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Starr’s Estate v. Commissioner | 274 F.2d 294 (1959)

A transaction’s structure can have a significant impact on its tax consequences. So, it’s unsurprising that many taxpayers attempt to structure transactions in ways that minimize their tax liability. In Starr’s Estate versus Commissioner, the Ninth Circuit evaluated a common tax motivated structure—a sale disguised as a lease.

Delano Starr owned and operated a manufacturing plant. Starr leased a fire sprinkler system from Automatic Sprinklers of the Pacific and had it installed in his plant.

Under the lease terms, Starr paid $1,240 per year for five years, totaling $6,200. The market value for a comparable sprinkler system was about $4,960.

After the initial five year term, Starr had the option to renew the lease for an additional five years at a rate of $32 per year. If Starr chose not to renew the lease, Automatic Sprinklers had the right to remove the sprinklers. However, sprinkler systems were custom made and had little value after removal. Thus, it wasn’t uncommon for lessees of sprinkler systems to keep them permanently.

Finally, the lease was silent as to the status of the sprinkler system beginning in year eleven.

On his federal income tax returns, Starr claimed the lease payments as business rental deductions. However, the commissioner of internal revenue disallowed the deductions after determining that the lease agreement between Starr and Automatic Sprinklers was, in substance, an installment sale.

Starr petitioned the tax court for a redetermination but died before the court issued its decision. Starr’s estate proceeded on his behalf. The tax court agreed with the commissioner’s determination and treated the lease payments as capital expenditures. Starr’s estate appealed to the Ninth Circuit.

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