TAX COURT LIMITS REGULAR TAX DEDUCTION FOR AFFILIATED GROUP, SAYS SPECIAL LOSS-ORDERING RULE DOESN'T APPLY TO BANK AND NONBANK MEMBERS.

                       UNITED STATES TAX COURT

Jack Forsberg, Tracy Martinez, Robert M. Ratchford, and David L. Zoss for respondent.

OPINION

[1] HALPERN, JUDGE: Norwest Corp. (Norwest), a Delaware corporation, is the petitioner in each of these consolidated cases. Norwest is the petitioner by virtue of being the successor in interest to various other corporations. When necessary for clarity, we shall refer by name to Norwest or one or the other of those predecessor corporations. Otherwise, we shall use the term "petitioner" to refer without distinction to Norwest or one or more of the predecessor corporations.

[2] These consolidated cases involve determinations by respondent of deficiencies in petitioner's Federal income taxes and claims by petitioner of overpayments, as follows:

                          Norwest Corp. & Subs., Successor in Interest

[3] Unless otherwise noted, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

                              CONTENTS

[4] On the date that the petition in each of these cases was filed, Norwest's principal place of business was in Minneapolis, Minnesota. Norwest is a bank holding company whose affiliates provide banking and other financial services.

[5] On April 19, 1991, United Banks of Colorado, Inc. (UBC), a Colorado corporation, was merged with and into Norwest pursuant to section 368(a)(1)(A). At all relevant times prior to its merger with Norwest, UBC was the common parent corporation of an affiliated group of corporations making a consolidated return of income (the UBC affiliated group). UBC was a calendar-year taxpayer. Petitioner is the successor in interest to the UBC affiliated group as it existed during the years in issue.

[6] On May 1, 1987, Intrawest Financial Corp. (Intrawest), a Colorado corporation, was merged with and into UBC pursuant to section 368(a)(1)(A). At all relevant times prior to its merger with UBC, Intrawest was the common parent corporation of an affiliated group of corporations making a consolidated return of income (the Intrawest affiliated group). Petitioner is the successor in interest to the Intrawest affiliated group for its taxable year 1980 and its short taxable year ended April 30, 1987.

[7] On April 1, 1982, UBC purchased for cash the stock of Lorin Investment Co., Inc. (Lorin), a Colorado corporation. At all relevant times prior to being acquired by UBC, Lorin was the common parent corporation of an affiliated group of corporations making a consolidated return of income (the Lorin affiliated group). Petitioner is the successor in interest to the Lorin consolidated group for its taxable years 1980 and 1981.

II. ATRIUM ISSUES

A. FINDINGS OF FACT

1. BACKGROUND

[8] During the years in issue, UBC owned in excess of 99 percent of the stock of United Bank of Denver (UBD), a national bank with its principal place of business in Denver, Colorado. UBD was the sole shareholder of Lincoln Building Corp. (LBC), a Colorado corporation. LBC was the real estate holding company for UBD. (In the papers filed in this case, the convention of the parties has been to use the term "the Bank" to refer to UBC, UBD, or LBC, individually or collectively, in cases where those corporations acted in concert or where separate identification would not be material. We shall adopt that convention.)

[9] During the 1970s, LBC owned a portion of a block in downtown Denver, Colorado, which is bounded by 17th Avenue to the south, by 18th Avenue to the north, by Broadway to the west, and by Lincoln Street to the east (the Broadway-Lincoln block). During the 1970s and throughout some of the years in issue, LBC owned two buildings located on the Broadway-Lincoln block, namely, Two United Bank Center Building, located at 1700 Broadway (2UBC) and Three United Bank Center Building, located at 1740 Broadway (3UBC). A sketch of the Broadway-Lincoln block, the two buildings, and certain other features is attached hereto as an appendix.

[10] 2UBC is a 22-story office building, which was constructed in 1954 and has approximately 390,000 square feet of rentable space. 2UBC is considered a notable building in Denver because it was the first modern highrise built in the city and was the first highrise designed by I.M. Pei. 3UBC is a four-story office building, which was constructed in 1958 and has approximately 115,000 square feet of rentable space. Throughout the 1970s, 2UBC was primarily leased to non-Bank tenants, and 3UBC was wholly occupied by the Bank. 3UBC served as the Bank's headquarters prior to completion in 1983 of One United Bank Center Building (1UBC). See infra sec. II.A.3.b.

[11] During the 1970s, LBC also owned land on the Broadway- Lincoln block between 2UBC and 3UBC and east of 2UBC extending to Lincoln Street. There were improvements on that land constituting an enclosed courtyard. on the corner of Lincoln Street and 17th Avenue of the Broadway-Lincoln block were a glass-enclosed restaurant and a small office building, both of which were owned by LBC.

[12] During the 1970s, LBC owned a portion of a block in downtown Denver, Colorado, that is bounded by 17th Avenue to the south, by 18th Avenue to the north, by Lincoln Street to the west, and by Sherman Street to the east (the Lincoln-Sherman block). That block is directly to the east of and across Lincoln Street from the Broadway-Lincoln block. During the 1970s and throughout some of the years in issue, LBC owned land and improvements on the Lincoln- Sherman block directly across from 3UBC, including a structure named Motorbank I. That structure consisted of three underground levels, two of which contained office space and one of which contained mechanicals, a ground level that contained office space, and 10 floors of above-ground parking space. Motorbank I had approximately 1,000 square feet of office space and approximately 103,000 square feet of parking space. 3UBC was connected to the Motorbank I parking garage by an elevated, enclosed pedestrian walkway and was connected to the Motorbank I office space by a passage under Lincoln Street. Motorbank I also had facilities to accommodate drive-up banking through about 1987.

[13] During the 1970s, LBC owned a portion of a block in downtown Denver, Colorado, that is bounded by 17th Avenue to the south, by 18th Avenue to the north, by Sherman Street to the west, and Grant Street to the east (the Sherman-Grant block). That block is directly to the east of and across Sherman Street from the Lincoln- Sherman block. In the late 1970s, LBC purchased property on the Sherman-Grant block.

2. EVENTS PRECEDING THE 1981 TRANSACTIONS

a. INTRODUCTION

[14] In the late 1970s, the Bank was in need of additional office space and was planning the development of a new office tower. Unable to acquire a site on Broadway (the intersection of Broadway and 17th Avenue, where 2UBC was located, was considered the "100 percent corner" in the central business district of Denver), the Bank decided to pursue the development of an office tower on the Lincoln- Sherman block. At that time, the Lincoln-Sherman block was on the fringe of the central business district and was considered to be a substantially less preferable location than the Broadway-Lincoln block. In the late 1970s, LBC acquired land on the Lincoln-Sherman block adjacent to Motorbank I and fronting on the corner of Lincoln Street and 17th Avenue in contemplation of the construction of a new headquarters building on the site.

[15] The Board of Directors of UBD had a working committee called the Directors' Facility Planning Committee (the Committee), which initiated or approved all major decisions regarding the Bank's real estate holdings. The Committee was closely involved in the planning of the new office tower project (the Project).

[16] In the late 1970s, Planning Dynamics Corp. (Planning Dynamics), was retained by the Bank as a consultant for the Project and was closely involved in the Project through 1986.

[17] In 1979, the Gerald D. Hines Interests (the Developer) was selected by the Bank as the developer for the Project.

[18] In 1979, the Bank and the Developer selected the firm of Johnson-Burgee (the Architects) to be the architects for the Project.

b. THE COMMITTEE MEETING OF AUGUST 24, 1979

[19] Architectural plans for the Project prepared by the Architects were presented to the Committee on August 24, 1979. The Architects proposed that a glass atrium be constructed on the Broadway-Lincoln block enclosing the area between 2UBC and 3UBC (and east of 2UBC) and that the atrium be connected to the new office tower on the Lincoln-Sherman block by an elevated, enclosed pedestrian walkway across Lincoln Street. The minutes of the Committee meeting on August 24, 1979, in part, provide:

          Mr. Hershner presented an architectural scale model of the

[20] In 1980, the Bank retained the Harrison Price Co. (Harrison Price) as an outside consultant to address a number of issues regarding the Project, including whether the proposed atrium should remain a part of the Project. Harrison Price prepared a report dated August 20, 1980, entitled "Economic Contribution of the Glass Pavilion to the United Bank of Denver", setting forth its opinion regarding the proposed atrium (the Harrison Price Report). The Harrison Price Report assumed that the proposed atrium would cost $16 million and estimated that it would generate a net operating deficit of $100,000 a year, based on revenues and operating expenses of $500,000 and $600,000, respectively. The Harrison Price Report concluded that the proposed atrium "is a rational and constructive commitment which will return a positive benefit to the stockholders" of the Bank. That opinion was based on three factors: (1) the proposed atrium would increase the rental rates for 2UBC and 3UBC to generate a value addition of $9 million, (2) the proposed atrium "provides a means to counteract any adverse perception of Number 1 United Bank Center associated with an off-Broadway location", and (3) the proposed atrium "will in all liklihood [sic] add power, presence, and image to the Bank's operation which will be reflected in greater market share."

d. THE PLANNING DYNAMICS REPORT

[21] In a letter dated August 25, 1980, Richard R. Holtz, president of Planning Dynamics, addressed the economics, aesthetics, and functionality of the proposed atrium (the Planning Dynamics report). Planning Dynamics estimated the incremental cost of building the proposed atrium to be approximately $9 million. Planning Dynamics estimated that constructing the proposed atrium would increase the rental rate for 2UBC by $2 a square foot, thereby increasing the value of 2UBC by approximately $7 million. Planning Dynamics estimated an increased rental rate for the new office tower of $1 a square foot, thereby increasing its value by approximately $12.3 million, $3.5 million of which would inure to the benefit of the Bank. Although Mr. Holtz believed that the proposed atrium would enhance the value of 3UBC, he did not project any increase in value to 3UBC in the Planning Dynamics report because 3UBC was wholly occupied by the Bank and was not considered as a sale property for the Bank. Planning Dynamics calculated a value over cost figure for constructing the proposed atrium of approximately $1.5 million. Planning Dynamics also estimated a net annual operating deficit of $100,000 a year, based on projected revenues and expenses of $500,000 and $600,000, respectively. In addition, the Planning Dynamics report stated:

          As you know the design problem from the beginning has been

[22] On August 25, 1980, the Committee considered the issue of whether the proposed atrium should be retained as part of the Project. The Committee reviewed the Harrison Price Report, the Planning Dynamics report, and financial projections showing the impact that construction of the proposed atrium could have on earnings by increasing the Bank's market share. The minutes of the Committee meeting on August 25, 1980, in part, provide:

     Bank management feels very positive about the project. The

[23] On September 8, 1980, the Committee approved the Facilities Master Plan, which included construction of the proposed atrium. On September 10, 1980, that plan was approved at a joint meeting of the boards of directors of UBC and UBD.

