## Facts

- William F. Owen, Jr. and Stephen McEachron formed a 50–50 general partnership, McO Investment (McO).
- In 1980, McO borrowed funds to buy seismic drilling equipment; the equipment secured the debt, and the partners personally guaranteed repayment.
- McO leased most equipment to Western Exploration, Inc. (Western), a corporation owned 50–50 by Owen and McEachron, which operated the drilling business.
- The leases lacked fixed termination dates and were cancellable by either party on short notice (generally 30 days; some 24 hours/day-to-day).
- The Owens claimed 1980 investment tax credits (ITCs) for the equipment, asserting the “short-term lease” exception for noncorporate lessors under I.R.C. § 46(e)(3)(B).
- In 1981, amid industry downturn, McO transferred all partnership assets to Western as part of consolidating the business in one corporation.
- At transfer, the liabilities secured by the assets exceeded the assets’ adjusted basis; Western assumed the liabilities.
- The Commissioner disallowed the 1980 ITCs and determined that the 1981 transfer produced recognized gain under I.R.C. § 357(c); the Tax Court sustained both determinations.

## Issues

1. Whether the Owens qualified for ITCs under I.R.C. § 46(e)(3)(B) based on McO’s short-notice, cancellable leases of equipment to their controlled corporation.
2. Whether the 1981 transfer of encumbered partnership assets to a controlled corporation in an otherwise § 351 exchange required gain recognition under I.R.C. § 357(c) because assumed liabilities exceeded adjusted basis.

## Decision

- The Ninth Circuit affirmed the Tax Court.
- The Owens were not entitled to the 1980 ITCs under the § 46(e)(3)(B) short-term lease exception for the related-party leasing arrangement.
- The 1981 transfer required recognition of gain under § 357(c) to the extent liabilities assumed by Western exceeded the adjusted basis of the transferred property, notwithstanding § 351 nonrecognition.

## Legal Principles

- The taxpayer bears the burden to show entitlement to an ITC and to establish that statutory exceptions for noncorporate lessors apply.
- For ITCs under the short-term lease exception in I.R.C. § 46(e)(3)(B), formal cancellation provisions do not control if the overall arrangement, viewed in context (including related-party structure and use of property), does not satisfy statutory requirements.
- In a transfer otherwise qualifying for nonrecognition under I.R.C. § 351, I.R.C. § 357(c) mandates gain recognition when liabilities assumed by the transferee exceed the aggregate adjusted basis of the transferred property.
- Section 357(c) applies by comparing liabilities assumed to adjusted basis; continuity of business purpose, continued personal guarantees, or continued economic exposure does not negate gain recognition once the statutory threshold is met.

## Conclusion

The court upheld the IRS’s denial of ITCs claimed through short-notice leases to a controlled corporation and held that § 357(c) required gain recognition when partnership liabilities shifted to the corporation exceeded the transferred assets’ adjusted basis, even though the transaction otherwise fell within § 351.


Owen v. Comm’r, 881 F.2d 832 (9th Cir. 1989)