## Facts

- In 1971, Lewis H. V. May and Nancy C. May deeded their medical office building in Temple City, California, to an irrevocable trust benefiting their four children.
- Dr. May and Harlos Gross (a friend) served as co-trustees.
- The deed was executed and delivered in 1971 but recorded in 1973.
- Dr. May continued to use the property for his medical practice under an oral lease from the trust.
- Dr. May paid $1,000 per month in rent; the government conceded the rent was reasonable.
- Gross periodically checked (about four times per year) whether the rent was paid.
- On their 1973 federal income tax return, the Mays deducted the rent as an ordinary and necessary business expense under I.R.C. § 162(a)(3).
- The Commissioner issued a deficiency notice disallowing the deduction; the Tax Court ruled for the taxpayers, and the Commissioner appealed.

## Issues

1. Whether rent paid by a taxpayer to an irrevocable family trust in a gift-leaseback arrangement is deductible under I.R.C. § 162(a)(3).
2. Whether the transfer-and-leaseback should be disregarded as lacking economic substance so that the payments are treated as nondeductible intra-family transfers.
3. Whether the taxpayer had “taken title,” was “taking title,” or retained “equity” in the property within the meaning of § 162(a)(3).

## Decision

- The Ninth Circuit affirmed the Tax Court.
- The court held the 1973 rental payments were deductible as ordinary and necessary business expenses under I.R.C. § 162(a)(3).
- Applying Ninth Circuit gift-leaseback criteria (from Brooke), the court treated the trust as having real ownership and the lease as a genuine rental arrangement.
- The court rejected the Commissioner’s attempt to collapse the transaction where the trust received reasonable rent and held title in an arrangement with economic reality.

## Legal Principles

- Under I.R.C. § 162(a)(3), rent is deductible if it is required for continued use or possession of property to which the taxpayer has not taken (and is not taking) title and in which the taxpayer has no equity.
- In gift-leaseback cases, deductibility turns on substance: whether the arrangement has economic reality, including a real transfer of ownership and a genuine obligation to pay rent.
- A completed transfer to an irrevocable trust can satisfy § 162(a)(3)’s “no title/no equity” condition where the taxpayer relinquishes ownership interests and thereafter occupies the property only as a lessee.
- Reasonableness of rent, actual payment, and trustee oversight support treating the lease as bona fide rather than a sham.

## Conclusion

The Ninth Circuit upheld the deduction of rent paid to an irrevocable family trust because the trust held the benefits and burdens of ownership and the taxpayer’s continued use of the property depended on paying reasonable rent, satisfying I.R.C. § 162(a)(3) and warranting no recharacterization of the arrangement as a nondeductible family transfer.


May v. Commissioner, 723 F.2d 1434 (9th Cir. 1984)