3. THE 1981 TRANSACTIONS

a. THE 1700 PARTNERSHIP

[24] 1700 Lincoln Limited (the 1700 Partnership) was a Colorado limited partnership. Hines Colorado Ltd. (Hines Colorado), a Colorado limited partnership, was the sole general partner of the 1700 Partnership, and ARICO America Real estate Investment Co. (ARICO), a Nevada corporation operating as a real estate investment trust, was the sole limited partner of the 1700 Partnership.

b. THE GROUND LEASE

[25] By a lease agreement dated February 5, 1981, LBC leased to the 1700 Partnership for a term of 70 years (1) land on the south end of the Lincoln-Sherman block (between Motorbank I and 17th Avenue) and (2) land on the south end of the Sherman-Grant block (together, the 1UBC land) (the Ground Lease). The Ground Lease provided that the 1700 Partnership would, at its own expense, construct an office tower on the Lincoln-Sherman block (1UBC) and a parking garage on the Sherman-Grant block (the Parking Garage), according to the plans and specifications appended to the Ground Lease. The Ground Lease provided for the payment to LBC of both a fixed rent and a rent based on the net cash flow generated by 1UBC and the Parking Garage.

[26] Following the execution of the Ground Lease and related documents, the 1700 Partnership commenced construction of 1UBC, which is a 52-story office tower with approximately 1,174,200 square feet of rentable space, and of the Parking Garage; construction was completed in the second half of 1983.

c. THE ATRIUM PROJECT AGREEMENT

[27] Concurrently with the execution of the Ground Lease, the Bank and the 1700 Partnership entered into an agreement dated February 5, 1981, whereby the Bank, at its sole expense, would construct a glass atrium (the Atrium) on the Broadway-Lincoln block, enclosing the area between 2UBC and 3UBC (and east of 2UBC) (the Atrium Project Agreement). The Atrium Project Agreement stated that the Atrium and the Skyway, see infra sec. II.A.3.d., were being constructed "in order to accomplish the appropriate integration of the New Project [1UBC] with the Principal Bank Property [2UBC and 3UBC]." The Developer and the 1700 Partnership would not have made the commitment to build 1UBC had the Bank not made a commitment to build the Atrium. In 1984, at the request of the Bank, the architectural plans for the Atrium were modified to reduce the scale of the Atrium and to address certain safety concerns.

d. THE SKYWAY AGREEMENT, THE 1981 EASEMENT AGREEMENT, AND THE SPACE LEASE

[28] Concurrently with the execution of the Ground Lease and the Atrium Project Agreement, the Bank and the 1700 Partnership entered into an agreement dated February 5, 1981, whereby the 1700 Partnership would construct an elevated, enclosed pedestrian walkway (the Skyway) connecting 1UBC with the Atrium, and the costs of construction and maintenance of the Skyway would be shared equally by the 1700 Partnership and the Bank (the Skyway Agreement).

[29] Concurrently with the execution of the Ground Lease, the Atrium Project Agreement, and the Skyway Agreement, the Bank and the 1700 Partnership entered into an agreement dated February 5, 1981, whereby the Bank granted to the 1700 Partnership, its successors and assigns, and to the current and future fee owners of the 1UBC land and improvements thereon, an easement for pedestrian access in, on, over, and through the common areas of the Bank's property on the Broadway-Lincoln and Lincoln-Sherman blocks, including the Atrium (the 1981 Easement Agreement). In addition, under the 1981 Easement Agreement, the 1700 Partnership granted to the Bank an easement for pedestrian access in, on, over, and through the common areas of 1UBC.

[30] Concurrently with the execution of the Ground Lease, the Atrium Project Agreement, the Skyway Agreement, and the 1981 Easement Agreement, the Bank and the 1700 Partnership entered into an agreement dated February 5, 1981, whereby the Bank agreed to lease (approximately 500,000 square feet of) space in 1UBC.

4. THE ROSS AND EASTDIL REPORTS

[31] In 1984, prior to construction of the Atrium, the Bank retained two real estate consulting firms, Ross Consulting and Eastdil Realty, Inc. (Eastdil Realty), to evaluate the Bank's real estate holdings and to make recommendations regarding the possible sale of properties held by the Bank. Ross Consulting prepared a report dated February 6, 1984, entitled "Working Outline--Real Estate Sale Considerations" (the Ross report), which was reviewed by the Committee at its meeting of February 17, 1984. The Ross report's recommendations regarding the Atrium were, in part, as follows:

          Our recommendations flow from the assumption that UBC will

          CONSTRUCTION OF THE ATRIUM WILL INHIBIT THE BANK FROM

          NOTWITHSTANDING THE SIGNIFICANT CONSTRUCTION RISK

5. THE COMMITTEE MEETING OF OCTOBER 24, 1984

[34] At the meeting of the Committee on October 24, 1984, Bank management proposed to offer 2UBC and the Ground Lease for sale at an asking price in the range of $33 million each. In its presentation to the Committee, management cited several reasons for selling 2UBC at that time, but acknowledged that "[a] sale now may not fully reflect the value to be added by the Atrium when it is completed." The committee approved the proposal to offer 2UBC and the Ground Lease for sale. In addition, management recommended that construction of the Atrium proceed. Considerations for completing the Atrium that were noted in the presentation to the Committee were as follows:

          A. The Atrium retains a great deal of appeal;

6. CONSTRUCTION AND OPERATION OF THE ATRIUM

[35] Construction of the Atrium commenced in April 1985 and was completed in late 1987; however, portions of the Atrium were open to the public in 1986. The Atrium sits on an irregularly shaped, 30,510 square-foot parcel of land on the Broadway-Lincoln block and has frontage of 96.40 feet along Broadway, 198.75 feet along Lincoln Street, and 113.32 feet along 17th Avenue. The Atrium covers a 24,333 square-foot area, encompasses approximately 4.6 million cubic feet of space, and, at its highest point, is 14 stories tall. The Atrium is constructed of glass, steel, and stone. The Atrium is physically attached to both 2UBC and 3UBC and is connected to 1UBC by the Skyway. There are pedestrian entrances to the Atrium in 2UBC, 3UBC, and the Skyway, and on Broadway, Lincoln Street, and 17th Avenue.

[36] The Atrium shares its mechanical systems with 2UBC; those systems are located below ground within 2UBC. The basement area of the Atrium is used for storage and houses a backup power generator. The Atrium contains space for one restaurant and retail space for one tenant.

[37] Beginning about 1988, UBD owned and operated The Atrium Cafe, which seated approximately 135 people, and UBD paid a fee to a contractor to manage the restaurant's operations. Beginning in 1994, UBD discontinued operating The Atrium Cafe and leased the space for the operation of another restaurant. UBD also leased space for the operation of "expresso carts".

[38] Beginning on October 12, 1987, for a 10-year term, the retail space in the Atrium had been leased for the operation of a Russell's convenience store (the Russell's lease).

[39] From the time of the Atrium's opening in 1986, the only operating revenues generated by the Atrium have been derived from the Russell's lease and from the operations of The Atrium Cafe and other food operations. Those operating revenues have been less than overhead expenses (maintenance, utilities, taxes, etc.), resulting in net operating losses during the period 1989 through 1995, as follows:

                 Income       Overhead     Total Atrium

7. THE ATRIUM ASSETS: COST BASES AND DEPRECIATION

[41] LBC constructed the Atrium Cafe and installed equipment, furniture, and fixtures therein.

[42] During the years in issue, LBC installed a security system and signage in the Atrium (the Atrium Security System and Signage).

[43] During the years in issue, LBC incurred costs to construct, equip, and install the Skyway, The Atrium Cafe, the Atrium Security System and Signage, and the remaining components of the Atrium (the Atrium Structure) (collectively, the Atrium Assets). The cost bases of the Atrium Assets placed in service during the years in issue, as adjusted pursuant to section 48(q) for the investment tax credits claimed with respect to such assets, were as follows:

                                      Cost Bases

                                      Depreciation Claimed

8. THE 2UBC TRANSACTION

a. THE VARIOUS AGREEMENTS

[45] Den-Cal Co. (Den-Cal) was a California limited partnership whose managing general partner was Emerik Properties Corp. (Emerik).

[46] By a purchase and sale agreement dated July 16, 1985, LBC sold 2UBC and the land thereunder and an undivided 50-percent interest in Motorbank I and the land thereunder to Den-Cal for $35,500,000 (the 2UBC Sale Agreement).

[47] Concurrently with the execution of the 2UBC Sale Agreement and other agreements, LBC and Den-Cal entered into an agreement that required LBC to construct the Atrium and the Skyway and to make certain improvements to 2UBC (the 2UBC Construction Agreement). Pursuant to the 2UBC Construction Agreement, LBC and Den-Cal granted to each other certain reciprocal easements pertaining to the ingress and egress of pedestrians through common areas, including the Atrium. In addition, LBC agreed to maintain its improvements on the Broadway- Lincoln block, including the Atrium, at its sole cost and expense.

[48] LBC agreed to operate the Atrium in an attractive and orderly manner and to refrain from substantially modifying the exterior design of the Atrium for a 35-year period commencing on November 1, 1986, and running through October 31, 2021, and thereafter until LBC provides at least 6 months' notice to Den-Cal of its election to terminate (the Atrium Operating Covenants). The 2UBC Construction Agreement, however, allowed LBC to terminate its obligations relating to the Atrium after June 30, 2001, upon payment to Den-Cal of a termination fee and the occurrence of certain other conditions. LBC and Den-Cal acknowledged that LBC's election to terminate the Atrium Operating Covenants "would result in the diminution in value of Two United Bank Center in an amount at least as large as the termination fee", and, accordingly, LBC granted to Den-Cal a lien to secure performance under the Atrium Operating Covenants in the event that the Atrium were razed prior to expiration of the obligations.

[49] The 2UBC Sale Agreement, the 2UBC Construction Agreement, and related agreements shall be referred to collectively as the 2UBC Transaction.

b. TAX TREATMENT OF THE 2UBC TRANSACTION

[50] As a result of the 2UBC Transaction, LBC realized the following amounts from the sale of its properties:

      Property                            Amount Realized

         Property                          Adjusted Basis

9. THE 3UBC TRANSACTION

a. THE VARIOUS AGREEMENTS

[52] By purchase and sale agreement dated December 31, 1987, LBC sold 3UBC, but not the land underlying 3UBC (the 3UBC land), to Holme, Roberts & Owen (HRO), a partnership that was engaged in the practice of law and that served as the Bank's legal counsel during the years in issue (the 3UBC Sale Agreement). The purchase price of $15,957,648 was paid by a note that was nonrecourse to the partners of HRO; however, the note was secured by a deed of trust to 3UBC and an irrevocable letter of credit in the amount of $2.4 million.

