Memphis, Tennessee, and T ina Quinn, CPA, PhD, associate professor of accountancy, Arkansas State University, Jonesboro.