## Facts

- Howard I. Lukens was a limited partner with a 4.6% interest in Univestors, a Utah partnership formed to purchase timeshare units in vacation homes.
- In 1981, Univestors purchased 27 timeshare units at a stated price of $3,600 per unit.
- Univestors made a total down payment of $21,600 and financed the remaining balance through a nonrecourse obligation.
- Under the financing terms, Univestors agreed to pay $570 per unit per year for 10 years, characterized as interest-only payments.
- After 30 years, because the obligation was nonrecourse, Univestors could either forfeit its interest in the timeshare units or make a balloon payment of $86,700 to complete the purchase.
- For tax year 1981, Lukens contributed about $993 as his share of the partnership’s down payment.
- Lukens claimed a $7,179.54 deduction on his 1981 federal income-tax return, reflecting his share of the partnership’s reported loss, largely tied to the claimed interest expense.
- The Commissioner of Internal Revenue issued a notice of deficiency disallowing Lukens’s deduction.
- The United States Tax Court found that each timeshare unit had a fair market value of $919 and that the units were not expected to appreciate enough to justify paying the balloon amount in 30 years.
- The Tax Court concluded Lukens would inevitably forfeit the timeshare interests rather than make the balloon payment, held the nonrecourse obligation was not a genuine debt for tax purposes, and treated the transaction as a sham.
- Lukens appealed to the U.S. Court of Appeals for the Fifth Circuit.

## Issues

1. Whether the nonrecourse obligation used to finance the timeshare purchases constituted genuine indebtedness so that the related “interest” could be deducted through the partnership.
2. Whether the timeshare purchase arrangement lacked economic substance and could be disregarded as a sham, making the claimed partnership loss non-deductible.

## Decision

- The Fifth Circuit affirmed the Tax Court’s judgment disallowing Lukens’s claimed deduction.
- The court upheld the finding that the timeshare units’ value ($919 per unit) was far below the stated purchase price and far below the economics needed to make the balloon payment rational.
- Because the partnership had an economically rational option to walk away at maturity, and the balloon payment was not expected to be paid in real terms, the court agreed the nonrecourse obligation did not function as true indebtedness for federal tax purposes.
- The court agreed that the transaction’s expected benefit depended on tax write-offs rather than a realistic opportunity for economic profit, supporting the sham determination.

## Legal Principles

- A deductible interest expense must be tied to “indebtedness,” meaning a real obligation with an expectation of repayment in economic reality.
- Nonrecourse debt may be disregarded for tax purposes when the debt amount and payment structure make repayment unlikely because the borrower can rationally abandon the property rather than pay a large final amount.
- When property value is far below the stated purchase price and the transaction is structured so that forfeiture is the predictable outcome, the purported debt can lack economic substance and will not support interest deductions.
- Courts may disregard transactions as shams when, viewed as a whole, they offer no meaningful pre-tax economic return and exist primarily to generate tax deductions.
- On appeal, factual determinations by the Tax Court—such as valuation and the expected economic behavior of parties under the deal terms—are reviewed deferentially and will be upheld absent clear error.
- In assessing whether an arrangement is entered for profit or for tax benefits, courts examine the taxpayer’s intent and the objective economic realities of the deal, not just the form of the documents.

## Conclusion

In Lukens v. Commissioner of Internal Revenue, the Fifth Circuit affirmed the Tax Court’s disallowance of Lukens’s 1981 partnership loss deduction from a timeshare investment. Because the timeshare units were worth far less than the stated price and the nonrecourse financing gave the partnership a predictable incentive to forfeit rather than pay the balloon amount, the court agreed the obligation was not genuine indebtedness and that the arrangement lacked economic substance, so the related interest-based deductions were not allowed.


Lukens v. Commissioner of Internal Revenue, 945 F.2d 92 (1991)