[53] By an agreement dated December 31, 1987, LBC leased the 3UBC land to HRO for a term commencing on December 31, 1987, and running for 34 years and 9 months (the 3UBC Ground Lease). For the period through September 30, 2012, the annual rent was $25,000 plus 30 percent of any net rental income generated by 3UBC in excess of $2.5 million. After September 30, 2012, the rent was to be at fair market value. Pursuant to the 3UBC Ground Lease, LBC and HRO granted to each other certain reciprocal easements pertaining to the ingress and egress of pedestrians through common areas, including the Atrium. Also, LBC agreed to operate the Atrium in an attractive and orderly manner and to refrain from substantially modifying the exterior design of the Atrium. In the event that the Atrium was materially damaged, destroyed by fire or other casualty, or taken by condemnation, LBC had the option to rebuild, replace, repair, or raze the Atrium. If LBC elected to raze the Atrium, LBC was required to cover the area with an attractive surface until rebuilding (if any) and to grant HRO a 40-foot setback easement on the south side of the 3UBC land.

[54] By an agreement dated December 31, 1987, UBD leased back the entirety of 3UBC from HRO (the 3UBC Space Lease). The 3UBC Space Lease had an initial term of 9 years and 6 months and automatically renewed for a second term running until September 30, 2012, unless UBD elected otherwise. The rent was $2,070,000 a year during the initial term and $2,333,452 a year during the second term. The 3UBC Space Lease required that UBD pay all expenses and taxes, maintain and repair the building, insure the building, and replace the building if destroyed.

[55] On December 31, 1987, LBC assumed HRO's lease of approximately 122,000 square feet of space in 2UBC and subleased to HRO approximately 130,000 square feet of space in 1UBC.

[56] The 3UBC Sale Agreement, the 3UBC Ground Lease, the 3UBC Space Lease, the agreements relating to HRO's lease in 2UBC and sublease in 1UBC, and related agreements shall be referred to collectively as the 3UBC Transaction.

b. TAX TREATMENT OF THE 3UBC TRANSACTION

[57] On its Federal income tax return filed for 1988, the UBC affiliated group reported gain on the installment basis using an amount realized of $14,201,933 from the sale of 3UBC. The parties agree that the reported amount is the correct amount realized for purposes of determining gain or loss from the sale of 3UBC.

[58] On its Federal income tax return filed for 1988, the UBC affiliated group reported gain on the installment basis using an adjusted basis of $5,321,361 for purposes of determining gain or loss on the sale of 3UBC. The parties agree that the reported adjusted basis is correct, except to the extent, if any, that the cost of the Atrium Assets, see supra sec. II.A.7., is allocable to the basis of 3UBC.

10. THE 1UBC LAND TRANSACTION

[59] By a purchase and sale agreement dated December 30, 1988, LBC sold the 1UBC land (together with LBC' s interest in the Ground Lease relating to the 1UBC land) to ARICO (the 1UBC land transaction). LBC realized $2,900,000 as a result of that transaction. On its Federal income tax return filed for 1988, the UBC affiliated group reported the sale of the 1UBC land as a long-term capital loss using an adjusted basis of $2,953,980. The parties agree that the reported adjusted basis is correct, except to the extent, if any, that the cost of the Atrium Assets, see supra sec. II.A.7., is allocable to the basis of 3UBC.

11. THE 1988 ATRIUM TRANSACTION

a. BACKGROUND

[60] On December 29, 1988, LBC and Broadway Atrium Limited (BAL), a Colorado limited partnership consisting of ARICO and Hines Colorado, formed Lincoln Atrium Limited (LAL), a Colorado limited partnership. LBC was the general partner of LAL, with a 1-percent "sharing ratio" based on an initial contribution of a 0.4848-percent undivided interest in the "Atrium" (as described in the LAL partnership agreement). BAL was the sole limited partner of LAL, with a 99-percent "sharing ratio" based on an initial contribution of a 48-percent undivided interest in the "Atrium", contributed to BAL by ARICO upon acquisition from LBC, see infra sec. II.A.11.b.

[61] On December 30, 1988, UBC, UBD, LBC, LAL, BAL, ARICO, the 1700 Partnership, and Hines Colorado entered into a number of transactions (the 1988 transactions).

b. THE ATRIUM SALE AGREEMENT

[62] The 1988 transactions included an agreement titled "Atrium Purchase, Sale and Lease Agreement", dated December 30, 1988, between UBD, LBC, and ARICO (the Atrium Sale Agreement). Pursuant to the Atrium Sale Agreement, LBC sold to ARICO an undivided 48-percent interest in the land underlying the Atrium, all improvements on that land, all rights and interests appurtenant to that land (collectively, the Atrium Land), and certain other property (together, the Atrium Property). In consideration of LBC's conveyance of the Atrium Property, ARICO agreed to pay a purchase price of $17,100,000 by means of a promissory note.

[63] The Atrium Sale Agreement contained a recital stating as follows: "Seller [LBC] desires to sell the [Atrium] Property to Purchaser [ARICO] and Purchaser desires to purchase the Property from Seller on the terms and conditions set forth in the Agreement."

[64] Section 8.13 of the Atrium Sale Agreement states as follows:

     The parties hereto hereby acknowledge and agree that the

[66] The Atrium Lease contained a recital stating as follows: "LBC and LAL desire to lease their undivided interests in the Atrium to Tenant [UBD] in order to provide unified operation of the Atrium and Tenant desires to lease such interest from Landlord for the same purpose."

c. TAX TREATMENT BY UBC OF THE 1988 ATRIUM TRANSACTION

[67] On its Federal income tax return for the taxable year 1988, the UBC affiliated group reported a gain on the sale of a 48- percent interest in the Atrium Structure and the Skyway of $3,803,496, based on an amount realized of $16,964,800, a cost basis of $15,345,273, and accumulated depreciation of $2,183,969. The reported amount realized was based on a total sales price for a 48- percent interest in the Atrium Structure, the Skyway, and the land underlying the Atrium of $17,100,000 less $135,200 allocated to the underlying land ($17,100,000 - $135,200 = $16,964,800). The reported cost basis equaled 48 percent of the cost bases of the Skyway and that part of the Atrium Structure placed in service prior to 1989, as adjusted under former section 48(q) for the investment credits claimed and investment credits recaptured with respect to those assets. The reported accumulated depreciation equaled 48 percent of the depreciation claimed on the Atrium Structure and the Skyway to the date of the reported sale. No gain or loss was reported as realized on the sale of the underlying land because the reported amount realized ($135,000) equaled the cost basis of the land.

[68] On its Federal income tax returns for the taxable years 1989 through 1991, the UBC affiliated group took deductions for rental expenses on account of the Atrium Lease.

d. UBC'S FINANCIAL STATEMENTS

[69] In the notes to UBC's affiliated financial statements for 1988 and 1989, UBC made disclosures of the Atrium Sale Agreement and the Atrium Lease as a sale and leaseback.

e. PETITIONER'S RESPONSES TO INFORMATION DOCUMENT REQUESTS REGARDING THE ATRIUM

[70] In a letter dated August 11, 1992, to the St. Paul office of the Internal Revenue Service (IRS) Appeals Division (Appeals Division), petitioner first claimed that the cost of the Atrium Assets should be allocated to the bases of adjoining properties. The Appeals Division referred petitioner's claim for cost allocation to the IRS Examination Division.

[71] On January 11, 1993, the IRS agent assigned to review petitioner's claim (the IRS agent) issued an information document request (IDR) to petitioner. Question four of that IDR states: "Who is the owner of the Atrium now? History of the Atrium ownership from 1985 till 1992?" In response to that question, petitioner stated, in part:

      On December 30, 1988, Lincoln Building Corporation sold an

B. THE ATRIUM ASSETS: ALLOCATION OF THE COSTS

1. ISSUE

[73] The issue is whether petitioner may allocate the cost of the Atrium Assets to the bases of other properties that were held by the Bank. If we decide that issue for petitioner, we must decide the nature and extent of the proper allocation.

2. ARGUMENTS OF THE PARTIES

[74] Relying on a line of cases that includes Estate of Collins v. Commissioner, 31 T.C. 238 (1958), and Willow Terrace Dev. Co. v. Commissioner, 40 T.C. 689 (1963), affd. 345 F.2d 933 (5th Cir. 1965) (the developer line of cases), petitioner argues that it is entitled under section 1016(a)(1) ² to allocate the cost of the Atrium Assets to the bases of properties that benefited from the Atrium. Petitioner claims that "[t]he Bank constructed the Atrium for the purpose of creating an office building complex with the expectation that the buildings within the complex would increase in value" and that the Atrium, as a stand-alone asset, has negative value. Petitioner asserts that an allocation of the costs of "the Atrium Assets in proportion to the relative fair market values of the benefited properties as of December 31, 1987, the close of the year in which the Atrium was completed", is "equitable" and would result in a "proper adjustment" under section 1016(a)(1). Petitioner proposes the following allocation:

             Property                      Cost Allocation

3. ANALYSIS

a. THE DEVELOPER LINE OF CASES

[76] In Country Club Estates, Inc. v. Commissioner, 22 T.C. 1283 (1954), the taxpayer transferred approximately 300 acres of land and certain improvements located thereon to the Tuscon Country Club (the Club). With the proceeds of a loan from the taxpayer, the Club agreed to construct on the transferred property a first- class country club that included an 18-hole golf course, club house, and recreational facilities. The taxpayer anticipated that the construction of the country club would enhance the value of the surrounding property, which the taxpayer subdivided into lots for sale. Relying on Commissioner v. Laguna Land & Water Co., 118 F.2d 112, 117 (9th Cir. 1941), affg. in part and revg. in part a Memorandum Opinion of the Board, ³ the taxpayer argued that the cost of the land transferred to the Club should be added to the cost of the lots sold. The Court distinguished Biscayne Bay Islands Co. v. Commissioner, 23 B.T.A. 731 (1931), ⁴ despite the possibility that the transferred land could revert to the taxpayer upon the occurrence of certain contingencies. The Court, citing Kentucky Land, Gas & Oil Co. v. Commissioner, 2 B.T.A. 838 (1925), ⁵ held that the basis of the lots included the cost of the property transferred to the Club because "the basic purpose of petitioner in transferring the land was to bring about the construction of a country club so as to induce people to buy nearby lots." Country Club Estates, Inc. v. Commissioner, supra at 1293.

[77] In Colony, Inc. v. Commissioner, 26 T.C. 30 (1956), affd. per curiam 244 F.2d 75 (6th Cir. 1957), a taxpayer in the business of developing and selling real estate argued that the cost of a water supply pumping system that provided water service to a subdivision should be added to the cost of the lots in the subdivision. This Court stated as follows:

          The difficulty with petitioner's contention is that, unlike

          A careful consideration of the cases above cited indicates

     As we read the Collins case, the pivotal consideration is

          The critical question is whether petitioner intended to

b. THE PRINCIPLES OF THE DEVELOPER LINE OF CASES

[80] The developer line of cases all involve real estate developers that seek to allocate the cost of certain common improvements to the bases of residential lots held for sale. Respondent suggests that the principles of the developer line of cases are applicable only in that context because, "[i]n that context, both the purpose for incurring the costs and the properties benefitted thereby are readily identifiable." An examination of the principles underlying the developer line of cases, however, does not suggest that those principles are restricted to any particular factual context or that difficulty in application justifies nonadherence. We need not decide whether those principles apply in every case; it is sufficient that we decide today that no rule of law proscribes their application to the case at bar.

