## Facts

- Rice’s Toyota World, Inc., an automobile dealer, entered a computer purchase-and-leaseback arrangement marketed by Finalco, whose materials emphasized generating early-year tax losses through accelerated depreciation and interest deductions.
- In 1976, Rice “purchased” a used computer from Finalco for a stated price of $1,455,227, funded by a $250,000 recourse note (three-year term) and two nonrecourse notes totaling $1,205,227 (eight-year term).
- Finalco had recently acquired the same computer for $1,297,643, less than Rice’s stated purchase price.
- Rice immediately leased the computer back to Finalco for eight years; lease payments exceeded Rice’s nonrecourse debt service by roughly $10,000 per year.
- Finalco’s rent obligation was contingent on revenues from subleasing the computer to end users.
- Rice paid off the recourse note during the first three years and paid interest on the remaining notes, then claimed depreciation deductions and interest deductions for 1976–1978.
- The Commissioner disallowed both depreciation and interest deductions as arising from a tax-motivated sham lacking business purpose and economic substance.
- The Tax Court sustained the disallowances; Rice appealed.

## Issues

1. Whether the sale-and-leaseback lacked business purpose and economic substance so that Rice was not entitled to depreciation deductions under I.R.C. § 167.
2. Whether, and to what extent, Rice could deduct interest under I.R.C. § 163(a) on recourse and nonrecourse notes associated with the transaction when portions of the arrangement lacked economic substance.

## Decision

- The Fourth Circuit affirmed disallowance of all depreciation deductions.
- The court affirmed disallowance of interest attributable to the nonrecourse portion of the inflated, non-economic “purchase price.”
- The court reversed in part and allowed interest deductions attributable to the recourse debt (and any economically real indebtedness), rejecting an all-or-nothing denial of interest.
- Disposition: affirmed in part and reversed in part.

## Legal Principles

- A transaction may be disregarded for federal tax purposes if it lacks (1) a non-tax business purpose and (2) objective economic substance, including a realistic possibility of pre-tax profit.
- Depreciation depends on genuine economic ownership; nominal title or basis inflated by non-economic financing does not support depreciation where the taxpayer lacks meaningful benefits and burdens of ownership.
- Interest is deductible only on “indebtedness” that is economically real; purported debt lacking substance (including nonrecourse obligations tied to inflated pricing and engineered cash flows) is not respected.
- Courts may disaggregate a transaction’s components, denying tax benefits tied to artificial elements while allowing deductions arising from enforceable, economically meaningful obligations (such as genuine recourse debt).

## Conclusion

The Fourth Circuit treated the computer sale-and-leaseback as lacking business purpose and economic substance for depreciation, but held that § 163(a) interest deductions could be allowed to the extent they stemmed from real recourse indebtedness, while denying interest tied to non-economic nonrecourse financing.


Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89 (4th Cir. 1985)