[81] The developer line of cases addresses the basic problem of what constitutes a proper adjustment to the basis of property in the context of a common improvement that benefits lots in a residential subdivision. Those cases focus on the common improvement and not directly on the lots held for sale. If an analysis of the common improvement indicates that (1) the basic purpose of the taxpayer in constructing the common improvement is to induce sales of the lots and (2) the taxpayer does not retain too much ownership and control of the common improvement, then the lots held for sale are deemed to include the allocable share of the cost of the common improvement. The rationale of the developer line of cases is that, when the basic purpose of property is the enhancement of other properties to induce their sale and such property does not have, in substance, an independent existence, total cost recovery for such property should be dependent on sale of the benefited properties. There is no principled basis here to distinguish between residential lots and the office buildings in question in the application of that logic. In sum, we believe that the logic underlying the developer line of cases is applicable outside the narrow context of allocating the cost of common improvements to the bases of residential lots held for sale and, therefore, we shall determine whether petitioner has satisfied the requirements set forth in those cases.

c. APPLICATION OF THE BASIC PURPOSE TEST

[82] The requirement that the basic purpose of a taxpayer in constructing a common improvement be to induce sales of benefited properties serves the purpose of justifying TOTAL cost recovery of the common improvement based on sales of the benefited properties. Cf. Noell v. Commissioner, supra at 725 n.10 (1976). ⁷ Petitioner apparently acknowledges that a pivotal question is whether the basic purpose of the Bank in constructing the Atrium was to induce sales of the Bank's adjoining properties. That question is one of fact, which we shall answer upon consideration of all the facts and circumstances. See Willow Terrace Dev. Co. v. Commissioner, 40 T.C. 689, 701 (1963).

[83] Petitioner asserts: "The Bank constructed the Atrium for the purpose of creating an office building complex with the expectation that the buildings within the complex would increase in value." That purpose alone, however, without an intention to induce sales of the benefited properties, is insufficient under the developer line of cases. Although the record indicates that the Bank was aware that construction of the Atrium would enhance the value of the Bank's adjoining properties, we believe that the basic purpose of the Bank in constructing the Atrium was not the enhancement of the adjoining properties SO AS TO INDUCE SALES OF THOSE PROPERTIES, but rather the resolution of certain design issues and the enhancement of the Bank's image. Value enhancement of the Bank's adjoining properties was simply a beneficial consequence of that basic purpose. ⁸

[84] On August 24, 1979, when architectural plans for the Project were presented to the Committee for the first time, construction of the Atrium was proposed as a means of resolving two major design issues: (1) counteracting the off-Broadway location of the proposed tower and (2) creating a center consisting of the proposed tower and the existing bank facilities. By September 1980, when construction of the proposed atrium was approved, the Bank had the benefit of both the Harrison Price and Planning Dynamics reports. Both reports recommended construction of the proposed atrium based on three factors: (1) increased rental rates of adjoining properties, (2) ability to counteract the off-Broadway location of the proposed tower, and (3) enhancement of the Bank's image, which would be reflected in a greater market share. Reflective of those reports, the minutes of the Committee meeting on August 25, 1980, in part, provide:

     Bank management feels very positive about the project. The

[85] In addition, when the budget for construction of the proposed atrium was approved in 1984, the Bank was advised by both Ross Consulting and Eastdil Realty that the cost of construction would far exceed any increase in values to the adjoining properties. Indeed, the Eastdil report noted that "[c]onstruction of the atrium will inhibit the Bank from selling its Broadway-Lincoln property as one unit. This may reduce the proceeds from the sale of the Bank's property on the block." (Emphasis omitted.) Ross Consulting recommended that "UBC should build only if legally or 'morally' bound to", and Eastdil Realty recommended "against building the atrium if the Bank can obtain release from its commitment for less than $22 million less whatever 'recognition value' the Bank believes the atrium would produce." At the Committee meeting of October 24, 1984, when the budget for the Atrium was approved, considerations for completing the Atrium that were noted in the presentation to the Committee were as follows:

          A. The Atrium retains a great deal of appeal;

4. CONCLUSION

[87] Our finding with respect to the Bank's basic purpose renders an analysis of the extent of the Bank's retained interest in the Atrium unnecessary. In any event, we believe that such an analysis would support our conclusion that cost recovery for the Atrium should be independent of sales of the adjoining properties. Although both the easements allowing ingress and egress of pedestrians and the Bank's obligation to maintain and operate the Atrium at its sole cost and expense for a period of years restricted the Bank's ownership and control of the Atrium, such restrictions did not prevent the Bank from entering into a series of transactions that included the sale of an undivided 48-percent interest in the Atrium to ARICO for $17.1 million in December 1988. Petitioner now challenges the form of that transaction and claims that the substance of the transaction constituted a financing arrangement. See infra sec. II.D. Although the fact that a taxpayer retains a salable interest in a common improvement is not dispositive of the analysis in the developer line of cases, see, e.g., Willow Terrace Dev. Co. v. Commissioner, 40 T.C. 689 (1963), the December 1988 transaction strongly indicates that the Bank did not intend to recover its investment in the Atrium through a sale of the adjoining properties.

[88] Lastly, we note that petitioner's reliance on the developer line of cases is the sole reason that the basic purpose test was applied in this case. Nothing in those cases precluded petitioner from arguing that interests in the Atrium were conveyed in conjunction with sales of its adjoining properties and that an equitable allocation of the cost of the Atrium Assets, pursuant to section 1.61-6(a), Income Tax Regs., should be made to those interests to properly calculate gain or loss on the conveyance of those interests. See, e.g., Fasken v. Commissioner, 71 T.C. 650, 655- 656 (1979) (when parts of a larger property are sold, an equitable apportionment of basis among the several parts is required for a proper calculation of gain, section 1.61-6(a), Income Tax Regs., but that principle is not limited to the severance of realty into two or more parcels, but applies with respect to parts of the bundle of rights comprising property, including easements). That argument, however, was not made by petitioner, and we need not address it any further.

C. THE ATRIUM ASSETS: LOSS DEDUCTION UNDER SECTION 165(a)

[89] In a footnote in petitioner's brief, petitioner, relying on Echols v. Commissioner, 950 F.2d 209 (5th Cir. 1991), argues that it is entitled to a loss deduction under section 165(a) for 1987 equal to the cost of the Atrium Assets because, although the Atrium was not abandoned in 1987, it was worthless. Petitioner asserts:

     The Atrium was completed during 1987; and an independent

[90] Section 165(a) allows a deduction for any loss sustained during the taxable year and not compensated for by insurance or otherwise. To be allowable, a loss must be evidenced by closed and completed transactions, fixed by identifiable events, and actually sustained during the taxable year. Sec. 1.165-1(b), (d)(1), Income Tax Regs. In Echols v. Commissioner, supra at 213, the Court of Appeals for the Fifth Circuit stated:

     the test for worthlessness is a combination of subjective and

D. THE 1988 ATRIUM TRANSACTION: DISAVOWAL OF FORM

1. ISSUE

[91] The issue is whether petitioner may disavow the form of the 1988 Atrium Transaction. If we decide that issue for petitioner, we must determine the substance of the 1988 Atrium Transaction.

2. ARGUMENTS OF THE PARTIES

[92] Relying primarily on Helvering v. F. & R. Lazarus & Co., 308 U.S. 252 (1939), and Frank Lyon Co. v. Commissioner, 435 U.S. 561 (1978), petitioner argues that the substance of the 1988 Atrium Transaction, not its form, should govern for Federal income tax purposes. Petitioner concedes that the 1988 Atrium Transaction was in form a sale by LBC of a 48-percent interest in the Atrium Property to ARICO for $17,100,000 and a lease of the Atrium Land by UBD from LBC and LAL (following various transfers of interests in the Atrium Property to LAL). Petitioner argues, however, that, "as a matter of economic SUBSTANCE, the 1988 Atrium Transaction was a loan from ARICO to the Bank." In addition, petitioner argues that, in cases where a taxpayer challenges the form of a sale-leaseback transaction, no higher burden of proof applies, and, therefore, petitioner need only persuade the Court of the substance of the 1988 Atrium Transaction by the usual preponderance of the evidence.

[93] In respondent's brief, respondent presents the issue as follows:

     the petitioner has taken the position that the costs of

3. ANALYSIS

a. INTRODUCTION

[94] The terms of the various agreements that constitute the 1988 Atrium Transaction are unambiguous, and we so find. Indeed, petitioner does not argue to the contrary. Rather, petitioner contends that "[t]he issue in this case is the characterization, for Federal income tax purposes, of a transaction that is cast IN FORM as a sale-leaseback, but in which the rights created are those of a borrower and a lender." This Court must determine as a threshold matter, however, whether petitioner may disavow the form of the 1988 Atrium Transaction.

b. THE DANIELSON RULE DOES NOT APPLY

[95] In Commissioner v. Danielson, supra, the Court of Appeals for the Third Circuit held that certain taxpayers were precluded from challenging for tax purposes the terms of certain agreements that made purchase price allocations to covenants not to compete. The court enunciated the so-called Danielson rule:

     a party can challenge the tax consequences of his agreement as

c. RESPONDENT'S WEINERT RULE

[96] Respondent argues that, apart from the Danielson rule, a rule that originated in Estate of Weinert v. Commissioner, 294 F.2d 750 (5th Cir. 1961), revg. and remanding 31 T.C. 918 (1959), precludes petitioner "from disavowing the form of the Atrium sale/leaseback because the taxpayer's actions do not reflect an honest and consistent respect for the transaction's putative substance." In Estate of Weinert, the Court of Appeals for the Fifth Circuit (the Fifth Circuit) stated:

          Resort to substance is not a right reserved for the

[97] We believe that respondent's Weinert rule is an offshoot of the Fifth Circuit's statement in Estate of Weinert. The Fifth Circuit did not state that a taxpayer can argue the priority of substance ONLY if his tax reporting and other actions show an honest and consistent respect for the substance of a transaction, but rather, that a taxpayer can argue substance over form AT LEAST when those conditions are met. In other words, the Fifth Circuit statement does not make honest and consistent respect for the substance of a transaction in tax reporting and other actions the sine qua non of a taxpayer's right to disavow the form of a transaction.

[98] We note, however, that this Court in Illinois Power Co. v. Commissioner, supra, applied respondent's Weinert rule and did not allow a taxpayer to disavow the form of a gift transaction because "for tax reporting and other purposes, * * * [the taxpayer] consistently treated the transfer as a gift." Id. at 1431. This Court, pursuant to the doctrine enunciated in Golsen v. Commissioner, 54 T.C. 742, 756-757 (1970), affd. 445 F.2d 985 (10th Cir. 1971), followed what it perceived to be the principles established in Comdisco, Inc. v. United States, 756 F.2d 569, 578 (7th Cir. 1985). Nothing in Comdisco, however, makes honest and consistent respect for the substance of a transaction in tax reporting and other actions a condition precedent to a taxpayer's right to disavow the form of a transaction. Indeed, the Court of Appeals for the Seventh Circuit quoted Estate of Weinert v. Commissioner, supra at 755, and applied the reasoning and rule expressed in that case, without expanding or altering the Fifth Circuit's statement. Comdisco, Inc. v. United States, supra at 578. If honest and consistent respect for the substance of a transaction were a precondition to a taxpayer's disavowing the form of a transaction, the Danielson rule or our own "strong proof" standard, see, e.g., Meredith Corp. & Subs. v. Commissioner, supra at 438 ("strong proof" required to show that an allocation of consideration is other than that specified in a contract), would be beside the point in any case where such condition was not met. We have not, however, gone that far, but have listed the taxpayer's honest and consistent respect for the substance of a transaction in tax reporting and other actions as but one of at least four factors to be considered in determining whether a taxpayer may disavow the form he has chosen. Estate of Durkin v. Commissioner, 99 T.C. at 574-575 (explaining application of Danielson rule and strong proof standard to facts of that case). In any case in which the taxpayer fails to show an honest and consistent respect for the substance of a transaction, it may be difficult (if not impossible) for the impossible) [sic] for the taxpayer to convince a court that he should be allowed to disavow his chosen form, but we cannot say that, as a rule of law, he is precluded from trying. ¹² Respondent's Weinert rule is too broad; the taxpayer's lack of an honest and consistent respect for the substance of a transaction may be an important (indeed, even decisive) factor in determining that the taxpayer cannot disavow his chosen form; it is not, however, a sufficient factor. See infra sec. II.D.3.e.

d. ESTATE OF DURKIN V. COMMISSIONER

[99] Respondent cites Estate of Durkin v. Commissioner, supra at 571-575, and argues that this Court looked to three factors to determine whether a taxpayer could disavow the form of its transaction:

     (1) whether the taxpayer seeks to disavow its own return

e. PETITIONER MAY NOT DISAVOW THE FORM OF THE 1988 ATRIUM TRANSACTION

[100] This Court has previously stated that a "taxpayer may have less freedom than the Commissioner to ignore the transactional form that he has adopted." Bolger v. Commissioner, 59 T.C. 760, 767 n.4 (1973). That freedom is further curtailed if a taxpayer attempts to abandon its tax return treatment of a transaction. See, e.g., Halstead v. Commissioner, 296 F.2d 61, 62 (2d Cir. 1961), affg. per curiam T.C. Memo. 1960-106; Maletis v. United States, 200 F.2d 97, 98 (9th Cir. 1952); ¹³ see also supra secs. II.D.3.c. and d. (discussing Estate of Weinert v. Commissioner, 294 F.2d 750 (5th Cir. 1961), and Estate of Durkin v. Commissioner, supra, respectively). Furthermore, when a taxpayer seeks to disavow its own tax return treatment of a transaction by asserting the priority of substance only after the Commissioner raises questions with respect thereto, this Court need not entertain the taxpayer's assertion of the priority of substance. See, e.g., Legg v. Commissioner, 57 T.C. 164, 169 (1971), affd. per curiam 496 F.2d 1179 (9th Cir. 1974).

[101] In Legg, the taxpayers sold an apple orchard for $140,000, received a downpayment of $20,000 and an installment obligation, and elected to report the transaction on the installment method. Id. at 167-168. Contemporaneously with that transaction, the taxpayers executed an irrevocable trust, funded with the installment obligation. Id. at 168. The Commissioner asserted that the transfer of the installment obligation to the trust was a disposition giving rise to gain. Id. The taxpayers argued to the Court "that since the sale and the creation of the trust transpired simultaneously, the transaction in substance was a sale consisting of a $20,000 downpayment and a lifetime remuneration of $6,000 per year", which transaction would not result in gain on the disposition of an installment obligation. Id. at 169. In response, this Court stated as follows:

          The petitioners' first contention has little or no

[103] Under these circumstances, we shall not allow petitioner to disavow the form and tax treatment of the 1988 Atrium Transaction. Essentially, the timing of petitioner's recharacterization of the 1988 Atrium Transaction gives this Court very little confidence in embarking upon a burdensome search for the substance of that transaction. Although there exists the possibility that our approach may forsake the true substance of the 1988 Atrium Transaction, that is a risk that this Court can bear in light of petitioner's actions. To allow petitioner to assert the priority of substance in this case would only embroil this Court in petitioner's post-transactional tax planning. We decline that invitation.

4. CONCLUSION

[104] Petitioner may not disavow the form of the 1988 Atrium Transaction.

III. CORPORATE MINIMUM TAX ISSUE

A. INTRODUCTION

[105] On its consolidated returns since at least 1976, and continuing through 1986, the UBC affiliated group computed its tax under section 56(a), if any, based on a "consolidated" computation of that tax (UBC's method), see infra sec. III.C.1. In the notice of deficiency for docket No. 3723-95, respondent accepted and used UBC's method in computing the tax under section 56(a) (the corporate minimum tax) for the UBC affiliated group's 1977, 1980, 1984, and 1985 taxable years. In the petition filed in docket No. 3723-95, petitioner claims that it is entitled to calculate the corporate minimum tax for the UBC affiliated group's 1977, 1980, 1984, and 1985 taxable years on a separate return basis (petitioner's method), see infra sec. III.C.2., ¹⁵ and claims refunds for those years on that basis.

B. THE CORPORATE MINIMUM TAX PROVISIONS

[106] The corporate minimum tax provisions, as in effect for the years in issue, are sections 56, 57, and 58, and the regulations thereunder. Section 56 provides, in part, as follows:

     SEC. 56 ADJUSTMENTS IN COMPUTING ALTERNATIVE MINIMUM TAXABLE

1. UBC's METHOD

[107] Under UBC's Method, which respondent contends is correct, each member of the UBC affiliated group first determines its separate "items of tax preference" pursuant to section 57. Then, each member's separate items of tax preference are aggregated to establish the UBC affiliated group's total for items of tax preference (UBC's total preferences). That total is reduced by the UBC affiliated group's regular tax liability (the amount that should appear on Schedule J of its return) (UBC's consolidated regular tax) or, if there is no such liability, the minimum tax exemption. ¹⁸ The 15 percent minimum tax rate of section 56(a) is then applied to the excess, if any, of UBC's total preferences over UBC's consolidated regular tax or the exemption amount. The resulting figure is the UBC affiliated group's corporate minimum tax.

2. PETITIONER'S METHOD

[108] Under petitioner's method, each member of the UBC affiliated group first determines its separate items of tax preference pursuant to section 57. Then, each member's separate regular tax deduction under section 56(c) (separate regular tax deduction) is determined by using the method of allocation provided in sections 1552(a)(2) and 1.1502-33(d)(2)(ii), Income Tax Regs. (the 1502-33(d) allocation). ¹⁹ The 15-percent minimum tax rate of section 56(a) is then applied to the excess of each member's separate items of tax preference over the amount, if any, determined under the 1502-33(d) allocation. Each member's resulting minimum tax, if any, is then aggregated to derive the UBC affiliated group's corporate minimum tax.

[109] Under petitioner's method, the aggregate of the members' separate regular tax deductions, which will be utilized by the UBC affiliated group to reduce items of tax preference subject to the 15- percent minimum tax, will not equal the consolidated regular tax liability of the group. That lack of equivalence is a result of the following: (1) Loss companies are not allocated any portion of the consolidated regular tax liability, which results in no separate regular tax deduction for such members with separately computed items of tax preference; (2) the separately computed items of tax preference are not aggregated on a consolidated basis; and (3) the aggregate amount allocated under the 1502-33(d) allocation to members with positive taxable income may exceed the consolidated regular tax liability of the group. ²⁰

D. ANALYSIS

1. ISSUE

[110] The issue is whether petitioner is entitled to refunds of payments made to satisfy the UBC affiliated group's corporate minimum tax liabilities for the years in issue.

2. ARGUMENTS OF THE PARTIES

[111] Relying principally on Gottesman & Co. v. Commissioner, 77 T.C. 1149 (1981), petitioner argues that, in the absence of any contrary guidance in the Code or regulations thereunder, section 56(a) imposes a minimum tax on every corporation and that the UBC affiliated group must, therefore, compute its corporate minimum tax by aggregating the tax imposed under section 56(a) on each member of the group. Petitioner argues that, in calculating each member's separate corporate minimum tax, it is entitled to adopt any reasonable method of determining each member's separate regular tax deduction under section 56(c), in particular the 1502-33(d) allocation. Petitioner goes so far as to argue that petitioner is REQUIRED to use the 1502-33(d) allocation for determining the separate regular tax deductions of the UBC affiliated group's members under section 56(c). Petitioner argues that, for the years in issue, the amount of the UBC affiliated group's corporate minimum tax under petitioner's method is less than the tax under UBC's method and, therefore, petitioner is entitled to a refund for those years.

[112] Respondent acknowledges that the regulations relating to consolidated returns (the consolidated return regulations) ²¹ do not directly address the computation of the corporate minimum tax for groups filing consolidated returns. Respondent argues, however, that under the general rule of section 1.1502-80, Income Tax Regs., the minimum tax liability of the UBC affiliated group is determined by the Code or other law otherwise applicable. Thus, respondent contends that section 56(a)(2) and (c), the legislative history thereof, and certain case law remain applicable, requiring the regular tax deduction of the UBC affiliated group under section 56(c) to equal the amount of tax ACTUALLY imposed on the group under chapter one of subtitle A of the Code for the taxable year (without regard to the corporate minimum tax and certain other provisions). Respondent argues that, under petitioner's method, the aggregate of the members' separate regular tax deductions will not equal UBC's consolidated regular tax. Moreover, respondent argues, petitioner's method reduces the UBC affiliated group's corporate minimum tax only if the total of the members' separate regular tax deductions exceeds UBC's consolidated regular tax. Respondent states: "Consequently, if the Court limits the total 'regular tax deduction' to the UBC group's consolidated regular tax liability, petitioner's overpayment claims become moot and resolution of the Separate Return Issue unnecessary." In other words, we need not determine the proper method of calculating the corporate minimum tax in the context of corporations filing consolidated returns if we decide that the deduction under section 56(c) for an affiliated group of corporations filing a consolidated return is limited to the tax ACTUALLY imposed on such group under chapter one of subtitle A of the Code for the taxable year (without regard to the corporate minimum tax and certain other provisions and reduced by the sum of certain credits) (the actually imposed chapter one tax).

3. DISCUSSION

[113] Initially, the dispute between the parties seems to involve two countervailing principles of the law relating to consolidated returns: (1) "'Each corporation is a separate taxpayer whether it stands alone or is in an affiliated group and files a consolidated return'", Wegman's Properties, Inc. v. Commissioner, 78 T.C. 786, 789 (1982) (quoting Electronic Sensing Prods., Inc. v. Commissioner, 69 T.C. 276, 281 (1977)), and (2) "the purpose of the consolidated return provisions * * * is 'to require taxes to be levied according to the true net income and invested capital resulting from and employed in a single business enterprise, even though it was conducted by means of more than one corporation'", First Natl. Bank in Little Rock v. Commissioner, 83 T.C. 202, 209 (1984) (quoting Handy & Harman v. Burnet, 284 U.S. 136, 140 (1931)). The nature of petitioner's refund claim with respect to the UBC affiliated group's corporate minimum tax liabilities, however, allows us to restrict our analysis to the centerpiece of the parties' dispute, i.e., the amount of the deduction under section 56(c) for an affiliated group of corporations. In other words, if we decide that the deduction under section 56(c) for an affiliated group of corporations is limited to its actually imposed chapter one tax, the parties will have no material disagreement in their computations pursuant to Rule 155 regarding the UBC affiliated group's corporate minimum tax liabilities for the years in issue. Therefore, we shall first address that issue.

[114] Section 1501 provides, in part, as follows:

     An affiliated group of corporations shall * * * have the

[115] Section 56(a) imposes, with respect to the income of every corporation, a tax equal to 15 percent of the excess of the sum of the items of tax preference over the greater of $10,000 or the regular tax deduction. ²³ Section 56(c) defines the term "regular tax deduction" to mean "an amount equal to the taxes imposed" by chapter one of subtitle A of the Code for the taxable year (computed without regard to the corporate minimum tax and certain other provisions), reduced by the sum of certain credits. In Norwest Corp. & Subs. v. Commissioner, T.C. Memo. 1995-600, which involved the same Norwest Corp. that is the successor in interest to the UBC affiliated group in this case, this Court held that the amount of the section 56(c) deduction for an affiliated group of corporations is limited to the actually imposed chapter one tax of the affiliated group. That holding was based primarily on the rationale of Sparrow v. Commissioner, 86 T.C. 929 (1986).

[116] In Sparrow, the taxpayers argued that the regular tax for purposes of calculating their alternative minimum tax under section 55 was the tax that would have been imposed under section 1 and not the lesser amount of tax that was actually imposed with the benefit of the income averaging provisions of sections 1301-1305. This Court stated:

     section 55(b)(2) (now section 55(f)(2)) defines regular tax as

[118] The 1502-33(d) allocation advanced by petitioner, however, would require us to read section 56(c) as defining the term "regular tax deduction" to mean an amount of tax that is not actually imposed by chapter one of subtitle A of the Code. That we cannot do. The statutory language is "taxes imposed". The 1502-33(d) allocation is a method of allocating the tax liability determined pursuant to section 1.1502-2, Income Tax Regs., for purposes of determining the earnings and profits of each member of an affiliated group. See sec. 1552; secs. 1.1552-1(a) and (b)(1), 1.1502-33(d)(2), Income Tax Regs. The amounts allocated to each member of an affiliated group under the 1502-33(d) allocation are certainly derived from and MAY in the aggregate equal the amount of taxes imposed on the affiliated group pursuant to chapter one of subtitle A of the Code for the taxable year, but are not, themselves, taxes so imposed. The fact that section 1.1552-1(b)(2)(ii), Income Tax Regs., TREATS the amounts allocated under the 1502-33(d) allocation as a liability of each member of the affiliated group does not convert such amounts into taxes IMPOSED by chapter one of subtitle A of the Code for purposes of section 56(c). ²⁴

[119] Petitioner's reliance on Gottesman & Co. v. Commissioner, 77 T.C. 1149 (1981), is misplaced. In Gottesman, this Court held that, since the consolidated return regulations did not mandate a consolidated calculation of the accumulated earnings tax under section 531, the taxpayer was permitted to use a separate company calculation. In this case, however, petitioner seeks to adopt a method that is contrary to an express provision of the Code, section 56(c). Gottesman is inapposite.

[120] In light of our analysis, we believe that petitioner's other arguments do not merit discussion. In conclusion, the deduction under section 56(c) for an affiliated group of corporations is limited to the group's actually imposed chapter one tax, an therefore, petitioner's claims for refunds must fail.

E. CONCLUSION

[121] Petitioner is not entitled to refunds of payments made to satisfy the UBC affiliated group's corporate minimum tax liabilities for the years in issue.

IV. FURNITURE AND FIXTURES RECOVERY PERIOD ISSUE

A. INTRODUCTION

[122] We must determine the applicable recovery period for certain furniture and fixtures (the furniture and fixtures) placed in service by various members of the UBC affiliated group during the group's 1987, 1988, and 1989 taxable years. The applicable recovery period is an element in the calculation of the deduction for depreciation allowed by section 167. The parties disagree as to whether the recovery period applicable to the furniture and fixtures is 5 years or 7 years. Petitioner argues that it is 5 years, while respondent argues that it is 7 years. UBC originally determined that the recovery period applicable to the furniture and fixtures was 7 years and applied that period to the furniture and fixtures in making its consolidated returns for 1987, 1988, and 1989. In the relevant petitions, petitioner avers that UBC's original determination of the applicable recovery period was mistaken, and that the correct applicable recovery period is 5 years. Petitioner asks that the Court determine an overpayment in tax on account of that mistake. The aggregate cost bases for the furniture and fixtures placed in service in 1987, 1988, and 1989 are $5,710,643, $1,490,930, and $546,707, respectively.

[123] The parties disagree as to whether a similar question is before the Court with respect to the UBC affiliated group's 1990 and (short) 1991 taxable years. During those years, various members of the UBC affiliated group placed in service additional furniture and fixtures (the 1990-91 furniture and fixtures). UBC determined that the recovery period applicable to the 1990-1991 furniture and fixtures was 5 years and applied that period to those furniture and fixtures in making its consolidated returns for 1990 and 1991. Respondent made no adjustment with respect to that determination. In the relevant petition, petitioner included the 1990-91 furniture and fixtures with the furniture and fixtures in its averment that UBC had mistakenly used a 7-year recovery period. In the answer, respondent merely denied petitioner's averment. In their respective trial memoranda, neither party identified the discrepancy in treatment between the furniture and fixtures and the 1990-91 furniture and fixtures. In their stipulations, however, the parties recognize the discrepancy, and petitioner concedes that it is not entitled to any additional depreciation with respect to the 1990-91 furniture and fixtures. On brief, petitioner argues that the only applicable recovery period issue before the Court concerns the furniture and fixtures. Respondent argues that the Court must also determine the applicable recovery period with respect to the 1990-91 furniture and fixtures because that issue either (1) was put in issue by the petition or (2) was tried with consent of the parties.

[124] We do not believe that petitioner intended to put into issue the applicable recovery period with respect to the 1990-91 furniture and fixtures, nor do we believe that that issue was tried with petitioner's consent. Rule 31(d) requires us to construe all pleadings to do substantial justice. Substantial justice would not be done were we to hold petitioner to an unintended construction of its pleading, especially in light of respondent's uninformative response. Clearly, the issue was not tried with petitioner's consent in light of the stipulation and the lack of any notice by respondent that he intended to raise the issue. The parties have relied only on the stipulated facts in briefing this issue, so we cannot conclude that petitioner failed to object to evidence that should have put petitioner on notice that the applicable recovery period with respect to the 1990-1991 furniture and fixtures had been put into play by respondent. Section 6214 provides us with jurisdiction to determine an increased deficiency if a claim therefor is asserted by the Secretary at or before the hearing. Respondent has not relied on section 6214, so we assume that respondent does not argue that he asserted a timely, appropriate claim. We conclude that the recovery period applicable to the 1990-1991 furniture and fixtures is not before the Court for decision.

B. APPLICABLE RECOVERY PERIOD; CLASS LIFE

[125] Section 168(c) provides that the applicable recovery period of 5-year property is 5 years and the applicable recovery period of 7-year property is 7 years. Section 168(e)(1) generally defines 5-year property as property having a class life of more than 4 years, but less than 10 years, and 7-year property as property having a class life of 10 years or more, but less than 16 years. "Class life", as defined by section 168(i)(1), is determined by reference to former section 167(m), as in effect prior to its repeal by the Omnibus Budget Reconciliation Act of 1990, Pub. L. 101-508, sec. 11812(a), 104 Stat. 1388, 1388-534. Section 167(m) provided for a depreciation allowance based upon the class life prescribed by the Secretary of the Treasury or his delegate. The class lives of depreciable assets can be found in a series of revenue procedures issued by the Commissioner. See sec. 1.167(a)-11(b)(4)(ii), Income Tax Regs. The revenue procedure in effect for the years in issue in this case is Rev. Proc. 87-56, 1987-2 C.B. 674 (Rev. Proc. 87-56). Rev. Proc. 87-56 divides assets into two broad categories: (1) Asset guideline classes 00.11 through 00.4, consisting of specific depreciable assets used in all business activities (the asset category), and (2) asset guideline classes 01.1 through 80.0, consisting of depreciable assets used in specific business activities (the activity category). The specific asset guideline classes in issue are asset guideline classes 00.11 and 57.0 (classes 00.11 and 57.0, respectively). Classes 00.11 and 57.0, and their headings, are as follows:

     SPECIFIC DEPRECIABLE ASSETS USED IN ALL BUSINESS ACTIVITIES,

[126] If the furniture and fixtures are described in class 00.11, they have a class life of 10 years and, by virtue of section 168(e)(1), are 7-year property, with an applicable recovery period of 7 years. See sec. 168(c)(1). If the furniture and fixtures are described in class 57.0, they have a class life of 9 years and, by virtue of section 168(e)(1), are 5-year property, with a applicable recovery period of 5 years. See id.

C. ARGUMENTS OF THE PARTIES

[127] The parties agree that the applicable recovery period for the furniture and fixtures turns on whether the furniture and fixtures are described in class 00.11 or class 57.0. Class 00.11 is in the asset category and class 57.0 is in the activity category. It is clear that, at least in theory, the same item of depreciable property can be described in both the asset category and the activity category. See, e.g., Rev. Proc. 87-56 (class 35.0, excluding assets in class 00.11 through 00.4). Petitioner, explicitly, and respondent, implicitly, agree that the furniture and fixtures are described in both class 00.11 and 57.0. They disagree, however, on the classification that takes priority.

[128] Petitioner argues that (1) logic and precedent require that the particular (class 57.0) should prevail over the general (class 00.11), (2) legislative and administrative history support that result, and (3) a recent ruling of the Commissioner's, Rev. Rul. 95-52, 1995-2 C.B. 27, amounts to a concession by the Commissioner with respect to the issue before us. Respondent relies on (1) the "plain language" of Rev. Proc. 87-56, (2) administrative history, and (3) our decision in Norwest Corp. & Subs. v. Commissioner, T.C. Memo. 1995-390.

D. DISCUSSION

[129] In Norwest Corp. & Subs. v. Commissioner, T.C. Memo. 1995- 390, we addressed the same issue presented in this case. We held that class 00.11 takes priority over class 57.0. Petitioner argues that that conclusion is wrong. Petitioner argues that, in Norwest Corp., we failed adequately to analyze two cases: Walgreen Co. & Subs. v. Commissioner, 68 F.3d 1006 (7th Cir. 1995), revg. and remanding 103 T.C. 582 (1994), on remand T.C. Memo. 1996-374, and JFM, Inc. & Subs. v. Commissioner, T.C. Memo. 1994-239.

[130] The primary issue in Walgreen Co. was whether certain leasehold improvements, currently described in class 57.0, were excluded from class 50.0 (class 50.0) of Rev. Proc. 72-10, 1972-1 C.B. 721, 730 (Rev. Proc. 72-10), by virtue of being described in class 65.0 (class 65.0) of Rev. Proc. 72-10. Class 65.0 is entitled "Building Services" and includes, among other things, "the structural shells of buildings and all integral parts thereof". The Court of Appeals for the Seventh Circuit (the Seventh Circuit) traced the provenance of class 65.0 to an asset category, "Buildings", in Rev. Proc. 62-21, 1962-2 C.B. 418, 419 (Rev. Proc. 62-21). The Seventh Circuit summarized the relevant aspects of Rev. Proc. 62-21 as follows:

     In 1962 the Internal Revenue Service prescribed useful lives

[131] Petitioner makes the simplistic argument that, since the Seventh Circuit stated that class 50.0 (now class 57.0) included all assets used in wholesale or retail trade except those in class 65.0, and the furniture and fixtures would not be in class 65.0, they must be in class 57.0. We do not draw that conclusion. The priority rule of Rev. Proc. 62-21 provided not only that the asset category of buildings prevailed over the activity category of wholesale and retail trade but also that the asset category that included office furniture and fixtures likewise prevailed. The consideration that the Seventh Circuit gave to the evolution of the asset classification system before accepting the assumption of the Government as to the survival of the Rev. Proc. 62-21 priority rule with respect to class 65.0 leads us to conclude that the Seventh Circuit might have reached a similar conclusion even without the taxpayer's concession to the Government's assumption. We attach little significance to the language to which petitioner directs our attention. Walgreen Co. & Subs. v. Commissioner, supra, does not support petitioner's argument.

[132] JFM, Inc. & Subs. v. Commissioner, supra, is also inapposite. In that case, among other things, we had to determine the classification under Rev. Proc. 87-56 of gasoline pump canopies and related assets. We determined that class 57.0 (and 57.1) specifically included gasoline pump canopies. We rejected the Commissioner's attempt to classify the assets under the broad definition of "Land Improvements" in class 00.3, on the basis that such class was a "catchall" provision, which specifically excluded assets "explicitly included" in other classes. Petitioner draws our attention to the following statement in JFM, Inc.: "It is clear that classes 57.0 and 57.1 were intended to cover all possible types of real or personal property used in marketing petroleum products". We made that statement in the context of rejecting the Commissioner's class 00.3 classification, which excludes assets described in other classes, and we do not read that statement as establishing any priority between class 57.0 and 00.11.

[133] Petitioner also relies on Rev. Rul. 95-52, 1995-2 C.B. 27, arguing that it shows that the recovery period of furniture can be 5 years because, under the circumstances in the ruling, furniture is included in class 57.0. It is true that, in the ruling, the Commissioner held that some furniture is in class 57.0. The furniture in question, however, was furniture described as "consumer durable property" (described in Rev. Proc. 95-38, 1995-2 C.B. 397, 398) subject to rent-to-own contracts entered into with individuals. The furniture was generally used in an individual's home. That furniture, thus, does not fall within class 00.11, which pertains to "Office Furniture, Fixtures, and Equipment".

[134] Petitioner's argument that legislative and administrative history support its position is basically an argument that policy goals such as simplification and controversy avoidance would be served by holding that the activity category includes ALL depreciable property used in the named activities. Whether or not that may be true, but it is not the pattern of the classification system, which, in specific instances, excludes asset category items from the activity category. See, e.g., Rev. Proc. 87-56, classes 35.0, 37.11, 80.0. Rev. Proc. 87-56 also excludes from the asset category items described in the activity category, see, e.g., classes 00.12, 00.3, 00.4. We do not discern the absolute position that petitioner advocates in the history it has cited to us.

[135] Petitioner's argument that the particular should prevail over the general is an argument based on common sense and general rules of construction. See, e.g., Wood v. Commissioner, 95 T.C. 364, 371 (1990) ("when Congress has dealt with a particular classification with specific language, the classification is removed from the application of general language"), revd. 955 F.2d 908 (4th Cir. 1992). Petitioner, however, has not persuaded us that, in this case, class 57.0 is the specific and class 00.11 is the general. There are exceptions from the asset category for items classified in the activity category and vice versa. We are not convinced that the activity categorization of class 57.0 is more specific than the asset categorization of class 00.11 in the case of office furniture and fixtures. Petitioner's suggested rule of construction is of no help to it here.

[136] Respondent argues that the plain language of Rev. Proc. 87-56 provides that the asset category consists of "Specific Business Assets Used in All Business Activities" and that the inclusive adjective, "all", plainly establishes a priority of asset categorization over activity categorization, except where a specific exception applies. We do not agree. The adjective "all" simply serves to define a class in the category; it does not help solve the priority question raised by a class in the activity category that, on its face, also includes the furniture and fixtures. Respondent also argues that his position is supported by the history of the asset depreciation guidelines. We have already discussed some of that history, but, at the risk of repeating ourselves, will set forth respondent's argument:

     Rev. Proc. 87-56's predecessors all grouped depreciable assets

E. CONCLUSION

[138] The furniture and fixtures are described in class 00.11. Therefore, they have a class life of 10 years and, by virtue of section 168(e)(1), are 7-year property, with an applicable recovery period of 7 years. See sec. 168(c)(1).

V. NET OPERATING LOSS ISSUE

A. INTRODUCTION

[139] Section 172(a) allows a "net operating loss deduction" for the aggregate of net operating loss carrybacks and carryovers to the taxable year. The term "net operating loss" (NOL) is defined in section 172(c). Section 172(b) provides the carryback and carryover periods for NOLs. Section 172(b)(1)(A) and (B) provides that, generally, the carryback period for a NOL is 3 years and the carryover period is 15 years. Section 172(b)(1)(L) provides a special rule with respect to the bad debt losses of commercial banks: The portion of the NOL of a commercial bank that is attributable to bad debt losses is prescribed a carryback period of 10 years and carryover period of 5 years. Section 172(l) provides a rule for determining the portion of a bank's NOL attributable bad debt losses:

     The portion of the net operating loss for any taxable year which

[140] The dispute between the parties concerns the calculation of that portion of the consolidated NOL of the UBC affiliated group for 1987 that is attributable to bank bad debt losses (and, thus, subject to the special carryback and carryforward rules of section 172(b)(1)(L)). For 1987, the UBC affiliated group consisted of both bank and nonbank members. The parties have no dispute over how to determine the bad debt portion of the NOL of any bank member. Their dispute concerns the determination of the bank bad debt portion of the CONSOLIDATED NOL. We agree with respondent's determination.

B. FACTS

[141] All of the facts relevant to this issue have been stipulated. In abbreviated form, those facts are as follows:

[142] By Form 1139, Corporation Application for Tentative Refund (the Form 1139), dated November 18, 1988, UBC claimed tentative refunds for the taxable years 1977, 1978, 1979, 1981, 1984, and 1985 based on the carryback of a NOL from the UBC affiliated group's 1987 taxable year (the 1987 consolidated NOL).

[143] UBC carried a portion of the consolidated 1987 NOL back to the UBC affiliated group's taxable years 1977, 1978, and 1981.

[144] On the Form 1139, UBC calculated the portion of the consolidated 1987 NOL subject to the 10-year carryback provided for by section 172(b)(1)(L) (the bad debt portion) by (1) determining the bad debt and nonbad debt portions of each loss bank member's NOL, (2) allocating the consolidated 1987 NOL among the loss members and, in the case of loss bank members, between the bad debt and nonbad debt portions of their NOLs, and (3) aggregating the portions of the consolidated 1987 NOL allocated to the bad debt portions of the loss bank members' NOLs.

[145] On the Form 1139, UBC determined the bad debt portion of each loss bank member's NOL by taking the excess of its NOL over its NOL less its bad debt deduction (i.e., an amount equal to the lesser of the bank's NOL or bad debt deduction). Thus, for example, in the case of United Bank of Aurora-South (Aurora-South), a bank member of the affiliated group, which had an NOL of $341,183 and a bad debt deduction of $136,881, the bad debt portion of the NOL was determined to be $136,881.

[146] After determining the bad debt portion of each loss bank member's NOL, UBC allocated the consolidated 1987 NOL among the group's loss members and, in the case of the loss bank members, between the bad debt and the nonbad debt portions of their NOLs. The allocation was made in proportion to the aggregate of the loss members' NOLs. For example, $41,861 of the consolidated 1987 NOL was allocated to the bad debt portion of Aurora-South's NOL (The bad debt portion of Aurora South's NOL was $136,881; the consolidated NOL, as adjusted by respondent, was $9,239,383, and the aggregate of all loss members' NOLs, as adjusted by respondent was $38,752,008. So, $32,636 = $136,881 x (9,239,383/38,752,008).) The sum of $48,710 of the consolidated 1987 NOL, as adjusted by respondent, was allocated to the nonbad debt portion of Aurora-South's NOL. (The nonbad debt portion of Aurora South's NOL was $204,302; $48,710 = $204,302 x (9,239,383/38,752,008).)

[147] After allocating the consolidated 1987 NOL among the loss members, UBC determined the bad debt portion of the consolidated 1987 NOL by aggregating the portions of the consolidated 1987 NOL allocated to the bad debt portions of the loss bank members' NOLs. The bad debt portion so determined was $8,731,874, of which $2,152,283 was attributable to separate return limitation year (SRLY) bank members and $6,579,591 was attributable to non-SRLY bank members. Based thereon UBC claimed consolidated 1987 NOL carrybacks to the UBC consolidated group's taxable years 1977, 1978, and 1981 under the provisions of section 172(b)(1)(L) totaling $6,924,421 ($6,579,591 (non-SRLY bank members) + $344,830 (SRLY carryback to 1981)).

[148] In respondent's notice of deficiency issued to petitioner for the UBC affiliated group's taxable years 1977 through 1980, 1984, and 1985 (the "notice"), respondent adjusted the consolidated 1987 NOL to take into account various proposed adjustments. As UBC did on the Form 1139, respondent calculated the bad debt portion of the consolidated 1987 NOL by (1) determining the bad debt and nonbad debt portions of each loss bank member's NOL, (2) allocating the consolidated 1987 NOL among the loss members and, in the case of loss bank members, between the bad debt and nonbad debt portions of their NOLs, and (3) aggregating the portions of the consolidated 1987 NOL allocated to the bad debt portions of the loss bank members' NOLs.

[149] In the notice, respondent, like UBC on the Form 1139, determined the bad debt portion of each loss bank member's NOL by taking the excess of its NOL over its NOL less its bad debt deduction (i.e., an amount equal to the lesser of the bank's NOL or bad debt deduction). Thus, for example, in the case of Aurora-South, which had an NOL of $341,183 and a bad debt deduction of $136,881, the bad debt portion of the NOL was determined to be $136,881.

[150] After determining the bad debt portion of each loss bank member's NOL, respondent, like UBC, allocated the consolidated 1987 NOL among the group's loss members and, in the case of the loss bank members, between the bad debt and the nonbad debt portions of their NOLs. The allocation was made in proportion to the aggregate of the loss members' NOLs. For example, $32,636 of the consolidated 1987 NOL (as adjusted by respondent) was allocated to the bad debt portion of Aurora-South's NOL. The bad debt portion of Aurora-South's NOL was $136,881; the consolidated NOL, as adjusted by respondent, was $9,239,383, and the aggregate of all loss members' NOLs, as adjusted by respondent was $38,752,008. Thus, $32,636 = $136,881 x (9,239,383/ 38,752,008). The sum of $48,710 of the consolidated 1987 NOL, as adjusted by respondent, was allocated to the nonbad debt portion of Aurora-South's NOL. The nonbad debt portion of Aurora-South's NOL was $204,302; $48,710 = $204,302 x (9,239,383/38,752,008).

[151] After allocating the consolidated 1987 NOL among the loss members, respondent, in the notice, like UBC on the Form 1139, determined the bad debt portion of the consolidated 1987 NOL by aggregating the portions of the consolidated 1987 NOL allocated to the bad debt portions of the loss bank members' NOLs. The bad debt portion so determined was $6,263,417, of which $1,677,978 was attributable to SRLY bank members and $4,585,439 was attributable to non-SRLY bank members. Based thereon the notice allowed NOL carrybacks to the UBC affiliated group's taxable year 1977 of $4,585,439 (non-SRLY bank members) and taxable year 1981 of $268,839 (SRLY carryback).

C. PETITIONER'S POSITION

[152] Petitioner contends that the method used both by UBC on the Form 1139 and respondent in the notice to determine the bad debt portion of the consolidated 1987 NOL is incorrect. Under the method asserted by petitioner, the bad debt portion of the consolidated NOL is equal to the excess of the consolidated 1987 NOL over the consolidated 1987 NOL computed without the bad debt deductions of the bank members. Under that method, regardless of whether the consolidated 1987 NOL on the Form 1139 ($12,549,042) or in the notice ($9,239,383) is used, since the bad debt deductions of the bank members for 1987 total $61,296,286, elimination of such bad debt deductions from the consolidated 1987 NOL (i.e., the "without" calculation) would eliminate the consolidated 1987 NOL and result in substantial consolidated taxable income for the UBC consolidated group. Under those circumstances, there would be no consolidated 1987 NOL to be allocated among the loss members of the group. Thus, under the method asserted by petitioner, the entire amount of the consolidated 1987 NOL is attributable to bad debt deductions of bank members, and the entire portion of the consolidated 1987 NOL allocated to the loss bank members is subject to the 10-year carryback provisions of section 172(b)(1)(L).

D. DISCUSSION

[153] Consider a business with $100 of gross income, deductions other than bad debts of $80, and deductible bad debts of $30. The business has a NOL of $10. Under the general rule of section 172(b)(1)(A), the NOL may be carried back 3 years and carried over 15 years, and the constituent parts of the NOL are of no importance in determining the business's eligibility for such treatment. If the corporation were a commercial bank, however, then, because of section 172(b)(1)(L), the constituent parts of the NOL would be important, because the special period rules of section 172(l) apply only to that portion of the NOL attributable to the deduction allowed by section 166 (the bad debt portion). In theory, the bad debt portion of the NOL might be determined in a number of ways. A simple way would be to determine that, since the bad debt deduction of $30 accounted for approximately 27 percent of the total deductions of $110, 27 percent of the NOL, i.e., $2.70, is the bad debt portion. Section 172(l)(1) adopts a different rule, one that is favorable to the intended recipients, commercial banks. Under section 172(l)(1), on the facts of our simple example, if the corporation were a commercial bank, the bad debt portion is $10. The assumption is that deductions for (losses from) bad debts constitute the NOL to the extent of such deductions.

[154] Neither party disagrees that section 172(l)(1) works as described. Their disagreement concerns the composition of the consolidated NOL. Respondent would allocate the consolidated NOL among the loss members of the UBC affiliated group in proportion to each loss member's share of the aggregate of all loss member's NOLs and would further allocate each bank loss member's share of the consolidated NOL between the bad debt portion of the bank member's NOL and the remainder of the bank loss member's NOL in proportion to those relative amounts. Thus, assume that affiliated group ABC, making a consolidated return of income, had a consolidated NOL of $10, and each member had separate taxable incomes as follows:

 _____________________________________________________________________

[155] The difference between the parties is whether the special ordering rule of section 172(l)(1) should be applied to a consolidated NOL. The gist of petitioner's argument is that the consolidated return regulations provide that the consolidated NOL must be determined on a consolidated basis. Petitioner would, thus, analogize an affiliated group with both bank and nonbank loss members (and with a consolidated NOL) to a separate corporation with both bad debt and nonbad debt losses (and an NOL) and apply section 172(l)(1) to the consolidated NOL.

[156] We find no basis in the consolidated return regulations for petitioner's analogy. Although the consolidated return regulations do speak in terms of a "consolidated net operating loss", see sec. 1.1502-21(b)(1), Income Tax Regs., it is quite clear that the consolidated net operating loss is to be determined by taking into account the "separate" taxable income, including the separate NOL, of each member of the group. See secs. 1.1502-12, 1.1502-21(f), Income Tax Regs. The separately determined losses of each member of the affiliated group do not lose their distinct character (to the extent that such distinct character is important) upon consolidation. Cf. Amtel, Inc. v. United States, 31 Fed. Cl. 598, 600 (1994), ("a member of an affiliated group may have a separate net operating loss with independent significance for income tax purposes") affd. without published opinion 59 F.3d 181 (1995). Moreover, section 172(l)(1) is a special rule that prioritizes a bank's losses. Nothing in that section leads us to believe that Congress intended to give a priority to a bank member's bad debt losses as against a nonbank member's losses in the context of a consolidated return.

E. CONCLUSION

[157] As stated, we agree with respondent's determination of the appropriate method to determine the bad debt portion of the consolidated NOL.

[158] Decisions will be entered under Rule 155.

APPENDIX Joint Exhibit 20-T

[appendix omitted]

² As pertinent to this case, sec. 1011 provides that the adjusted basis for determining gain or loss from the sale or other disposition of property is the cost of such property, see sec. 1012, adjusted as provided in sec. 1016. Sec. 1016(a)(1), in part, provides that proper adjustment is to be made for expenditures, receipts, losses, or other items, properly chargeable to capital account. Sec. 1.1016-2(a), Income Tax Regs., in part, states: "The cost or other basis shall be properly adjusted for any expenditure, receipt, loss, or other item, properly chargeable to capital account, including the cost of improvements and betterments made to the property."

³ In that case, the Court of Appeals for the Ninth Circuit affirmed the Board of Tax Appeals' determination that a taxpayer should be allowed to deduct from the sales proceeds of certain lots expenditures made for streets, drives, curves, and other improvements, which benefited those lots.

⁴ In that case, the Board of Tax Appeals rejected the taxpayer's contention that no part of the cost of construction and development of an island subdivision should be allocated to a large interior area of the island that was reserved for 10 years (later extended an additional 3 years) as a playground and recreational center for the use of lot purchasers:

     [The interior] area was not permanently and irrevocably

⁶ The Court of Appeals for the Fifth Circuit stated as follows:

          The problem presented by these cases is whether deduction

⁸ It appears that petitioner would likely not dispute that assertion; in its brief, petitioner states: "[A]lthough the impetus for building the Atrium came from the construction of 1UBC (including the need for a 'front door on Broadway'), the Bank expected that 2UBC -- the largest building to which the Atrium is physically attached -- would be the beneficiary of the largest value increase."

⁹ Petitioner proposes the following finding of fact:

     During 1978-1979, while the Bank was negotiating and planning

     It is the Bank's intention to investigate the possibility of

¹¹ We decline respondent's invitation to reconsider our position and to adopt the rule.

¹² In Federal Natl. Mortgage Association v. Commissioner, 90 T.C. 405, 426-428 (1988), affd. 896 F.2d 580 (D.C. Cir. 1990), we set forth two grounds for not allowing the taxpayer to disavow the form of transaction reported on its original income tax return and financial reports. The first "more procedural" ground was that the taxpayer's tax reporting and other actions did not show an honest and consistent respect for what, at trial, it claimed to be the substance of the transaction. With respect to the first ground, we said that we were "disinclined" to recharacterize the transaction by hindsight. The second ground "[m]ore importantly" was that the form of the transaction corresponded to its substance. The Court of Appeals for the District of Columbia Circuit affirmed our decision on the basis of our substantive analysis. Federal Natl. Mortgage Association V. Commissioner, 896 F.2d at 586. Had the first ground been sufficient, we would have had no reason to discuss the second (more important) ground.

¹³ In Maletis, the Court of Appeals for the Ninth Circuit stated as follows:

          The Bureau of Internal Revenue, with the tremendous load it

¹⁵ It should be noted that, during those years in issue, no member of the UBC affiliated group actually filed separate tax returns.

¹⁶ Items of tax preference are set forth in sec. 57.

¹⁷ The quoted provisions were in effect for the UBC affiliated group's 1985 taxable year. For purposes of this case, prior versions of sec. 56, in effect for 1977, 1980, and 1984, were not materially different from the 1985 version.

¹⁸ This sentence reflects a stipulation of the parties. We believe that the minimum tax exemption amount would be used if the consolidated regular tax were greater than zero and less than $10,000.

¹⁹ Sec. 1552(a) provides that, pursuant to regulations prescribed by the Secretary, the earnings and profits of each member of an affiliated group, see sec. 1504, required to be included in a consolidated return for such group filed for a taxable year shall be determined by allocating the tax liability of the group for such year among the members of the group in accordance with one of several methods set forth in sec. 1552(a)[(1)] through (4)), which method must be elected in the first consolidated return filed by the group. Beginning with its 1967 taxable year, the UBC affiliated group elected to allocate its consolidated regular tax liability among its members in accordance with sec. 1552(a)(2) and sec. 1.1502-33(d)(2)(ii), Income Tax Regs. Sec. 1552(a)(2) provides:

     The tax liability of the group shall be allocated to the several

²¹ See secs. 1.1501-1 through 1.1552-1, Income Tax Regs.

²² On Mar. 19, 1970, the Internal Revenue Service (the IRS) issued Technical Information Release No. 1032, which stated, in part, as follows:

          The Internal Revenue Service today announced that

²³ One court has stated that the purpose of the corporate minimum tax "is to make sure that the aggregating of tax-preference items does not result in the taxpayer's paying a shockingly low percentage of his income as tax." First Chicago Corp. v. Commissioner, 842 F.2d 180, 181 (7th Cir. 1988), affg. 88 T.C. 663 (1987). This Court in First Natl. Bank in Little Rock v. Commissioner, 83 T.C. 202, 214 (1984), examined the legislative history of the corporate minimum tax and distilled two general principles:

     First, the tax was intended to limit the tax benefits and